Credit Risk Management for Energy Companies

The management of credit risk has for energy companies in recent times become a greater focus on attention. Along with that focus has come increased sophistication in the methods of measuring, monitoring and managing credit related risks. This program provides participants with a solid foundation in the concepts and methodologies that are currently employed by energy companies in managing default risks. The measure of counterparty credit exposures is explored in depth using the common metric of Credit Value at Risk (CVaR). When the credit quality of the counterparty is incorporated in the analysis, another metric emerges: Credit Risk, which in turn is closely related to Capital at Risk. This is not a course in how to analyze the creditworthiness of a company. Its scope is broader, showing how credit risk management system ought to function to measure and manage default exposures as well as approaches to aggregating these risks for enterprise-wide risk measures.
CPE Credits: Accounting & Auditing 2; Consulting Services 1; Management 1; Specialized Knowledge & Applications 12.
Day 1
Credit Risk Issues in Energy

Enterprise Risk

• Categories of Risk in the Energy Enterprise
• Risk and Capital Adequacy
• Portfolio Approach to Capital Allocation in an Energy Company
• Credit Risk, Risk & Capital
• Inter-departmental Risk Transfers
• Interdependence of Risk in the Energy Enterprise

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 Identification

• Separating physical from financial risk
• Equality of physical energy flows and indexed cash flows

Risk Measures in Credit Analysis

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

Credit & Capital at Risk

Capital at Risk

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

Measuring Default Risk

• 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

Concepts Underlying Credit Risk Analysis

Evolution of Modern Risk Measures

• Subjective vs. objective risk analysis
• Probability and risk distributions
• The confidence level
• Risk aversion and capital allocation
• The concept of volatility
• Annual vs. period volatility
• Questioning volatility assumptions for the energy sector

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 CVaR as a Basis for CaR

• Methods for translating CVaR to capital requirements
• Using marginal default rates with time buckets
• Portfolio diversification effects
• Price correlation
• Jointly supported credits and credit uplift
• Correlation of default probabilities

Day 2
Analysis of Credit Risk in Energy Transactions

Credit Risk in Common Physical and Financial Contracts

• Components of counterparty exposure
• Credit exposure for index sales contracts
• Credit exposure from basis trades

Credit Implications of Exchange-Traded Futures

• Margins
• Cash liquidity risk
• Standard delivery vs. paper hedging

Credit Risk in Option Structures

• Option buyers and sellers
• Swaptions
• Cancelable/extendible contracts

Embedded Lending in Energy Structures

• Synthetic storage
• Physical swaps/exchanges
• Loans hidden in term-pricing structures

Contracts Priced Off-Market

• Monetizing unrealized gains
• Prepaids
• Blend & extend swap structures

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
• Establishing margin thresholds
• New transaction with negative correlation
• Periodic pricing resets to market
• Bond puts
• Default swaps and options

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