16 Apr 2012

Commodity risks – how energy suppliers manage them can make a big difference to markets and customers

Written by Jim Pierobon

More than a decade after the Enron debacle, one would think managing an energy company’s risks is a widely-agreed upon practice with similar types of standards. Yet with the ongoing volatility in oil and natural gas prices, accidents and ‘Acts of God’ that just keep happening and the growing interdependence in commercial markets on other companies’ risk exposures, that notion apparently is farther from reality than many executives think.

The completion recently by the Committee of Chief Risk Officers (CCRO) of recommended Risk Management Standards for Energy Market Participants suggests this industry may have a lot of work to do. Just meeting widely-agreed upon standards to ensure that effective risk management is within reach of company’s management could be an enormous undertaking for some companies.

The CCRO developed 27 standards without consideration for any regulatory or regulatory process, according to Executive Director Bob Anderson. Among the more active CCRO companies are Calpine, NRG Energy, Constellation Energy and ConocoPhillips.

Run this four-point spot check list for your company, your commercial partners and/or for companies you own stock in. It might save — or make you — a lot of money:

1. Independent Risk Governance (standards 1-6): The “Governing Body” (over risk management, typically the Board of Directors, Audit Committee or a Management Committee) periodically re-affirms its understanding of the firm’s risks and the firm’s capacity to fulfill potential future financial and physical obligations.

2. Risk Policies and Procedures (standards 7-22): They should include risk analyses and reporting; specific limits to market and credit risks; authorization of counter-parties and associated credit terms and limits; and monitoring of all transaction compliance issues.

3. Qualified Personnel (standards 23 & 24): The quality of the education program is readily apparent in the consistent manner that communication and discussion of risks is undertaken.

4. Risk Management Infrastructure (standards 25-27): A risk management system must capture transaction details, business process requirements, risk metric calculations and financial reporting.

The Commodities Futures Trading Commission could enhance the transparency of energy markets with rulings and definitions expected under the Dodd-Frank Act.

The timing for the CCRO’s paper may be prescient. Certain financial reporting requirements could grow significantly after this Wednesday’s public meeting of the Commodities Futures Trading Commission. The five commissioners may finalize its definition of a “swap dealer” and “major swap participant” among other terms as it continues its work on the Dodd-Frank Wall Street Reform and Consumer Protection Act.

For the first time, energy companies may be obligated to capture and report a significant amount of data that regulators and sophisticated investors can cull to better monitor and understand energy commodity markets. Ostensibly, that could lower risks to energy markets.

A swap is a derivative in which counterparties exchange cash flows of one party’s financial instrument for those of the other party’s financial instrument. The benefits depend on the type of financial instruments involved. A derivative is a security whose price is dependent upon or derived from one or more underlying assets. Its value is determined by fluctuations in the underlying asset.

While energy risk management might seem a somewhat arcane subject to improve what ails U.S. energy markets, there is a LOT of money spent on getting it right. If something goes wrong, not only are energy marketers and utilities at risk, so are the companies that rely on them and their end-users.

PJM Interconnection, which manages the power grid throughout many Mid-Atlantic states and parts of the upper Midwest, cited the CCRO’s paper in this Feb. 7 filing to the Commodities Futures Trading Commission about managing risks in competitive wholesale power markets. PJM asserted that it and other Regional Transmission Organizations (RTOs) and Independent Systems Operators (ISOs) should be exempted from certain rules under the Dodd-Frank law if the market participant’s risk management policies, procedures, and controls reflect certain criteria. “These criteria generally are the same criteria as those suggested by the Committee of Chief Risk Officers,” PJM stated.

You can access the CCRO paper for a fee here. There you will also find perspectives on energy risk management from companies such as PPL and NRG Energy and consultants such as PWC.

Leave a Reply