by Jim Campbell
In June, Calpine Corporation named Gary Germeroth to lead Calpine’s risk management function as executive vice president and chief risk officer.
Here he discusses key risk management issues facing Calpine, independent power producers and the industry as a whole; how to communicate effectively at the board level; and what he’s looking forward to when Calpine finally emerges from bankruptcy.
Calpine is a major U.S. power company, capable of delivering nearly 25,000 MW of electricity from natural gas-fired and renewable geothermal power plants to customers and communities in 18 states. The company filed for Chapter 11 in 2005 and is currently working through the restructuring process.
You have been involved in risk management and the energy industry for more than 25 years, including working for the last eight years with utility industry consultants PA Consulting. How would you characterize the evolution of the utility business over the last five years?
To answer this question we need to consider the positions of the power merchants vis-a´-vis the utility companies themselves.
The wholesale power and natural gas sector underwent tremendous fundamental changes subsequent to the collapse of Enron. Managing capital requirements and collateral became standard rituals as opposed to the prior environment where the collateral required for a transaction was much less mathematical and often could leverage off corporate guarantees. Once rating agencies began to focus on the tightening capital characteristics downgrades were triggered, which then led to additional capital requirement outlays. So it was an interesting cascading effect that often affected debt requirement triggers or debt refinancing capabilities.
This drive to properly collateralize credit risks helped lead to some of the major financial restructurings that have occurred in the merchant power sector during this time frame.
From the utilities’ perspective, the majority of companies were not as adversely affected because their credit positions were buttressed by regulatory compacts. They had a better safety net. With that backstop a number of utilities began to leverage their enhanced credit position while negotiating collateral requirements with the non-utility sector. At times, the capital requirements did not match the economic specifics of the transaction, however, it was required to get the transaction executed. This is an interesting legacy that still exists today in many negotiations between utility and nonutility sectors.
You are responsible for managing market, credit, business and operational risks for Calpine. In your view, what are the major risks facing utility companies today?
Utilities will always be faced with a tremendous amount of regulatory risks. Today there is a great deal of uncertainty on what the future rules will be related to carbon emissions, the whole greenhouse gas issue and what programs will be instituted and who will ultimately pay for them. The evaluation of these risks is a challenging task and is made more challenging by the current political uncertainty regarding where these issues will play out.
Calpine filed for Chapter 11 reorganization in late 2005. What unique risk management opportunities and challenges do you anticipate as Calpine focuses on its emergence from bankruptcy later this year?
Once we get out and have a restructured balance sheet we will become a lot more like everyone else in terms of capital management. We have to be able to manage different investment opportunities just like everyone has to do every day when they look at their portfolio and say, “Is this the level of return I want from this asset or is there a better opportunity elsewhere?”
What role does corporate culture have in risk management and how are you developing a consistent risk vision across business divisions at Calpine?
Risk management begins at the board level. It is extremely important that it be top-down. You have to make sure that everyone throughout the organization understands that the board of directors is totally onboard with having good risk management procedures, methods and structures. The reason that is so important is that as soon as someone believes in his or her own mind that isn’t true, then you lose some of that leverage. That’s why it has to be board-directed.
Another way we changed the structure here at Calpine is that I now report directly to the audit committee, which before wasn’t the case. Before we made this structural change you had that level of potential doubt in someone’s mind that ultimately a risk choice would come back to a commercial decision. The fact of the matter is that now, by reporting directly to the audit committee, I’m charged with giving an independent view of all risk components. If my view happens to be different from the commercial view, my perspective goes directly to the audit committee and senior management whether it’s a market or compliance issue.
It’s also important that all senior managers portray that risk management is an important aspect of what we do.
How do you and your team leverage technology to improve Calpine’s risk forecasting and risk management performance?
Our portfolio has a lot of complexity in terms of the methods you could employ to evaluate our components. We have approximately 20 co-generation plants that all have different operational constraints and characteristics that are very important to their actual positions. Our combined-cycle generating units also face modeling challenges as position results can vary materially based on various modeling techniques.
We also face the challenge of modeling generating units that are often the marginal price setting units in the markets. Estimating forward position expectations on these marginal units is much more difficult than evaluating a base load fleet. Ultimately, the goal is to build an infrastructure of analytical tools and systems that actually helps make better decisions in shorter timeframes.
What additional capabilities would be helpful for your team to enhance the evaluation and communication of the risks Calpine faces?
As you go up the highest levels of the organization, it’s extremely key to make information understandable because you can have the greatest mechanical systems but if you can’t put it into terms that are clear and concise at the board level you’re probably not going to get very far. To do that you also have to undertake a program of constant communication where you are always trying to bring information to the top level of the organization that provides more savvy explanations of what’s going on within the organization. You have to come up with a program of tackling different issues and force-rank them. All the while you must take care never to deliver the information in a condescending manner. It’s a fine balance.
When you work directly with senior management it becomes more operational where you start to discuss more of the aspects of what my fleet is doing and what the market is doing. You can discuss, for example, what happens when you don’t have maintenance scheduled appropriately. It becomes more granular.
How do you measure the results of your risk management efforts?
Ultimately the results are measured by providing comprehensive and understandable risk reporting throughout the organization. Different levels of the organization require different levels of detail and perspective on our portfolio information. It is my group’s goal to meet all of these various needs throughout the entire organization.
You can do a lot of surveys to derive KPIs (Key Performance Indicators) from them but the effectiveness of those surveys is questionable to me. I get a lot of feedback from different levels within our organization that I rely on so that I can mobilize resources to address different issues. You’re always trying to be as proactive as possible and think beyond where you are trying to go.
Another key aspect of the responsiveness issue is being able to explain the limitations of systems. Everything is possible but sometimes it takes a lot of work to get there and at the end of the day it’s not really material. You need to look at the broad spectrum of companies and understand that we are different from other companies.
What would you like the industry to know about Calpine as it works to come out of bankruptcy?
This restructuring gets Calpine back on a level playing field and we feel that there are definite opportunities in this sector that are attractive. We are going to do our best to extract value from those opportunities. We know the emergence is going to happen even if we aren’t sure when. We are going to be like everyone else and pursue the opportunities that make sense for us.
Jim Campbell has been providing technology solutions to leading companies for more than 25 years. He is currently a utility industry account executive, based in Dallas, for the SAS Institute, Inc. Contact him at firstname.lastname@example.org.