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

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