30 Nov 2011

Energy risk officers recommend risk management standards for power, gas market participants

Written by Jim Pierobon

Utilities, power suppliers and regional organizations that coordinate the flow of electricity throughout the U.S. are taking steps to better understand the creditworthiness of market participants and ways to mitigate risks inherent in the purchase, supply and transmission of electric power.

The Federal Energy Regulatory Commission’s Order 741 requires initial compliance filings by Independent System Operators (ISOs) / Regional Transmission Organizations (RTOs) by December 14, 2011.

Rather than rely solely on efforts by the market participants to recommend what could be widely disparate credit and risk management reforms, the Committee of Chief Risk Officers, a non-profit association of energy industry risk officers created a working group under an anti-trust compliant protocol to survey ISOs, RTOs, utilities and power suppliers about what they think should make for minimum participation requirements related to a firm’s risk management capabilities.

The over-arching goal is to protect the integrity of markets and market participants from the sometimes significant risks that undercapitalized or undisciplined participants present.

Consider this scenario: on a very hot day in the congested power corridor between New Jersey and Washington, DC, a large power supplier finds itself weakened by a series of bad bets on natural gas prices. It risks defaulting on a contractual obligation to supply enough electricity to meet surging demand for failure to demonstrate its creditworthiness.

Prudent and consistent credit risk controls stand a strong probability of ferreting out such a weakened player with sufficient time for the market manager, in this case PJM Interconnection, to develop a work-around plan.

A risk management verification system is thought to be necessary to secure an exemption from oversight of ISO markets by the Commodities Futures Trading Commission under the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.

Perhaps that is one reason why PJM, which operates the U.S. Mid-Atlantic grid, stated in a June 30, 2011 compliance filing under FERC Order 741 that it looked forward to working with the CCRO to “consider developing an industry-accepted set of standards applicable to risk control in [financial transmission rights] markets,” according to Platts Megawatt Daily.

The ‘fruits’ of CCRO’s labors through several meetings in Houston and Washington, DC this past summer and early fall, along with weekly conference calls in between, have culminated in recommendations by the CCRO for market participants. They are being finalized this week at the CCRO’s meeting in Washington December 1-2.

Here’s a snapshot of the one of the DRAFT recommendations as it pertains to energy organizations’ over-arching risk management culture and framework:

“While a firm’s risk management culture is not directly observable, it is evident in the firm’s risk management framework” which includes:

  • “A clearly defined risk appetite and associated risk tolerances, approved by the Governing Body” (e.g. the firm’s Board of Directors);
  • “A risk governance structure is in place including defined organizational entities and clean roles and responsibilities aligned throughout the organization, up through senior management and the Governing Body.”
  • “Formal communication networks are established such that risk issues are communicated in a timely and efficient manner and meaningful discussion takes place.”

The November 28, 2011 draft of the CCRO’s paper, entitled “Risk Management Standards for Energy Market Participants,” can be viewed here.

An early consensus emerged  from the early surveys about the need for certain types of credit and risk standards, according to CCRO Executive Director Bob Anderson. But there has been disagreement on others. What most, if not all, companies want in the end is one common set of standards that can be used across all ISOs / RTOs

Individuals interested in knowing more about the CCRO or updating its recommendations should contact the CCRO either via its web site, an email to [email protected] or by calling 281-825-4870, extension 7003.

The CCRO, based in The Woodlands, north of Houston, has established a solid track record of tackling various energy market issues dating back to responses to Enron’s failure and the impact it had on power markets, regulators and federal lawmakers.

Since its launch in 2002, the CCRO has issued 25 white papers on topics such as “Market Clearing in the Energy Industry”, “Measuring Financial Liquidity” and “Enterprise Risk Management and Supporting Metrics.”

While not exactly grist for front-web-page news, had the CCRO been around 15 or so years ago, the California electricity and Enron debacles might not have happened. Competitive energy markets and energy traders would have avoided a serious black eye that some say still hampers their activities and reputations today.

Interested parties can interact with the CCRO at different levels or simply “observe” its working group activities. To participate fully in its working groups, active members pay $51,500 annually. Companies can observe for as little as $750 per quarter.  There are variations in between.  Details are here.

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