Best Practices: Enterprise-Wide Energy Risk Management

Day 1

Enterprise Risk and Capital

Risks in the Energy Enterprise

• Categories of price risk
• Physical and volumetric risks
• Cash liquidity risk and financing risks
• Credit risk as non-performance risk

Interdependence of Risk

• No risk elimination; only risk trade offs
• Choosing among risk positions
• Price risk vs. credit risk

Operational Risks

• Components of operational risk
• Emergence of operational risk in the energy sector
• Risk event frequency vs. loss severity

Risk & Capital Requirements

• Risk and capital adequacy
• Portfolio approach to capital allocation in an energy
company
• Risk aggregation and diversification
• The efficient allocation of risk capital

Risk Identification & Unbundling

• Separating physical from financial risks

Approaches to Enterprise-Wide Risk Aggregation

• Bottom-up approaches
• Top-down approaches
• CFaR
• Advantages/disadvantages

The Concept of Value at Risk

The Emergence of Modern Risk Metrics

• Inadequacy of earlier risk measures
• Translating subjective probability into objective probability
• Measuring & controlling risk in an energy company
• Sarbanes-Oxley & corporate governance

Risk and Maximum Potential Loss

• Assigning an Acceptable Level of Uncertainty
• Measuring Worst-Case Loss
• Measuring Risk by Counting Price Paths
• Establishing Confidence Levels
• The Role of Time in Risk Measures

Conceptual Foundation of Risk Analytics

Risk as Dispersion of Possible Outcomes

• Probability vs. Frequency Distributions
• Relationship between Standard Deviation & Volatility
• Adjusting Volatility for Term
• Applicability of Volatility to Energy Risks

Understanding Volatility

• Types of Volatility
• Measuring Historic Volatility
• Path Dependency of Volatility
• Deriving Annual and Periodic Volatility

Measuring Confidence

• Interpreting Z values to Measure ‘Tail’ Risk
• Skewed Distributions
• Kurtosis

Aggregating Risks for Multiple Positions

• Aggregating Means and Volatilities
• Aggregating Risk for Multiple Positions
• Correlation as the Key Element in Risk Aggregation
• Volumetric and Other Non-Additive Risks

Day 2

Applying Risk Analytics to Energy

Key Factors in Measuring Risk

• Holding Period and Confidence Level
• Volatility and Risk Distribution
• Return on Capital
• The Closed Form Calculation

Aggregating Risk Measures

• Additive Risks
• Basis Spread Risk
• Using Delta to Measure VaR for Option Positions

Determining the Appropriate Volatility Level

• Using the Appropriate Volatility Input for Calculation Risk
• Complexities of Energy Volatility
• Volatility Smiles & Skews
• Term Structure of Volatility
• Instantaneous vs. Implied (Average) Volatility
• Seasonality

Earnings at Risk (EaR)

The Emergence of EaR

• The Limitations of VaR for Energy Companies
• Measuring Risk for Accrual Accounting
• Earnings at Risk/Profits at Risk
• The Appropriate Holding Period for EaR

Evaluating Hedge Strategy with EaR

• Measuring Residual Risk After a Hedging
• Evaluating ‘Dirty’ (Imperfect) Hedges
• Integrating EaR with VaR
• Expanding the Scope of EaR beyond Price Risk
• Using Simulation Models to Include Volumetric and Other
non-Price Risks

Historical Simulations

• Model Assumptions
• Building a Historical Simulation
• Incorporating Correlation in an Historical Simulation
• Advantages/Disadvantages of the Historical Approach

Monte Carlo Simulations

• Creating Random Price Paths
• Analyzing Distribution of Price-Path Outcomes
• Monte Carlo for Aggregating Multiple Risks
• Advantages/Disadvantages of Monte Carlo Methods
• Monte Carlo vs. Historic Method
• Aggregating Volumetric and Price Risks Using Monte Carlo

Using Historical Approach with Monte Carlo Methods

• For Single Risk VaR/EaR
• For Multiple Risk VaR/EaR

Using Risk Simulations to Evaluate Hedges Beforehand

• Evaluating alternative hedge strategies
• Advantages of simulation methods
• Differences between EaR and VaR with option hedges
• Modeling binary asymmetries in EaR models
• Limitations of EaR

Stress Testing

• Identifying Model Risk
• Divergence of Future Events from Historic Pattern
• “Fat Tails”
• Energy Stress Factors

Day 3

Credit Risk Metrics

Characteristics of Energy Credit Risk

• Uncertain exposure amounts
• High volatility
• Weak counterparties & sector concentration

Nonperformance Risk

• Insolvency
• Enforceability of contracts & suitability
• Political/regulatory risk
• Force majeure & “price” majeure

Risk Metrics in Credit Analysis

• Current and potential exposures
• Credit exposure vs. credit risk
• Using CVaR to measure maximum potential exposure

Capital at Risk (CaR)

• The concept of CaR
• Pricing capital requirements in a transaction

Credit Quality Metrics

• Relating credit ratings to default probability
• Ratings migration
• Marginal vs. cumulative default probabilities
• Expected recovery rate

Credit Scoring

• Sourcing information
• Credit scoring vs. rating agencies
• Analyzing spreads in bond yields
• Using market spreads to measure credit risk
• Credit derivative pricing as a risk measure

Credit Risk Management

Calculating CVaR

• Components in calculating credit value at risk (CVaR)
• Impact of holding period on CVaR
• The profile of CVaR for term contracts
• Aggregating credit exposures
• Using marginal default rates with time buckets

Aggregating Price Risks and Credit Risks

• Portfolio diversification effects
• Price correlation
• Jointly supported credits and credit uplift
• Correlation of default probabilities

Mitigating Credit Risk

Netting and Risk Offsets

• Transactional netting
• Netting default claims
• Bilateral netting
• “Cherry picking”
• Cross-affiliate netting

Multilateral Netting

• Clearing
• Margining
• The clearinghouse: advantages and limitations

Unwinding Risk Positions

• Reversing transactions
• Buyouts and assignments
• Credit Risk in unwinding structures
• Managing credit exposure under netting
• Reliability of netted exposures as a risk measure

Credit Risk Mitigation Tools

• Bank stand-by letters of credit & guarantees
• Intermediation/sleeving
• Margins and margin triggers
• Establishing margin thresholds
• New transaction with negative correlation
• Periodic pricing resets to market
• Bond puts
• Default swaps and options