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Fifteen years ago, you couldn’t fill a small room with energy CEOs interested in discussing how credit risk affects their companies’ bottom lines. But a recent series of contract defaults, bankruptcies, Sarbanes-Oxley controls, and merger-and-acquisition activity has placed credit-risk management squarely on the industry’s radar.

Energy and utility companies are doing business with long-time customers who have seen their credit ratings drop to the brink of junk status. Based on the huge disparity among credit scores, it’s a real case of the “credit haves” doing business with the “credit have-nots.” In other words, it’s an accident waiting to happen. According to a June 2005 study, energy firms continue to “exhibit very high risk levels,” and out of the 20 riskiest companies in the S&P 500, five were energy companies.

While credit risk is nothing new in the risk-savvy environs of banking, manufacturing, and finance, credit risk management has struggled to find a foothold in the energy industry because of a lack of dedicated focus and funding. As a result, it is commonplace to find inconsistent credit-risk methodologies, poor technology implementation processes, and a lack of integrated, robust risk systems interfacing with internal accounts receivable/payable information and timely, industry-specific external credit data.

Every classic case of a risk management blow-up (Barings Bank, Orange County, and Long-Term Capital Management, to name a few) started with strong earnings that were poorly understood and never questioned. Today, it’s clear that an integrated risk system that measures, monitors, and manages credit-related risk is no longer a Wall Street extravagance, but rather an industry essential.

Credit Risk: Overlooked and Underdeveloped

Even though credit risk can, on average, comprise some 25 percent to 30 percent of a company’s overall risk portfolio, it’s often an underdeveloped and overlooked area, especially in the energy sector. But an unrecognized or hidden credit issue can be the masked disaster waiting to happen.

Case in point: according to a March 2004 survey run by the Global Association of Risk Professionals (GARP), credit risk is oftentimes managed and strung out across a hodgepodge of (sometimes more than 20) systems. In the survey, respondents were asked how many systems managed credit risk across their entire organization. More than 54 percent answered two to five, 16 percent said 5 to 10, and 15 percent used 11 to 20 or more.

Although energy companies span multiple commodity streams (crude oil, refined products, natural gas, power, coal, and others), it is rare that all commodities in a company’s portfolio adequately can be captured in a single system—hence the proliferation of systems. Surely it’s not difficult to imagine that if any of these all too numerous risk systems are not properly implemented and seamlessly integrated with one another, they easily could necessitate hundreds of hours of bad data cleanup, multiple “off-line” calculations, and manual input ( i.e., human