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The Hidden Costs of Sarbanes-Oxley

Can they be reduced?

Fortnightly Magazine - July 2007

would have to wait until the trade settles. If the trader is accurate, profits still would be made as expected. However, the rest of the organization would fail to benefit from this superior insight. If any of the asset operators that rely on natural-gas prices made an operating decision based on the curves derived from risk control, they would have operated inefficiently even when an alternative forecast is better.

The counter argument that the trader is biased and does not consistently have a better view of the market can be controlled by setting up systematic back-casting tests that constantly evaluate the trader’s forecasts over time. If the distribution around that forecast is tighter than that of the historically derived risk-control forecasts, then the organization can be confident in the accuracy of the trader’s curve and include it in the operation of its assets.

Figure 3 compares an illustrative distribution around the trader forecast compared with the risk-control derived histogram from Figure 2. In this example, a very small portion (the area shaded in red) of the trader’s distribution is higher than the expected price derived from risk control. If this area is small, the organization can conclude with a high degree of confidence that market prices likely will fall below current levels.

Sarbanes-Oxley has been expensive for energy merchants. It has required the redesign of processes, the addition of controls, and an overall decrease in operational and strategic flexibility. Internal processes have been redesigned with the thought of risk and control and not with operational efficiency and shareholder-value optimization. Controls and processes are positive as long as they do not cripple the organization.

Communication between traders and the rest of the organization should not be prohibited. Traders should simply be monitored with an analytic framework that is constantly evaluating their effectiveness. In this way, the organization will make both shareholder and the auditor happy.