Energy

Energy Risk Management

Traditionally, utilities have managed risk by erring on the side of excess: through overdesign, overcapacity, guaranteed rates of return, and fuel pass-through charges. Risks were controlled by a regulatory compact between utilities, ratepayers and regulators which essentially guarantees that there is always a plentiful, reliable source of power to end users, and a steady revenue stream back to utilities to cover associated costs. However, this relatively risk-free situation is changing fast, as the industry evolves to introduce competition.

These changes together with recent energy market turbulence have prompted the energy industry to revisit risk management structures and fundamentally change the approach to risk strategy. Driving this change are managers who have succeeded in stepping away from measuring and managing risks one at a time in order to better evaluate their firm's "risk landscape" in the aggregate. By examining risks in this holistic fashion, firms can realize enormous benefits in their capital structure, budgeting, capital allocation and other areas.

With a multidisciplinary team drawn from our energy and finance practices, NERA has been a pioneer in assisting clients to managing risk and pricing in the face of competition. We have used and developed sophisticated financial techniques to value high-risk investments or reduce risk, including applying option pricing theory. We have used these techniques to develop investment strategies for electric utilities that recognize the value of flexibility in the face of uncertainty about future fuel and construction costs. We have also worked with the issue of pricing and hedging risks related to natural disasters such as hurricanes and earthquakes.

A particularly significant area of exposure at present is acquisition and sale of electricity supply. As restructuring evolves, utilities will no longer acquire generation supply to conform with integrated resource plans, but rather will begin basing such decisions upon financial and price risk management decisions. This can create new risks arising from mismatched wholesale purchase and retail sales obligations; a significant change from how utilities have operated in the past. Increasingly, utilities are applying financial theory to optimize resource procurement and devise risk management strategies.

With extensive experience in risk analysis and risk management techniques, NERA experts are well versed in modeling, analyzing and communicating the effects of combined risks to energy companies. We typically aggregate these risks across multiple risk factors and business units, taking into account correlations and diversification effects, to measure their combined effect on performance measures such as earnings-at-risk or cash-flow-at-risk. We can also assist clients in measuring individual risk exposures on a consistent basis. Once risk has been properly assessed and measured, our energy professionals assist our clients in institutionalizing these methods as well as assist in bringing other best practice approaches to their daily operations.