Integrated Risk Modelling for Trading & Hedging Decisions


Turning Quantitative Models & Systems for physical and derivatives portfolios in energy and commodity markets into Decision-Support Tools. This article explores some of the benefits of having a shared risk information environment to support trading, valuation, hedging, and risk management decisions.


By Carlos Blanco & Michael Pierce


institutions. There are multiple reasons for this system sub- performance. On one side, some energy risk managers have fallen into the complacency trap. Without additional pressure from senior managers or regulators to improve the risk models and metrics used as part of the risk management process, some managers have opted to maintain the status quo, allowing their firms to implement ETRM systems that offer limited risk functionality but excel at performing other tasks such as scheduling, nomination or accounting for physical trades. As a result, those risk managers and traders find themselves


T


he risk technology and models used by most Energy Trading and Risk Management Systems (ETRM) is years behind from the state of the practice in financial


having to conduct a piece-meal analysis of the various risks involved in trading and hedging strategies from scattered sources of information residing in different systems. Other managers have taken a more proactive role, and


regularly identify the key risk information gaps (Table 1) and continually develop and improve the tools to breach them.


Dynamic Risk Simulation & Decision-Support Metrics Traditionally, risk managers at many energy firms have


been too busy implementing short-term static risk metrics such as Value at Risk. Many of those metrics have significant limitations, and do not allow the inclusion of material risks in a transparent and efficient manner.


Organisational Level Board of Directors


Table 1: Main Information Gaps From a Risk Management Perspective Risk Management Information Gaps


Greater transparency on material risks and better understanding of high level risk/return tradeoffs of alternative hedging alternatives.


Senior Management


Knowledge of firm-wide exposures and interactions. Impact of hedging on shareholder value maximization. Evaluation of risk-return tradeoffs and optimisation based on risk tolerance and multiple constraints.


CFO / Treasury


Anticipate potential cash flow shortfalls and develop contingency plans. Evaluation of pre- and post- hedge effectiveness. Negotiation of key price and collateral clauses in long term contracts. Risk-adjusted pricing for large transactions.


Procurement/Logistics Groups


Market Risk Managers


Assistance with (re)negotiation of critical contract clauses. Increased focus on operational efficiency around physical procurement contracts. Benchmarks to determine group performance.


In-depth understanding of multiple risk dimensions before and after hedging at the portfolio level (market, collateral, liquidity, cash flow…).


Credit Risk Managers Source: NQuantX worldPower 2010 37


Dynamic Counterparty risk assessments. Impact of netting and collateral clauses in OTC Master Agreements (netting and collateral). Integration of Accounts Payable and Receivables, as well as potential collateral needs in the cash flow management programme.


Reports & Metrics


Risk and Hedging Strategy Dashboards.


Firmwide exposure; ‘At-Risk’ and Hedge recommendations . Stress Test Reports.


Cash Flow at Risk; Collateral at Risk; Hedge effectiveness; Earnings at Risk.


Cost-at-Risk; Operating Cash Flows reports.


Dynamic risk simulation of material risks. Valuation and risk adjustments.


Potential Future Exposure and Credit Risk Reports. Risk charges and risk-adjusted pricing.


Page 1  |  Page 2  |  Page 3  |  Page 4  |  Page 5  |  Page 6  |  Page 7  |  Page 8  |  Page 9  |  Page 10  |  Page 11  |  Page 12  |  Page 13  |  Page 14  |  Page 15  |  Page 16  |  Page 17  |  Page 18  |  Page 19  |  Page 20  |  Page 21  |  Page 22  |  Page 23  |  Page 24  |  Page 25  |  Page 26  |  Page 27  |  Page 28  |  Page 29  |  Page 30  |  Page 31  |  Page 32  |  Page 33  |  Page 34  |  Page 35  |  Page 36  |  Page 37  |  Page 38  |  Page 39  |  Page 40  |  Page 41  |  Page 42  |  Page 43  |  Page 44  |  Page 45  |  Page 46  |  Page 47  |  Page 48  |  Page 49  |  Page 50  |  Page 51  |  Page 52  |  Page 53  |  Page 54  |  Page 55  |  Page 56  |  Page 57  |  Page 58  |  Page 59  |  Page 60  |  Page 61  |  Page 62  |  Page 63  |  Page 64  |  Page 65  |  Page 66  |  Page 67  |  Page 68  |  Page 69  |  Page 70  |  Page 71  |  Page 72  |  Page 73  |  Page 74  |  Page 75  |  Page 76  |  Page 77  |  Page 78  |  Page 79  |  Page 80  |  Page 81  |  Page 82  |  Page 83  |  Page 84  |  Page 85  |  Page 86  |  Page 87  |  Page 88  |  Page 89  |  Page 90  |  Page 91  |  Page 92  |  Page 93  |  Page 94  |  Page 95  |  Page 96  |  Page 97  |  Page 98  |  Page 99  |  Page 100  |  Page 101  |  Page 102  |  Page 103  |  Page 104  |  Page 105  |  Page 106  |  Page 107  |  Page 108  |  Page 109  |  Page 110  |  Page 111  |  Page 112  |  Page 113  |  Page 114  |  Page 115  |  Page 116  |  Page 117  |  Page 118  |  Page 119  |  Page 120  |  Page 121  |  Page 122  |  Page 123  |  Page 124  |  Page 125  |  Page 126  |  Page 127  |  Page 128  |  Page 129  |  Page 130  |  Page 131  |  Page 132  |  Page 133  |  Page 134  |  Page 135  |  Page 136  |  Page 137  |  Page 138  |  Page 139  |  Page 140  |  Page 141  |  Page 142  |  Page 143  |  Page 144  |  Page 145  |  Page 146  |  Page 147  |  Page 148