Your SlideShare is downloading. ×
Download presentation source
Upcoming SlideShare
Loading in...5

Thanks for flagging this SlideShare!

Oops! An error has occurred.

Saving this for later? Get the SlideShare app to save on your phone or tablet. Read anywhere, anytime – even offline.
Text the download link to your phone
Standard text messaging rates apply

Download presentation source


Published on

  • Be the first to comment

  • Be the first to like this

No Downloads
Total Views
On Slideshare
From Embeds
Number of Embeds
Embeds 0
No embeds

Report content
Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

No notes for slide


  • 1. Successfully Managing Risk from the Power Plant to the Boardroom The Art of the Corporate Decision
  • 2. Three Thoughts…
    • To Be Successful, You Need To Manage Your Risks Across The Enterprise
    • Risk Management Is Easy
    • Uncertainty Can Bankrupt You
    When we talk about risk management, we really mean managing our risk/return dynamics!
  • 3. Charting a Path to Corporate Success
    • To Be Successful You Must:
    • At The Enterprise Level!
    Your Risk & Return Understand Identify Measure Manage
  • 4. Risk, What Risk?
    • To Be Successful, You Need To Manage Your Risks Across The Enterprise
      • “ We got out of trading, we don’t have risk”
        • If you have assets, consume raw materials, employ people, etc.  You have risk!
        • Generating units are extremely risky assets
          • Market and volumetric risks
          • Often operate outside the formal risk structure
  • 5. Spectrum of Enterprise Risks
    • Market Risk
      • Risks associated with changes in market factors such as commodity prices, exchange rates, basis, liquidity, and interest rates
    • Credit Risk
      • The risk that a counterparty may default or become less able to fulfill their contractual obligations (financial and physical)
    • Operational Risk
      • The breakdown in management controls, information technology, processes, and people
    • Business Risk
      • Risks specific to the industry and markets in which a firm operates. For energy firms these may include
        • Plant outages, weather, customer migration, volumetric risk, regulation
    Understand Identify
  • 6.
    • Most Energy Firms Manage Their Risk In “Silos”
    • Problems With The Silo Approach
      • A firm’s risks are intertwined
        • Risks cannot be neatly divided across business processes
      • Introduces inefficiencies and inaccuracies
        • Diversification benefits may be lost or overstated
        • Redundant systems and people
        • Inconsistent data sources and assumptios
      • Actually increases the firm’s operational risk!
    Why Manage Risk at the Enterprise Level? Physical Nat Gas Power Planning Financial
  • 7. Enterprise Risk Management
    • Address Risk Across Each Of The Firm’s Business Processes:
    IT & Infrastructure Physical Assets Engineering Operations & Production Asset Management Trading & Risk Management Fuel Procurement Strategic Planning Corporate Strategy Credit Management
  • 8. Enterprise Risk Management
    • Enterprise Risk Management Is NOT:
      • Performing all risk management and risk controls from a single corporate office
      • Using one super computer
    • Enterprise Risk Management IS:
      • Incorporating risk management into all of a firm’s business processes and decisions
      • Training employees to make risk-adjusted decisions
      • Ensuring consistent risk policies and procedures
      • Providing risk controls
      • Communicating this with the firm’s management and stakeholders!
  • 9. Roadblocks to Managing Enterprise Risk
    • If Enterprise Risk Management Is So Important, Why Isn’t Everyone Doing it?
    • Roadblocks To Managing Enterprise Risk
      • The “science” of risk management
      • IT and infrastructure
  • 10. Roadblock 1: The “Science” of Risk Management
    • Steps To Implementing Enterprise Risk Management
      • Define and document risk management policies and procedures
      • Implement systems to measure risk
      • Engage in activities to manage risk
    • Risk Versus Uncertainty
      • Risks are uncertainties to which we can assign a probability
        • If you draw a single card from a standard deck of cards you can calculate the exact probability of it being the ace of spades
        • If you bet on the ace of spades, you can asses the risk of losing the bet and take action to mitigate your risk
      • Uncertainty – take a thousand decks of cards, mix them, and randomly create a deck of fifty-two
        • What is the probability of drawing the ace of spades?
        • You don’t know!
      • People Often Mistake Uncertainty For Risk!
        • Can be a very painful mistake…
  • 11. Roadblock 1: The “Science” of Risk Management
    • “ Soft” Risks – Risks That Are Difficult to Quantify
      • Most operational risks fall under this category
        • What is the probability that one of your generating plant operators will encounter a situation they are not prepared for and cause the plant to trip off-line during the peak period?
        • What is the probability that one of your credit analysts will type in a number incorrectly and expose the firm to significant, but unseen, credit risks?
        • What is the probability that your most valuable employee will leave the firm?
      • What type of probability distribution do you use to measure these risks?
        • How do we develop the statistical parameters necessary to model these distributions?
      • Lack of liquidity and transparency in power markets turn even simple market risks into “soft” risks for power generators!
  • 12. Roadblock 2: IT and Infrastructure
    • A Simple Example: An Energy Firm That Owns A Single Electric Generating Plant And Sells The Output Into The Market
      • What are all of the parameters that affect the value of this plant and the risk in monetizing this value?
        • Plant processes that change second by second and affect the component health of the plant and the plant’s availability
        • We have financed the plant over a twenty year horizon and future economic growth scenarios and potential environmental regulations significantly affect the risk/return profile of the plant and the firm
        • Hourly traders need to know the current status of the plant (is it up or down, how fast can it ramp, how many MW are available, etc.)
        • The structuring desk needs to know future expected plant availability and market conditions to sell the plant forward
        • Planners and longer-term analysts need to produce risk-adjusted revenue and cash flow, fuel use, and plant operation projections that use longer-term plant operating characteristics combined with forecast market and regulatory conditions
  • 13. Roadblock 2: IT and Infrastructure
    • A Simple Example: An Energy Firm That Owns A Single Electric Generating Plant And Sells The Output Into The Market
      • Tremendous amount of raw data and information that must be managed across this process
      • Multiple business entities within the firm are involved – each with their own needs and operating targets.
  • 14. Roadblock 2: IT and Infrastructure
    • Efficiently Managing This Process Requires State-of-the-art IT And Substantial Infrastructure Investment
    Generation Asset Information Flow Scheduling & Dispatch Fuel & Emissions Volumes & Rates Plant Status Instrument & Controls Trading Asset Optimization Market Interface Financial Planning Structuring Resource Planning
  • 15. Roadblock 2: IT and Infrastructure
    • The Most Commonplace Physical Energy Products – such as generating assets, natural gas storage, cross-commodity transactions, and weather-sensitive demand – Are Extremely Complex Compared To Financial Transactions
      • Do not lend themselves to closed-form valuation
      • Monte Carlo methods are the most widely-used technique in valuing these products
      • Monte Carlo simulations require significantly more computing power than closed-form solutions
      • Today’s computer hardware provides the tools to successfully address complex business analysis using Monte Carlo methods
      • Still, performing on-the-fly valuations of these physical energy products poses a continuing challenge
  • 16. Removing the Roadblocks
    • Implement Enterprise Risk Management Policies And Procedures
      • Forms the framework around which we identify, understand, measure, and manage risk across the enterprise
      • Should also include initiatives to educate employees on considering risks in their day-to-day decision making
      • Further information:
        • Committee of Chief Risk Officers Website ( )
        • “ Managing Energy Risk: A Nontechnical Guide to Markets and Trading” by John Wengler
  • 17. Removing the Roadblocks
    • Risk Versus Uncertainty
      • Incorporate rigorous stress testing and scenario analysis across the decision-making process – from intra-day trading to long-term strategic planning
      • Use a blend of analytical approaches to embody fundamental and market-centric views and gain perspective on the full range of possible decision outcomes - fundamental analysis, technical analysis, and experience each provide different yet complementary insights into how future events will effect current business decisions
      • Don’t rely on a single risk metric – apply a combination of metrics
        • Risk-adjusted return on capital (RAROC)
        • Economic capital
        • “ At risk” metrics: VaR, cash flow at risk, earnings at risk, volume at risk,
        • The “Greeks”
  • 18. Removing the Roadblocks
    • IT And Infrastructure
      • Open system architecture
        • Communicate across applications and platforms
          • Intra- or inter-business process
          • From real-time to mid-term to long-term for data capture and analysis
          • New and legacy systems
        • Integrate proprietary analytics and valuation
          • Capitalize on the firms intellectual capital
          • Manage “soft” risks
      • True front-to-back solutions
        • Reduce operational risk by enabling consistent assumptions & valuation methods across the enterprise
        • Eliminate risk silos with cross-commodity capabilities (i.e., managing risk across all commodities)
  • 19. Removing the Roadblocks
    • IT And Infrastructure (continued)
      • Distributed processing, including distributed Monte Carlo
        • Allow for “on-the-fly” valuation of complex energy deals
        • Enable intra-day and even real-time portfolio and credit risk metrics
      • Browser-based, n-tier architecture
        • Scalable as the number of users, size of the portfolio, and complexity of deals increases
        • Easily deployed across the enterprise to reduce versioning risk and to lower upgrade and maintenance costs
  • 20. Parting Thoughts
    • Silo Approach Provides Incomplete & Potentially Inaccurate View Of The Firm’s Risks – may actually increase operational risk exposure!
    • Firms that Implement Enterprise Risk Management Will Achieve Competitive Advantage – driving real value to the firm’s bottom line!
    • Risk Management Is Easy…
      • Metallgesellschaft AG ($2.4bn, 1993)
      • Orange County ($1.6bn, 1994)
      • Daiwa Bank ($1.1bn, 1995)
      • Barings Bank ($1.3bn, 1995)
      • Sumitomo Corporation ($1.8bn, 1996)
      • Long Term Capital Management ($3.6bn, 1998)
      • Ashanti Goldfields ($100m, 1999)
      • Enron (2001)
      • Allied Irish Bank ($700m, 2002)
    Uncertainty can be very painful…
  • 21. Parting Thoughts
    • “ Rare events exist because they are unexpected.” - Nassim Taleb (Fooled by Randomness)
    • “ If you give a pilot an altimeter that is sometimes defective and he will crash the plane. Give him nothing and he will look out the window.” - Nassim Taleb (interview in Derivatives Strategy)
    • “ Any idiot can face a crisis – it’s day to day living that wears you out” – Anton Chekhov
  • 22. Questions & (hopefully) Answers
    • John P.W. Brown VI
    • Vice President, Energy Market & Asset Analysis
    • [email_address]