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Future Imperfect II: Managing Strategic Risk In the Age of Uncertainty

Part two of our series shows how utility companies can manage, but never eliminate, strategic risk.

Fortnightly Magazine - February 2007

scenario might cite the inability of the industrial nations to persuade the developing world to participate in effective carbon constraints, and so no controls are established anywhere. The high cost of natural gas could arise from two possibilities: (a) terrorist threats that render LNG terminals unlicensable in the United States; and (b) high demand for natural gas used to produce liquid fuels from low-quality crude oils or solid hydrocarbons. In that world, coal would become the low-cost alternative, the solid form of “black gold.”

Moreover, some strategically important scenarios might not fall directly from the systematic process sketched out above. Utility planners should be alert to these, as they might offer essential clues to unsuspected risks or opportunities.

Consider, for example, a technology arising from outside the customary sphere of utility cognizance to threaten the well-ordered marketplace—distributed telecommunication and computing technologies, which are enabling intelligent micro-grids to enter unexpected markets like autos. The advances pioneered in autos could diffuse quickly to stationary electrical grids, especially those operating on the customers’ side of the meter. If that happens, then both mobile and stationary applications would converge in performance, scale, and technological configuration— leading to sharply discontinuous change in both autos and utilities.

The pace and direction of these changes will be driven by the auto industry, which must reform its product in response to public concerns with energy security and global warming, private concerns with fuel prices, and opportunities for dramatically improved performance of motor vehicles. In such a market, entrepreneurs and innovators might find opportunities in the automobiles and electric energy for new offerings and innovative business models. If one finds credibility in this line of reasoning, then a wild-card scenario might usefully supplement the more formal methods sketched out previously.

Once in place, thoughtful scenarios can help to manage strategic risk in several ways. First, they provide a platform for focused organizational learning about the key forces influencing corporate strategy. Second, they offer insight into the ways the world might unfold. These enable the utility to construct “signposts,” early warnings of the way important but uncertain events are turning out. Third, the scenarios serve as a communication device within the utility company, a commonly understood rationale for the strategic actions being taken. Fourth, scenarios provide a “virtual wind tunnel” to test the implications of strategic commitments under a variety of circumstances.

But fifth, and certainly most important, scenarios enable strategic-level managers to ask the all-important question, “What would we do if this came to pass?” The answer to that question takes the utility from the realm of thought to the realm of action, enabling the company not only to “take up arms against a sea of troubles,” but also to define and shape what those arms will be. And for this latter, we must turn to a complimentary planning tool—real-options analysis.

To Manage Asymmetric Risk: Real Options

An option offers the opportunity to make a decision after time reveals the future rather than before. For example, purchasing a call option gives the holder the right, but not the obligation, to acquire