Utilities must enter real-time risk on the books

Dana Bacciocco, Associate Editor

Energy firms are the next “big thing” in risk, according to a recent report from Meridien Research.

“The energy risk market is still a relatively young market,” said Damon Kovelsky, Meridien Research analyst and author of the report. “Energy firms engaged in trading activities need to be educated on the intricacies of risk. As more firms become more active and sophisticated at trading, energy markets will start to look more and more like the financial products markets with established market makers and brokers.”

While aggregate demand is consistently rising, the energy market is inconsistent. To compensate for the market, energy companies use hedging to ensure the bottom line and speculation to increase it. It follows that energy companies must deal with risk management to be successful. The Meridien report, “Energy Risk Applications: Reconfiguring the Wheel” examined the market for energy risk applications and the forces driving companies to deploy sophisticated risk management techniques to their trading operations. The report revealed the level of sophistication in the energy risk market is still far below that of financial products; uptake has been neither universal nor uniform, even with the recent surge of interest in energy risk management.

An AMR Research report titled “Outlook Report on Utilities Applications” expects a number of platforms to emerge that will be able to support new financial instruments. While online energy exchanges are starting to offer some risk management and financial tools, according to Jill Feblowitz, utilities consultant with AMR Research, an online trading study shows current and potential general exchange users prefer their own financial services when conducting transactions through an exchange. Top services provided by trading exchanges are documentation, comparison shopping, advanced planning, and aggregated suppliers.

As utilities lay the foundation for future competitive markets:

  • AMR Research expects the level of trading commodity trading in electric power to increase. It is starting to catch up with the established natural gas market.
  • Risk management tools are becoming more and more popular in the energy industry determining profitability within the industry.
  • Utilities and suppliers will take advantage of technology available for buy and sell side applications to solidify collaborative business relationships and should integrate at the enterprise level in a private trading exchange (PTX).

Meridien noted that while major energy firms acting as market makers lead the way, several risk management strategies are emerging and the assortment of risk applications is growing. In one corner are the vendors from the financial products market, in the other are vendors with applications rooted in energy management. Either way, unique energy industry business requirements run deep and must be factored into the risk equation.

Energy risk factors include storage or lack thereof, weather impact, and interdependent markets and players. Furthermore, regulatory changes make trading problematic, with inconsistent levels of deregulation and new reporting rules from SEC and FASB. And players are only recently appreciating straight-through processing (STP)-end to end automation of the trading process. Meridien called STP a distant goal and an element of operational risk, but cited the gaping hole in energy risk management as credit risk-currently determined by unsophisticated in-house systems or analysis from a credit agency like Moody’s, where less than one percent of FERC-approved power marketers are rated. Transferring best-practiced risk management solutions from financial products will not do, according to the report.

AMR Research’s outlook report sees the next wave of profit for utilities riding on the adaptation to a dynamic commodity market environment, investment in technology/ applications for competitive strategy, and speed of business, i.e. automation of business processes. Generation companies and retail operations can improve profits by managing risk in an increasingly liquid energy trading market. The tools and systems that support wise energy risk management strategies should feature:

  • Robust analytics that tie in with enterprise applications and allow dynamic access to price and position-tools that are able to integrate with the enterprise will be the most successful.
  • Trade management capability, which provides for deal-tracking and physical scheduling-with the increase in the volume of transactions, trade management is essential for effective risk management.
  • Integration with marketing and operations systems for demand data-as retail commodity exchanges begin to drive costs down by streamlining the process, they will become more attractive to the commercial and industrial customer.
  • Performance ability for analysis across markets and commodities-tools that offer increased capabilities for analysis across markets and commodities will receive attention.

In concert with brisk trading, another opportunity to save money in any organization is to reduce the amount of time spent completing business transactions. Removing time-consuming unnecessary or manual steps and implementing the right applications can improve corporate efficiency. It is essential to the trading cycle, making deals and transactions, and promptly getting them on the books.

For more information about the reports mentioned, visit www.amrresearch.com and www.meridien-research.com.

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