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Energy Risk Management: Rise of the Chief Risk Officer

The new CROs are bringing back much-needed discipline to restore investor confidence.
Fortnightly Magazine - October 1 2002

their ratings and grow this business."

Accordingly, the industry's leading companies have worked hard in the past 12 to 18 months to advance their risk-management capabilities, and positive results are already emerging from this effort. At AEP, for example, the company's enterprise risk-management system revealed credit risks involving a $150 million plant-construction deal that was being negotiated. AEP withdrew from negotiations and consequently avoided a significant bad-debt exposure when the counterparty became insolvent.

Similarly, TXU's risk analyses recently led the company to re-think a major pipeline project. Rather than canceling the project, the company restructured its plans to bring in a partner, which reduced TXU's capital requirements and actually shortened the development time frame.

Going a step further, Sempra Energy attributes its very solvency to the enterprise risk management approach that it has taken since the company was formed.

When California's utility market was deregulated, Sempra's risk analysts identified a high degree of price-risk exposure associated with the state's stranded-cost recovery plan. "We made the decision early that we did not want that risk," says Mark Randle, vice president of energy risk management. "It wasn't responsible to our customers and our shareholders. So we adopted a strategy to recover our stranded costs and get out from under the market cap early. That's why we're solvent today with a strong credit rating."

Hidden Exposures

The payoffs may be great, but creating a risk-management culture has its price.

First, the present business climate has companies retreating from what might be strategic and justifiable risks. This might be unavoidable to the degree that capital resources are limited, but there is a danger that companies will become risk-hypersensitive.

"In the next 12 to 18 months, we'll see extra conservatism because of what has happened," says Steve Lis, a consultant with PwC Consulting. "People are becoming risk-averse, and the opportunity for value creation has been taken off the table."

In the long term, a more rigorous approach to unearthing risks should allow companies to take risks with greater confidence in their understanding of the implications. In the short term, however, it might exacerbate the trend toward risk-aversion.

Second, for some companies, the factors that make the CRO seem like an SOB could be disruptive. Any process change can be stressful, and the transition toward an enterprise view of risk often encounters resistance from the existing culture. "People need to see their role as being a partner to the business and helping to ensure the company's assets are protected," Lis says. "But this can be interpreted as control rather than partnering."

The key to overcoming such challenges starts at the top of the organization. Senior management, from the chairman down through all the business-line managers, must be completely vested in the idea of adopting a risk-management culture. "I have the full support of the executive committee," AEP's Smith says. "If you don't have that, you might as well forget it."

At the same time, however, companies must ensure that their risk-management goals are well understood by everyone at the company. "Communication with the front office and commercial operations