Introduction to risk management approaches
Tokyo, Power Market Seminar METI, June 14th, 2018
Ready for energy market risks?
2METI_energy_markets_seminar_14062018_VF.pptx
Within the past decades, major failures and unusual events have increased the awareness on financial and commodity risks
Source: Press articles, Roland Berger analysis
Illustration – Energy and financial risk eventsFinancial sector
Oil & Gas
Electricity & Others
1995Barings failure
2004China Aviation loses USD 550 m on oil products
2002Enron & US merchants bankruptcies
1998LTCM failureBasel I agreements reviewed
2005Delta & Northwest Airlines go on chapter 11 due to soaring oil prices
2003British Energy quasi bankruptcy
1988Basel I agreements
1980'sFirst oil derivatives
1996First electricity futures (US and Nordpoolin Europe)
2005Basel II agreements
2006British gas prices turn negative for 3 daysAmaranth loses USD 6 bn. on US gas market
2005Opening of European CO2 market
2008SocieteGeneraleloses EUR 5 bn. on trading positions
2008Oil price spikes to USD 147/ barrel25 airlines cease activity in six months due to 2007-2008 oil spike
2007Price of EU CO2 crashes to zero
2010Dodd-Franck Act brings major financial reform in the USBasel III agreements
2011Spot Asian LNG prices increase ~50% following increased post-Fukushima demand
2009Power price spikes to EUR 3000/ MWh in France
2011UBS loses USD 2 bn.on trading positionsMF Global bankruptcy
2012Gas prices reach a 10-year low in the US
2010Market coupling put in place in Continental Europe
1994JP Morgan introduces Risk Metrics
1994Orange County loses USD 1.6 bn. on oil products
2000California CrisisGerman Renewable Energy Act
1993G30 Recom-mendations
1993MGRM loses USD 1.5 bn. on oil products
1998Liberali-zation of German energy market
2014Significantly decreasing oil price
2011Fukushima nuclear disaster, shutdown of 9.7 GWnuclear capacity
2014/15Historically low interest rates
2015Ryanair losses EUR200 mn on failed oil price gamble
2013/14Negative clean dark spread
2016Japan adopted negative interest rate policy
2016Tullow Oil slumps to GBP 1 bn loss as low oil prices bit into revenues
2016Brexit and potential impact of UK leaving EU-ETS
2017Deutsche Bank posted its third consecutive loss in a row
2017/18Small airlines face a brutal reckoning as oil prices surge
2017/18US blames Russia for cyber attacks on energy grid in US and Europe
2018Mifid II and Mifid to apply to all member states in the EU
3METI_energy_markets_seminar_14062018_VF.pptx
Commodity prices have been very volatile, creating risks for market participants
Source: Bloomberg, Euromonitor, Roland Berger analysis
SILVER [Spot price, US$/OZ]
COPPER [LME Copper 3 Month Rolling Forward, US$/MT]
COTTON [ESALQ Cotton Spot Price/Brazil, BRl/pound]
CORN [Spot price, US$/MT]
02000400060008000
10000
Jan-
00De
c-00
Nov-0
1Oc
t-02
Sep-
03Au
g-04
Jul-0
5Ju
n-06
May-0
7Ap
r-08
Mar-0
9Fe
b-10
Jan-
11De
c-11
Nov-1
2Oc
t-13
Sep-
14Au
g-15
Jul-1
6Ju
n-17
May-1
8
0
20
40
60
Jan-
00De
c-00
Nov-0
1Oc
t-02
Sep-
03Au
g-04
Jul-0
5Ju
n-06
May-0
7Ap
r-08
Mar-0
9Fe
b-10
Jan-
11De
c-11
Nov-1
2Oc
t-13
Sep-
14Au
g-15
Jul-1
6Ju
n-17
May-1
8 0
100
200
300
400
Jan-
00De
c-00
Nov-0
1Oc
t-02
Sep-
03Au
g-04
Jul-0
5Ju
n-06
May-0
7Ap
r-08
Mar-0
9Fe
b-10
Jan-
11De
c-11
Nov-1
2Oc
t-13
Sep-
14Au
g-15
Jul-1
6Ju
n-17
May-1
8
0
100
200
300
400
Jan-
00De
c-00
Nov-0
1Oc
t-02
Sep-
03Au
g-04
Jul-0
5Ju
n-06
May-0
7Ap
r-08
Mar-0
9Fe
b-10
Jan-
11De
c-11
Nov-1
2Oc
t-13
Sep-
14Au
g-15
Jul-1
6Ju
n-17
May-1
8
4METI_energy_markets_seminar_14062018_VF.pptx
Within the commodities world, energy is even more volatile, especially electricity, that cannot be stored (so far)
Source: EIA, Bloomberg, Roland Berger analysis
ELECTRICITY [EPEX Phelix Day-Ahead Electricity Auction Price, EUR/MWh]
CRUDE OIL [WTI Spot Price FOB, US$/BARREL]
EURO/DOLLAR [1€ = x US$]
NATURAL GAS [Henry Hub Spot Price, US$/MMBTU]
00.40.81.21.6
Jan-
00No
v-00
Sep-
01Ju
l-02
May-0
3Ma
r-04
Jan-
05No
v-05
Sep-
06Ju
l-07
May-0
8Ma
r-09
Jan-
10No
v-10
Sep-
11Ju
l-12
May-1
3Ma
r-14
Jan-
15No
v-15
Sep-
16Ju
l-17
May-1
8
1
5
25
Jan-
00No
v-00
Sep-
01Ju
l-02
May-0
3Ma
r-04
Jan-
05No
v-05
Sep-
06Ju
l-07
May-0
8Ma
r-09
Jan-
10No
v-10
Sep-
11Ju
l-12
May-1
3Ma
r-14
Jan-
15No
v-15
Sep-
16Ju
l-17
0
50
100
150
Jan-
00No
v-00
Sep-
01Ju
l-02
May-0
3Ma
r-04
Jan-
05No
v-05
Sep-
06Ju
l-07
May-0
8Ma
r-09
Jan-
10No
v-10
Sep-
11Ju
l-12
May-1
3Ma
r-14
Jan-
15No
v-15
Sep-
16Ju
l-17
020406080
100
Jun-
00Ap
r-01
Feb-
02De
c-02
Oct-0
3Au
g-04
Jun-
05Ap
r-06
Feb-
07De
c-07
Oct-0
8Au
g-09
Jun-
10Ap
r-11
Feb-
12De
c-12
Oct-1
3Au
g-14
Jun-
15Ap
r-16
Feb-
17De
c-17
5METI_energy_markets_seminar_14062018_VF.pptx
Volatility only appears in liquid and competitive market – Japan is only at the beginning of this journey – Time to get prepared
121213121212121211
109999988888
76
5
69
6
09/16
64
505/16
76
65 70
6 6 5
75
61
63
08/1606/16
60
07/16
71
4
65
7
12/16
70
60
10/16
72
6
11/165
67
64
67
404/16
63
8
6864
06/17
63
63
57
78
907/1708/17
8
58
73 72
89
66
10/17
65
09/17
7
02/17
74
7
63
63
77
6
70
03/1701/17
59 57
70
7
67
05/17
56
7
04/17
81
10
79
01/18
83
02/18
1012/17
74
9
64
11/17
72 71
Competitive supplierLegacy utility Share of Competitive supplier [%]
1110111112121211
998
02/18
4,514
2,775
11/17
4,075
43910/17
33609/17 12/17
3,4563,085
417334 45001/18
349
4,744
4,2943,107
4,171
3,755
3,111
25504/17
3,082
267
3,084
3,738
2,9422,8162,963
28508/17
3,453
07/17
33406/17
339
3,219
2,751
05/17
3,2823,418
Emerging wholesale market, driven by retail market liberalization > Active retail market with
broad diversity of profiles, yet modest volume
> Still modest wholesale market trading volume –Low liquidity and market depth
> Wholesale market dominated by bilateral/OTC trading - Japan Power Exchange (JEPX) still marginal²
Electricity [TWh]
Natural gas [Mm3]
Source: Japan Electricity and Gas Market Surveillance Commission
6METI_energy_markets_seminar_14062018_VF.pptx
For utilities and retailers, the risk management imperative starts with the possibility (the obligation?) to trade energy, physical or financial
Utilities / Retailers
Source: Roland Berger analysis
Clients
> Sales of physical commodity delivery contracts
> Sale of energy services, price visibility
Suppliers / Other utilities
> Purchases of fuels (oil/gas/coal/…)
> Purchase of electricity
Regulator
Other market players (OTC)
Organized markets
> Opening of the possibility to exchange commodity via bilateral wholesale contracts
> Existence of a market place for the commodity, with visible, volatile market prices
7METI_energy_markets_seminar_14062018_VF.pptx
In a fully liberalized market, assets and client base are optimized vs. the market – Illiquid market call for gradual optimization
Power generation / Storage
L/T contract (flexibility)
L/T contract (ferm)
Contracted (flexibility)
Contracted(firm)
BOUGHT SOLD
Hypothetical portfolio with volume risk
MARKET
Optimization ina liquid market
> Each position is optimized separately against the market
1 Optimization ina non liquid market
> Portfolio resources and commitments are optimized globally (under retail supply constraints)
> Residual flexibilities are optimized against the market
MARKET
2
Source: Roland Berger Strategy Consultants
Optimization method according to market liquidity
8METI_energy_markets_seminar_14062018_VF.pptx
Portfolio Management and Trading help structure and manage risks
PM&T function overviewProcesses/activitiesInput Output
> Asset characteristics– Fuel
procurement contracts
– Generation plants
– Customerloads
> Financial andrisk expectations
> Marketconditions(price, volume, liquidity)
> Power plants dispatch program
> Network scheduling
> Delivery program
> Trading transactions
Portfolio Management (PM)
Trading (T)
> Portfolio structuring– Fuel sourcing (type of fuel, contracts, …)– Influence on generation fleet
(repowering level of flexibility, …)– Orientation of customer portfolio (
contracts, management / interruptions of loads, …)
> Flow Trading (power, gas, coal, oil) buy/sell transactions, for external parties and for the portfolio manager ("window to the market")
> Asset-backed Trading > Proprietary/own account trading
> Portfolio optimization– Fuel contracts utilization
(LT vs. sport, flexibility,…)– Own generation vs.
purchases
Source: Roland Berger Strategy Consultants
Risk monitoring & control
9METI_energy_markets_seminar_14062018_VF.pptx
Energy utilities and other commodity-intensive companies are facing significant risk management challenges
Commodityrisk management challenges calling
for a specific framework
Wholesale markets• Increased price volatility• Difficulty to forecast prices• New and evolving market places / market indices• Technical / logistical constraints (transport, storage,…)
Business model• Geographical expansion/acquisitions• Multi-commodity exposure• Sourcing and hedging strategies• Role of "trading"• Organization, P&L responsibilities and transfer price schemes
Scrutiny from financial community• Financial predictability / performance management• Focus on multiple P&L, balance sheet and cash
indicators• Risk governance and control as a must
Volume uncertainties• Supplier / customer consumption uncertainties
(temperature, hydrology, physical failures, ...)• Contract / load modeling challenges• Lack of volume risk experience in financial sector
Complex exposure• Price level and volatility• Volume risk with possible price correlation• Counterparty risk• FX risk linked to commodity prices
Customer needs• Flexibility driven offerings with complex contract structures• Coexistence of tariffs and competitive offers• Difficulty to impose premiums / penalties• Difficulties to pass-through cost increases to customers
(competition, regulated prices, political impact...)
Internal challenges• Multiple parties involved: Strategy, Finance (Controling,
Treasury, Accounting), Operations, R&D• Education of Top Management / Directors
10METI_energy_markets_seminar_14062018_VF.pptx
Real-life example: proprietary trading losses close to 9 M€ at a small energy trader due to losses on all commodities
5,1 M€
2,2 M€
8,4 M€
Proprietary Trading loss
Options
0,5 M€
Emissions
0,9 M€ 0,5 M€
GasCrudes Coal
1,2 M€
Power
Cause All Improper marketview / unclear R&R
Cluster risk / improper market
view
No position management / no risk management
Improper marketview / no riskmanagement
- Luck ?
• Several traders with a long position (≈600 GWh) based mostly on chartist analysis
• Power prices decrease
• Long position of 120.000t• Price drop of 20$
• Long position in gas US (10$)and short position in gas EU (22$)
• Spread increase
• Several traders with a long position at oil high prices (102$/b) to speculate on the closure of Strait of Hormuz; but prices went down
• Most of positions switched from long to short the following month, when prices went up
• High cluster risk: no alignment of trade strategies, no cluster risk monitoring• No risk / return policy, monitoring etc.• Lack of Market vision: traders not specialized for PT, lack of strategy
coordination etc.• Risk policy not exhaustive: lack of limits cascading• Lack of safeguards: alerts for large position (overall T&O) etc.
Source: "Trading & PFM Risk Policy" Audit Committee (19th September), Interviews
Breakdown of the Proprietary Trading loss by commodity in a trading year
11METI_energy_markets_seminar_14062018_VF.pptx
Failing to assess and manage market risks leads to financial loss –Root causes can be analyzed, and point to risk management policy
Why can trading / retailing activities lose money ?
Risks were too high Risk control was insufficient
Too large positions were taken…
… with too little market view and risk-return preferences
Risk management framework was partly inadequate
Risk framework was not enforced effectively
High cluster risk
(no alignment, specialization of
traders, no cluster risk
monitoring…)
No risk / return policy
(no target, no monitoring…)
Not exhaustive
(relevance and cascading of risk
indicators, missing rules, risk reporting
etc)
No power for enforcement
(too weak riskcontrol, Senior
Management lackof involvement etc.)
Lack of safeguards
(limitation of trader deals, management
alerts etc.)
Not at the right level
(too high limits, lack of limits on certain
topics etc.)
Lack of market view
(market selection, market trader experience…)
Unclear role & respon-sibilities
(positions not managed)
Source: Roland Berger project experience
Generic issue analysis tree on trading losses
12METI_energy_markets_seminar_14062018_VF.pptx
Roland Berger energy market risk management framework
1
23
4
INFRASTRUCTUREa) Governanceb) Organizationc) Processesd) IT
5a) Risk indicators & dashboardsb) Control processes
> Risk limit setting> Commitment/contract approval> Deal-entry and valuation> Risk limit compliance> etc.
a) Available management levers b) Portfolio management methodc) Risk attributes in client contracts
RISK CONTROL
PORTFOLIO MANAGEMENT
a) Return/risk preferencesb) Hedging expectations c) Business model and transfersd) Financial predictabilitye) Non-economic accounting effects
a) Characterization of the commodity portfolio risks> Risk factors> Consequences
b) Links and trade-offs between risk categories
BUSINESS OBJECTIVES
RISK IDENTIFICATION
Risk management requires a comprehensive framework, with sophistication level gradually adapted to market realities
Source: Roland Berger analysis
13METI_energy_markets_seminar_14062018_VF.pptx
Risk is not bad! Not being aware of the risk / return equation can harm profit (P&L) and value (Balance Sheet)
Possible risk management objectives Zoom on return/risk preferences
> Avoid large losses due to market risks
> Ensure consistency with energy return/risk preferences
> Support financial performance management over budget, medium and long-term horizons
> Support operational decisions (hedging, optimization,…)
> Support investment decisions and strategic choices
> Build a competitive advantage through return/risk strategies
> Demonstrate risk management abilities to stakeholders
> Support financial communication
Motivation and objectives
1
Source: Roland Berger analysis
Returns(e.g. EBITDA)
Risks (e.g. EBITDA@R)
Ris
k To
lera
nce
Bor
der
Forbidden situation
PROTECT VALUE
Current situation
ENHANCE VALUE
Optimized situation Market
efficiency frontier
BUSINESS OBJECTIVES / Return/risk preferences
14METI_energy_markets_seminar_14062018_VF.pptx
Depending on the shareholder structure and market characteristics, many utilities also consider financial predictability as very important
> "We need a stable earnings trajectory with maximum predictability for the budget year"
> "We do not feel comfortable risking more than x% of our yearly earnings on this business"
> "We want to keep our target rating of X"
> We need to capture the average market price
> "For this type of project, corporate requires a hurdle rate of x%"
> "This particular hedge is too expensive for the risk reduction it provides"
Risk adverse company (e.g. municipal utilities, small retailer, ...)
Risk tolerant company (e.g. oil & gas producers, ...)
Financial plan [EUR]
Time
Earningsuncertainty
Financial plan [EUR]
Time
Earningsuncertainty
N N+1 N+2
N N+1 N+2
Reference value
Financial predictability
Source: Roland Berger analysis
Objectives Implications on financial predictability
1 BUSINESS OBJECTIVES / Financial predictability
15METI_energy_markets_seminar_14062018_VF.pptx
Energy market risks can be characterized by underlying risk factors and expected consequences
Internal factorsExternal factors
Exchange/ interest ratesMarket shocks
Infrastructure failure
Customer behavior/ consumption
Regulation
Human factor
Industrial failures
IT failure
Commodity price/ volatility
WeatherCounterparty/
competitors behavior
Modeling issue
Underlying risk factors
Market> Commodity price risk> Volume uncertainties> Induced FX risk
Counterparty> Impact of client or wholesale
counterparty failures
Business> Impact of competitive
environment factors
Operational> Impact of company internal
factors
Risk categories
Identification
Source: Roland Berger analysis
CONSEQUENCES
Reputation
Legal
Security
Financial> P&L> B/S> Cash
Strategic
2 RISK IDENTIFICATION / Characterization of the commodity portfolio risks
16METI_energy_markets_seminar_14062018_VF.pptx
> Renewable production forecast is a new challenge that players will need to face:– Network safety problems arise when
renewable production is above 30% of installed capacity
– Renewable producers will be asked to be more and more involved into TSO system services and future capacity markets
> In Spain or Denmark, Direct Marketing players need to give D-1 forecast and have to pay penalties when experiencing forecast errors
> Renewable energy forecast need specific competencies because of its high variability and uncertainty characteristics
Volume risk is emblematic of energy markets – Generation side
Required specific competences
> Meteorology> Advanced statistics
Source: Roland Berger analysis
Portfolio management – Case study from a renewable energy generator
Variability of solar power production within a day is dependent on:> Nebulosity> Sunshine> Spatial configuration of solar panels
3500
3000
2500
2000
1500
1000
500
0
00:00
02:00
04:00
06:00
08:00
12:00
14:00
16:00
18:00
20:00
Cloudy dayPaverage real(W)
Paverage forecast (W)
2 RISK IDENTIFICATION / Characterization of the commodity portfolio risks
17METI_energy_markets_seminar_14062018_VF.pptx
-1,500
-1,000
-500
-
500
1,000
2013/7/16 2013/10/16 2014/1/16 2014/4/16 2014/7/16 2014/10/16
Open positon
0%
200%
400%
600%
800%
1000%
2013/7/16 2013/10/16 2014/1/16 2014/4/16 2014/7/16 2014/10/16
Hedge ratio
Portfolio management – Case study from a European utility
Source: Roland Berger analysis
Volume risk is emblematic of energy markets – Supply side
Open positions [hourly, in MWh] Hedge ratios [purchases/ sales, in %]
2 RISK IDENTIFICATION / Characterization of the commodity portfolio risks
18METI_energy_markets_seminar_14062018_VF.pptx
Portfolio management helps balance and transfer risk to the market through multiple levers – Price hedging only one of them
Wholesale RetailIN THE LONG TERM
> Long-term contract with producers
> Production investment> Financial participation with
off-take contract
> Marketing strategy (customer segments, products…)
> Lobbying strategy
IN THE MEDIUMTERM
> Portfolio flexibilities (storage, contract flexibility…)
> Organized market instruments (forward, options, virtual capacity, financial hedges…)
> OTC market contracts (forward, swaps, structured contracts…)
> Products/ offer pricing> Plant availability> Accurate forecasting
IN THE SHORT TERM
> Portfolio flexibilities (storage, sourcing contract options…)
> Spot buy/ sell
> Customer load management flexibility (interruptibility, load shaving, …)
Other market players
ClientsUtility / Retailer
Organized & OTC marketsRegulator
Suppliers
Transactions and mitigation levers
Source: Roland Berger analysis
External risk transfer possibilities Sample risk management levers
3 PORTFOLIO MANAGEMENT
19METI_energy_markets_seminar_14062018_VF.pptx
Price position management can rely on four (typical) hedgingstrategies
Hedging strategies
2"Anticipative" hedging
A "campaign price" based on pre-purchases
Sold at
Sourced at
Average cost of anticipated purchases
Market Client
Client Client
First…
…then
2014
3 "Late" hedging
A price which was fixed before the sale to the client, based on market prices at the day of the quoting
Sold at
Sourced at
Combination of forward and spot products to match aggregated client loads
Client Client
Market Client
2014
4For variable prices based on x.y.z. formulas only, hedge "along the formula"
Sales price for the delivery period, being equal to the average forward price for this period during the month before, plus margin
Sold at
Sourced at
Average forward price during the month before (like the sales formula)
Client Client
Market Client2014
Variable price 1.0.1
1/30th everyday during the month before delivery
1 Back-to-back hedging
A price which was fixed during the sale to the client, based on forward price for client specific profile
Sold at
Sourced at
Forward price for delivery period at same time of the sales for client specific profile
Market Client Client
Simultaneous sales and hedging of the client profile
20142014
3 PORTFOLIO MANAGEMENT
20METI_energy_markets_seminar_14062018_VF.pptx
Hedging, even if feasible, is not always desirable … Depending on risk appetite and limitations
GOODREASONS
DOUBTFULREASONS
WHY TO HEDGE? WHY NOT TO HEDGE?
• Make up for a weak operational performance• Capture "market risk premiums"
• Respect the risk profile expected from investors• Ensure a competitive advantage / avoid a disadvantage
• Support the market guidance• Ensure Management serenity• Avoid cost of financial distress• Enable investments in low cycle periods
• Benefit from upsides• Avoid inefficient or costly hedges• Avoid to hedge unknown / uncertain volumes
• Generate profits from hedges
• Avoid inefficient or costly hedges• Avoid to hedge unknown / uncertain volumes
3 PORTFOLIO MANAGEMENT
21METI_energy_markets_seminar_14062018_VF.pptx
Specific energy procurement and portfolio management strategies apply to B2C and Industrial & Commercial segments
1) Synthetic load profile 2) Recorded load profile
Procurement of power and gas
DESCRIPTION
CHARACTE-RISTICS
> Households and very small businesses with SLP1)
within own and external grid territory> Small customers with RLP2) in the own grid territory,
which are neither price-sensitive nor fickle
Steady long-term development of the portfolio for the following years
General immediate procurement of the volumes after closing (back-to-back) to secure margins at minimal risk
> (Yet) high inertia of customer base> Volume requirements can be derived from SLP for a
certain time period> Number of customers depends on own price policy in
comparison to competitors
> All RLP customers within external grids as well as larger price-sensitive RLP customers in the own grid
> Massively multi-site small customers, aggregated (e.g., chains of stores)
> Individual contracts with industrial and commercial customers – high range of volumes
> Industry and company-specific volume requirements and load profiles
> High volume risks and low margins
B2B customersB2C customers
Source: Roland Berger analysis
3 PORTFOLIO MANAGEMENT
22METI_energy_markets_seminar_14062018_VF.pptx
In contrast to the B2C segment, B2B offerings may contain multiple flexibility attributes with impact on the company's risk exposureTypical flexibility/ constraint attributes in energy contracts for industrial customers
Source: Roland Berger analysis
Before contract signature
Price flexibilities> Fixed price, with or without fixed
component> Total or partial indexation of
contractual price, cap & floor> Different price structures by
predefined periods> Capture of average market price on a
pre-defined period of time
> Total or partial indexation of delivery price, cap & floor– Electricity, gas, oil, coal– Other commodities or indices
> Stop-loss option : Money given to customer if market price goes down
Volume flexibilities> Full supply> Partial supply (especially blocks)
> Take or pay contracts> Volume increase or decrease, with or
without penalties> Interruptibility option at supplier's
hand (peak shaving of customer or aggregated supplier's load curve)
> Consumption forecast to reduce balancing penalties
> For a multi site offer: Addition or withdrawal of sites
Term flexibilities> Flash offers over a defined period> Extension of price validity duration> Long-term commitment (5 years or
more)
> Contract extension option at supplier's hand (against lower price for the prompt period)
> Contract extension option at hand of the customer
> Early termination option at hand of supplier or customer
During contract delivery period
3 PORTFOLIO MANAGEMENT
23METI_energy_markets_seminar_14062018_VF.pptx
The definition of relevant risk indicators does not require pure mathematics but even more common sense and creativity
FINANCIAL IMPACT
RISK SCOPE
PORTFOLIO SCOPE
OBJECTIVES
Relevant market risks indicators
1
2
3
> Price and/or volume> Single or multiple commodities
> P&L (gross margin, EBITDA, Net Result)> Balance sheet> Cash
> Operational decision support> Risk control> Financial performance management> Financial communication
> Contracted vs. non-contracted positions> Statistical modeling> Timeline
5
4
Definition of risk indicators
DEVIATION TYPE
> Mark to market/ mark to model value> Small deviation (sensitivity)> Statistical deviation (E@R, V@R,
P&Lx%...)> Stress tests and scenarios
4
Source: Roland Berger analysis
RISK CONTROL / Risk indicators & dashboards
24METI_energy_markets_seminar_14062018_VF.pptx
The proper implementation of risk management involves several mutually reinforcing dimensions
Governance & organization
Risk managementInfrastructure
Skills
Processes &procedures
Risk reporting
IT tools
Risk policy
3
4
1
2
5
6
Overview
Source: Roland Berger analysis
5 INFRASTRUCTURE
25METI_energy_markets_seminar_14062018_VF.pptx
Risk governance principles come from financial best practices 1) and are fully applicable to Utilities
2 Implication of Senior Management
Rationale: Place risk management close to shareholders risk / return aspirations and avoid making risk control become an experts reserved domain
1 Separation between exposure management and risk control
Rationale: Avoid major losses due to possible human flaw
3 Mark to market valuation of transactions and use of official market price references for risk measurement and investment decisions
Rationale: Account reliably for structural decisions (budgeting and investment)
4
Usage of proper risk indicators to ensure objective, exhaustive, consistent and reliable measurement
Rationale: Capture all the risks to estimate properly decisions and control
5 Promotion of enforceability of risk management through the company
Rationale: Involve all entities within the company (Finance, BU management, operational staff) to create awareness
Risk governance best practices
1) Twenty recommendations of the "Group of Thirty" in 1993
5 INFRASTRUCTURE: Governance
26METI_energy_markets_seminar_14062018_VF.pptx 26
The market risks control framework rely on a steering control entity at corporate level, relayed by entities at operational level
Typical risk control organization
Board of Directors
CEO
CFO CRO
BU #1
BackFrontMiddle
Shareholders
Corporate risk oversight
Business unit risk management
CommitteeDirect reportingFunctional reporting
• A market risks control entity should be set up at corporate level to steer the implementation of the market risks management organization and to look after the correct application of the defined governance principles
• It can either be independent, in charge of market risks control or attached to the internal control entity
• Additional local risk control entities can be created at operational level if needed (e.g. : in case of a specific activity)
• Meanwhile, because of possible conflict of interests, the independence between control and operational activities should always been abided by
5 INFRASTRUCTURE: Governance
27METI_energy_markets_seminar_14062018_VF.pptx
The root of all evil: bonuses!
Source: Survey, Roland Berger analysis
Key findings
• Most companies have metric- based bonuses, but with a discretionary component
• Most companies compensations are based on a combination of company and individual performance
• Some companies identify individual behavior as a factor in bonus calculation
• Most companies allocate between 0.5% and 15% of GM as bonus pool
Share of bonus pool in gross margin - Benchmark of energy traders
0%
Player 7
Player 8
5%
5%
Player 5
Player 6
4%
Player 4 5%
Player 3 7%
Player 2 15%
Player 1 30%
Bonus pool policy for energy traders
5 INFRASTRUCTURE: Governance
28METI_energy_markets_seminar_14062018_VF.pptx
The energy risk policy sets the framework for market risks management and is shared between organization, management and shareholders
Table of contents of the client market risk policyKey principles for a market risk policy
• A risk policy is:– not a buy / sell strategy document– a normative document that:
- helps integration of risk management into the operations by giving them a qualitative and quantitative framework
- defines the control framework
• Other guidelines documents can be found in the company, such as:– Hedging policy / strategies description– Pricing policy– Offerings / products policy...– ...
• The risk policy is a document that must not be reserved to a specific group (e.g. shareholders or Front Offices…) but must be shared and acknowledged at all levels of the company
1. Risk management objectives, scope & stakes– Financial magnitudes and corresponding risk management goals– Commodities addressed (Gas, electricity, fuel, etc.)– Time horizons– Business Units / subsidiaries concerned
2. Risk identification– Characterization of the portfolio risks– Qualification of these risks
3. Risk governance– Governance principles (segregation of duties, risk committees…)– Organization
4. Risk management principles– General management principles– Discretionary risks vs. minimum exposure (risk profile)
5. Risk measurement & control– Indicators & reporting– Control processes: limits exceeding, etc...
Appendixes: Risk limits, Authorized instruments & products, risk committee composition, risk reporting, control procedures…
Source: Roland Berger Strategy Consultants
5 INFRASTRUCTURE: Policy
29METI_energy_markets_seminar_14062018_VF.pptx
Ten questions to challenge your position
6. Do we have a proper risk governance / organization in place?
7. Do we have the proper skills and resources to manage and control our risks?
8. Do we measure and consolidateour risks? with relevant indicatorsand limits?
9. Do we have proper risk policiesthroughout the company?
10. Are our executives on board?
1. What risks are we exposed to? Today and in the future?
2. Which are the ones that can bemanaged? with which levers?
3. Which are the ones that weshould hedge? why?
4. Do we have clarity on P&L responsibilities and transfers?
5. What is our desired level of financial predictibility?
Contact:Denis Depoux, Head of Global Energy Competence [email protected] / + 86 137 88 99 32 72 (Asia)
[email protected] / +81 (3) 358 76-683 (Japan)[email protected] / + 33 6 72 51 32 85 (Europe)