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Risk Management Starts at the Top

How to sort out strategies and weather the storm.

Fortnightly Magazine - October 2006

that risk, whether through action or inaction. Every action requires an answer to those six questions. Inaction means ignoring the questions, not knowing that the risk exists, or not knowing about the risk-management tools that are there for the asking. Lack of knowledge is not an excuse for those who have a fiduciary duty to safeguard a company, because techniques have evolved to do something about those risks—and none too soon, because concerns about declining oil supplies, location of energy resources in unstable parts of the world, and uncertainty about energy prices will not go away, and may increase in the future.

The real business of risk management starts at the top. Although risk management often is portrayed as some highly mathematical and arcane practice, ultimately the risk-management policies and procedures are designed to help the energy company meet its financial and operational goals. Although the senior level managers and boards do not need to be mathematicians, it is important that they understand the basics of risk management and set the direction that it needs to follow—and make sure that the policies and procedures are followed. Otherwise, their decisions about the company’s direction will be invalidated, with potentially disastrous consequences.

 

Endnotes

1. The risk management staff at Enron routinely was ignored and was quite ineffectual in pressing its case, according to Bethany McLean’s and Peter Elkind’s book The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (New York: Portfolio. 2003).

2. This process is discussed in great detail in the Committee of Chief Risk Officers Organizational Independence and Governance Working Group’s white paper on governance. Committee of Chief Risk Officers. Governance and Controls . Volume 2 of 6. 19 November 2002. p. 3.

3. The collapse in 2005 of China Aviation Oil occurred because traders persistently flouted risk controls.

4. In the case of China Aviation Oil, that new policy led to bankruptcy and the jailing of the CEO.

5. Traders are known to be very aggressive and will push limits in search of trading profits, without always considering risk. When they are trading with their own money that is one thing, but if they are risking the company’s resources, that means they need to hew to the rules.

6. Peter Thal Larsen, “Today Leeson Would Work for a Hedge Fund,” Financial Times , 21 February 2005. p. 16.

7. Brett Friedman and Tim Essaye, “ Corporate Risk: What Does Management Really Know?” Public Utilities Fortnightly . Volume 143. No. 2. February 2005. p. 56.

8. Committee of Chief Risk Officers. Introduction and Executive Summaries of CCRO Recommendations. Volume 1 of 6. 19 November 2002. pp. 9-10.

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