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By Executive Decision

Energy Trading & Risk Management: A better framework for making decisions is required to ensure earnings stability and shareholder value in the utilities industry.

Fortnightly Magazine - October 2005

the organization, senior management must initiate and continuously champion the new decision framework. The requirement that all investment decisions must explicitly identify and evaluate the risks, as well as returns, across a broad range of outcomes (a confidence interval) may significantly change how different parts of an organization interact. The challenge will be how to make that change and incorporate that approach into the corporate culture. Therefore, it is best to show the advantages in one part of the organization, probably either the corporate planning group or the risk management group, and then use that group to spread to other parts of the organization.

Bottom Line

The bottom line is that an effective executive decision framework provides better answers in the complex utility environment that exists today. With hindsight, we can all agree that there was a significant overbuild of gas-fired, combined cycle generation in 2001. Gas prices were low and were expected to remain low; with its low emissions, gas was the fuel of choice. However, gas price volatility was always greater than coal. A fully evaluated analysis including the price and volume risks of both technologies would have significantly reduced the number of gas-fired plants being built. Today the same decision-making approach that resulted in a glut of combined-cycles could result in a wave of new coal fired generation. But is that the right answer given environmental and other uncertainties?

By explicitly considering the range of risks to which utilities are exposed, some companies have been able to reduce costs and allocate resources more effectively. It is not unusual for the resources to go to the project with the greatest net present value or to the project first requested. But resources are limited and, in large organizations, there are numerous projects of relatively equal "value" competing for them. Often, by explicitly evaluating how each of the projects supports corporate goals and affects the corporate risk profile more value-creating activity can be performed.

As we look to the future and consider the complex issues associated with evolving environmental compliance; the price volatility of fuel, energy, and emission credits; and the choices related to allocating resources to generation or transmission infrastructure, reliance on tradition single-point financial estimates is likely to result in significant adverse results. A robust executive decision framework that considers various outcomes for numerous variables is bound to permit more informed and higher value decisions.

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