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Risk Experts Speak Out: Where the CCRO Fell Short

A surprisingly timid effort for an industry on the brink.

Fortnightly Magazine - January 15 2003

to agree resulted in the lowest common denominator, which unfortunately will not go far in restoring investor and regulator confidence in beaten-down energy merchants.

If the CCRO is serious about its mandate to recommend leading risk management practices to facilitate the redemption of energy merchant sector, it must move beyond the timid cherry-picking it has shown in its current recommendations and address:

  • The viability of bank/Securities and Exchange Commission-style regulation to enforce the independence of merchant energy companies' risk function;
  • Adoption of the latest and most accurate risk/valuation techniques; and
  • Disclosure of all relevant information to investors.

References:

  1. Committee of Chief Risk Officers Recommendations, Volume 2, page 3, Nov. 19, 2002.
  2. http://www.garp.com/newsletters/mar2002.htm
  3. While most energy merchants do not directly link mid-office compensation to individual trades or desk results, stock options and bonus do tend to be positively correlated with overall energy merchant results.
  4. E.g., Constellation, Sempra, Progress Energy
  5. In the single minded drive for earnings at Enron, some mid-offices strove to transform themselves into "profit centers".
  6. CCRO Recommendations, Volume 2, Page 3.
  7. The State acts as the guarantor for energy supply (e.g. California Department of Water Resources' power purchase contracts to support California utilities), just as it acts as a guarantor for commercial banks through FDIC. Therefore the State has a direct interest in ensuring that merchant energy companies remain capable of meeting their obligations.
  8. The Enron collapse has so far resulted in the Sarbanes-Oxley Act, and the New York Stock Exchange has proposed a rule requiring that outside directors-board members not otherwise affiliated with the company-hold a majority of board seats. "Enron's Legacy: Massive Change," Houston Chronicle, Dec. 1, 2002.
  9. Banks are required to maintain capital equal to at least 8% of their total risk-weighted assets, under the 1988 BIS Accord, Crouhy, Risk Management, page 60.
  10. Allegations were made by ex-Enron employees in 2001 that long-dated portion of forward curves were shifted at Enron to generate false profits for EES. "The Other Enron whistleblower," Houston Business Journal, Feb. 22, 2002.
  11. Crouhy, page 67.
  12. "Energy Modeling: Prices, Volatilities, Risks, and Curves", FEA Fall 2002 lecture series, page 3.
  13. New York Regulation 126.
  14. As is recognized in the BIS 2000+ Accord
  15. Australian Financial Markets Association
  16. "Alternate Power Source," Business Week, page 38, Dec. 9, 2002.
  17. "Enron revelations prompt examination in many business areas," Houston Chronicle, Nov. 30, 2002.
  18. 1998 Basle Accord, Group of 30 Policy Recommendations, BIS 98, BIS 200+ Accord, G-12 Counterparty Risk Management Policy Group Recommendations.

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