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Betting Against the Gods

In search of the Holy Grail of utility risk management.

Fortnightly Magazine - October 2006

your exposure,” he says.

Many experts say a true corporate-wide holding company level value at risk calculation can be provided by a system that can manage the data across all of the individual silos within the organization. They say the silos can be separated through Chinese walls and security provided within the system. But integrating that system can be extremely complex if a utility’s culture does not allow for the change in business operation, or the management does not have a strong risk-management culture. It’s not as simple as buying a system, experts say, adding a comprehensive risk identification approach is needed like PG&E Corp. completed. Oddly, Triple Point Technology took a poll of its clients (not just utilities) and found that 89 percent said they wanted straight-through processing, while only 11 percent said they had it.

The Investment Banks: A New Era of Service

Financial institutions such as investment banks are becoming ever more involved in offering utilities risk management services and advice. The question many utility executives are asking themselves is how these new offering should alter a company’s approach to risk management.

For example, Joe Gold, Barclays Capital's Head of US Commodities, says that he would not advise that utilities outsource their risk management – a concept that some utilities had been exploring as of late. Gold says that such a strategy has inherent risks in the current regulatory climate. Utilities have an increasing incentive to understand their commodity risks. "Commodities risks need to be something that management understands well. If utilities have very close relationships with a number of financial institutions, they must make sure they can manage those risks. Some utilities understand the risks in great detail, some do not," he says.

Gold makes an important distinction. He would not recommend a utility outsource its risk management which would involve allowing another firm to make decisions for it. However, he would recommend that utilities understand and hedge 100% of the risks that they can.

Gold prefers to be an equal partner with utilities when they are making decisions, and once the utilities have decided, Barclays Capital works with them to figure out the most cost effective way to manage those risks that they have identified.

Meanwhile, Frank Napolitano, managing director at Lehman Brothers, who oversees sales and origination for the firm’s Energy Trading division, explains that only in the last two years has Wall Street focused its derivatives talent against utility industry problems “as part of the core Wall Street game plan.”

The result, he says, is a completely new discussion that many utilities never thought possible. Analysts say the investment banks are using these new energy risk-management services as a way to enhance advisory services that had long existed.

Gold explains that Barclays Capital already has extensive and long relationships with utilities in a number of areas such as lending. "If I walk into a CEO's office to discuss a risk management strategy, it would most likely not be the first time that they would have heard of or dealt with Barclays, as the bank is