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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

strategies and avoid costly pitfalls-will gain ground over their competitors in the long term. Ultimately, as margins grow thinner, capital constraints grow tighter, and competition becomes more fierce, a clearer understanding of enterprise risks might separate the quick from the dead.

AEP: Red Light, Green Light

When Scott Smith joined AEP in early 2001, he was given an enormous task: implement an enterprise risk management (ERM) approach that would inform AEP's decision-making processes.

The result was what Smith calls the "USA Today" approach, and already it has helped AEP save millions, if not hundreds of millions, of dollars.

In mid-2001, a group of 125 AEP executives convened to define and categorize the company's risks. On that basis, the company established 10 risk categories:

  • strategic franchise,
  • legal & regulatory compliance,
  • staffing & organization,
  • credit,
  • market,
  • operational systems & technology,
  • environmental,
  • sovereign,
  • financial documentation & reporting, and
  • liquidity.

Next, AEP created an organizational structure that would report risk data to the company's executive risk committee. Most of the hot-button areas report directly to Smith's 65-person organization. Others report through other company officers, and Smith himself reports to the CFO and the audit committee of the board of directors.

AEP then set policies, procedures, and triggers for risks in each area. In each group, the status of a risk factor is signaled with a "stoplight" icon, with red, yellow, or green indicators signifying risk priority.

This process is used throughout the organization. For example, the general counsel's staff members report to him in this stoplight format. "They don't bother to report the greens," Smith explains. "But he looks at the yellows and really focuses on the reds." The general counsel then takes 100 pages or more of documents and distills it into a single page with stoplight icons at the top. This is reported to the executive risk committee, along with reports from the company's other risk areas.

To date, most of AEP's 10 risk categories have been integrated into the reporting process, but Smith says his task is far from complete. "It hasn't been easy. Just when you think you're done, a new risk pops up. I don't know if the process will ever be done." -M.T.B.

The Committee of CROs: United We Stand

When human beings face a crisis, their typical response is either to fight or flee. Because neither action is particularly constructive, people strive to develop more rational responses-such as analysis, diplomacy, and cooperation.

A group of chief risk officers (CROs) did just that recently by forming the Committee of CROs (CCRO) in May 2002. The group now includes risk officers from about 30 companies, who are working to identify best practices in risk management for the energy and utility industry.

"The trigger for this activity was the continued dissatisfaction among securities analysts with the disclosures companies were making," says Richard Osborne, CRO of Duke Energy.

In a May 2002 Special Comment publication, for example, Moody's Investors Service said, "Differences in accounting methodologies and the degree of latitude available to the energy merchants make financial statement comparisons difficult."

To address this