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Frontlines

The Northeast Blackout goes political.
Fortnightly Magazine - September 15 2003

business acumen and management systems"-qualities they will need for survival in the future.

Simpkins of TXU takes this notion a step further. "This period will prove highly beneficial to the industry going forward. Indeed, without it, the industry would not be able to grow and prosper the way I think it will in the future."

A variety of developments in the next couple of years will probably improve liquidity in wholesale energy markets.

Nevertheless, even as some risks ebb, others will intensify. Specifically:
Environmental Issues: More stringent clean-air policies are lurking on the horizon. Even without new legislation, target dates in existing regulations are set to create new environmental requirements. "Environmental policies are very fragmented, and they change continually," says AEP's Smith. Uncertainties around environmental regulation will command more attention from risk-management organizations.
Security: The Department of Homeland Security is in the process of promulgating new security regulations for critical infrastructure industries. While these regulations should theoretically serve to mitigate some risks, their full scope and effect on utilities remains unknown.
Market Design: Changes in wholesale power market structures will have sweeping effects on utilities' strategies. The efforts of the CCRO and other industry advocates have advanced the debate around key issues such as market-price indices and clearing mechanisms, but many other questions are unanswered. Battles between federal and state regulatory interests continue to delay the process of market restructuring, and multilateral clearing structures have been slow to develop. "There is still a lot of uncertainty over how transmission markets will be working in the next couple of years," Adams says. "That is a dicey proposition if you are trying to manage generation assets or are in the final phases of completing them."
Capital Adequacy: The risk factor that keeps utility executives awake nights is the need to convince ratings agencies and Wall Street that the industry has learned its lesson. "With a continued downward spiral, there would be no capital for investment in infrastructure," says PSEG's Brooks. "Capital allocation decision making could have the most impact on that, but the risk is real that we won't pull out of this slump."

The industry has much work to do in the ongoing struggle to manage its various risk factors. Fortunately, the fundamentals of the industry are solid, and leading players are investing resources toward a more stable future.

"Companies are cutting down on operations expertise and financial management expertise, but they are spending more in the risk management arena," Simpkins says. "As we go forward and develop more liquidity, you will see this industry become more innovative, savvy, and technology-oriented."

As companies develop such skills, their ability to adapt to changing conditions and capitalize on opportunities will improve. And as current events demonstrate, adaptability is the most basic of survival traits.



Monte Carlo Management

As risk-management organizations assume a broader role, the tools of financial risk management are being applied to an increasing range of issues-some of which are notoriously difficult to quantify.

Monte Carlo simulations are one method of forecasting (or "modeling") how various factors might affect the value of a