Adopting digital capabilities to transform operations and processes holds immense promise for utilities. Indeed, it’s the best path to growth.
Betting Against the Gods
In search of the Holy Grail of utility risk management.
a big lender to the sector," Gold says.
Similarly, Lehman Brothers has also had long standing advisory and banking relationships with the utilities sector.
According to Napolitano, Lehman Brothers’ Energy Trading division works with utility corporate clients in two fundamental ways. The first way, he says, is through direct transactions via the bank’s energy products and service offerings. The second is more indirect, by working in concert with the investment banking industry, M&A and global finance groups, as well as using its Risk Solutions Group in the development of more complex transactions that cover corporate wide risks.
Lehman’s Risk Solutions Group (RSG), which resides within the investment banking group, is meant to house derivatives literate, corporate finance literate, and industry literate professionals that are capable of understanding a corporate client’s baskets of risks on an enterprise-wide basis, Napolitano says.
He says the difference between Lehman’s Energy Trading Division and the RSG group is like the difference between providing the tools for building a house and building the house. RSG offers solutions around problems that corporate clients looked on as basic problems from being in the business. “We are finding ways to do something about those very fundamental things. In our view, it is creating more certainty around the cash flow and earnings streams,” he says.
For example, if a utility is doing business with a counterpart that has a lower credit rating, as a result, than the utility warehouses or holds the credit exposure, he explains.
“Today, we can provide credit derivatives that in effect insulate them from the risk of credit default of the counterparts, so they can effectively remove the credit risk piece of that counterparty transaction. We are seeing on awful lot of opportunity related to energy transactions because of the decrease in credit quality that has largely occurred post 2001 for the wholesalers who participate, broadly speaking, in the domestic natural-gas and power markets,” he says.
Napolitano also says that the Energy Trading group has been able to standardize products that companies had been using for the purposes of hedging and modify them and restructure those products to create a more cash collateral light approach to margining.
For example, 10 years ago, before energy derivatives were prevalent, if a party wanted to hedge its long-term exposure to something like natural gas, it could do it through the futures market, which meant they’d go to NYMEX and through a broker to execute an order, which required a lot of collateral.
“We have through the over-the-counter market—which is the derivatives market, away from the futures exchanges—created products that understand the counterparty credit risk, price it accordingly, don’t require as much cash collateral as a result, so it decreases the working capital component to the utilities and than we as an institution [syndicate the risks],” he says.
They get the benefit of the hedge, they get the benefit of the decreased working capital component to defend the hedge, and they do it via a derivatives structure, Napolitano explains.
As tempting as it might be to rely on an investment bank’s talented