Energy Risk Management
Credit Rating Perspective
Energy Trading & Marketing
Credit Rating Methodology
Our Objective:
• Understand an energy companies’ risks and how well
those risks are managed
• Both quantitative and qualitative analysis tools are
used to evaluate risks
• Findings are incorporated into credit ratings
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Analysis Tools
Three pronged approach
Risk Management Practices
– Evaluation of a company’s ability to identify and monitor
significant risks, limit losses and operate within well
communicated risk tolerances
Capital Adequacy
– Measures discrete risks of market, credit and operational
risks
Liquidity
– Measures exposure to collateral calls under stress
scenarios
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Risk Management Practices
•Qualitative assessment of risk management practices
•Analysis will be tailored for specific business model
•For a company that has good financial flexibility and
capital or takes few unusual or complex risks, risk
management practices will be less important
•For a company that has weak financial flexibility and
capital or takes unusually high or complex risks, risk
management practices will be very important
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Risk Management Practices
Framework
I.
Policies – Risk Culture and Structure
II. Infrastructure – Process and Technology
III. Methodology – Measurement and Reporting
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Policies
Business Strategy
–
What is the business model? What risks are included in
the business strategy?
Risk Tolerance
–
Is the risk tolerance consistent with the business strategy?
Authorities
–
Do authorities reflect a desired tolerance for risk?
Disclosure
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Is the risk and its effect on cash flow disclosed externally
and internally?
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Policies Evaluation
In the policy dimension, Standard & Poor’s will look for:
– Corporate commitment to risk management
– Communication with board on risk positions and risk
management programs
– Clearly defined and communicated risk management policies
– Corporate governance structure that supports risk
management
– Independent risk management function
– Consistency between business strategy and risk
– Senior management’s involvement in the risk process
– Risk limits that reflect risk tolerance and capital deployed
– Compensation is tied to achievement of risk management
objectives
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Infrastructure
Technology
•Is sophisticated software and effective hardware in place?
Operation
•What is the quality of the operational processes?
Data
•What is the level of data integrity?
People
•Are the appropriate people employed and are the proper
incentive programs in place?
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Infrastructure Evaluation
In the Infrastructure dimension, Standard & Poor’s will look for:
– Qualified risk management staff
– Adequate training and budget available to risk management
staff
– Compensation linked to achievement of risk management
objectives
– Proper infrastructure exists to support risk management
– Data quality – data is validated and timely
– Controls are in place with respect to data usage
– Technology used is consistent with risk tolerance and
business strategy
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Methodology
VaR, stress testing and other measures
– Are the models and stress tests appropriate for the business
Model vetting
– Are the models properly vetted?
Valuation
– How are the positions valued?
Performance
– Are the methodologies tied into performance?
Management understanding
– Does senior management understand the model risks?
Methodology questions will be tailored for business model
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Methodology Evaluation
In the methodology dimension, Standard & Poor’s will look for:
–
–
–
–
–
–
–
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Identification of metrics used to quantify risks and manage limits
Understand how metrics influence decision making
Metrics are commensurate with business strategy
Independent validation of models
Models that are validated against actual market outcomes
Risk factors that are evaluated periodically
Assumptions that are reasonable
Reports that are in place to support compliance with risk
management policies
– Reports effectively control business activities and disclose risks on
a timely basis
– Appropriate risk management documentation is in place
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Capital Adequacy Model
Addresses the potential economic loss due to market,
credit and operational risk of a trading operation
Estimate the amount of risk capital and impute it as debt
Current Model imputes debt = 6x trading VaR + 4x
probability adjusted credit exposure
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Market
• For trading positions, Standard & Poor’s primarily
relies on VaR calculation
• Use a 10 day holding period with 99% confidence
interval
• Multiple is used depending on credit rating, e.g. 4x
that number is necessary for a “BBB” rating
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Credit
• Credit risk is measured by taking the one year default
probability times the unsecured credit line for each
counterparty
• That number is multiplied by a factor depending on
credit rating, e.g. 4x for investment grade
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Operational
• Operational risk should incorporate both financial and
physical operational risk
• Currently using 50% of the market risk capital
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Liquidity Analysis
Standard & Poor’s Objective:
• To measure the sufficiency of liquidity under stress
scenarios
•Credit Event
Downgrade to non-investment grade
•Market Event
Stress test movement in commodity prices
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Liquidity Analysis Tools
• CELA measures a company’s exposure
to a credit event
• MCELA measures a company’s
exposure to a simultaneous credit event
and market event
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Liquidity Analysis Tools
Credit Event Liquidity Adequacy
CELA =
Primary liquidity
.
Neg MTM without price stress
Market and Credit Event Liquidity Adequacy
MCELA =
Primary liquidity
.
Neg MTM with price stress
Primary liquidity = unrestricted cash + committed credit lines
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Ratings Implications
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Ratings Implications
Investment Grade companies
should maintain an MCELA
ratio of 1.0x
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Mitigating Factors
• Discretionary inventory
• Reserves
• Discretionary business
• Capital spending
• Debt maturity profile
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Arleen Spangler
Director, Utilities, Energy and Project Finance
Standard & Poor’s
55 Water Street
New York, NY 10041
P 212-438-2098
F 212-438-2154
arleen_spangler@sandp.com
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