What is risk management?
No, it's not a brainteaser. It's the driving question behind , a new book from authors Shirley S. Savage and Peter R. Savage that offers a risk primer for energy company employees and executives.
Understanding risk management is no longer an option, it's a necessity, the authors say. "Throughout the power industry, there's still a fundamental lack of understanding of what risk management is about," they write. "Billions of dollars are at risk, simply because many companies have failed to grasp the basic point: that [risk management] is not about making money, but how to insure against losing it. Risk management will always tend to clip the peaks of success, but it will always minimize the penalties of failure."
Why a book on risk management? Given the recent upheaval in the market, the scrutiny is understandable. But the spotlight on risk management isn't due just to the energy trading scandals. Instead, it owes much to deregulation. "For a hundred years, utilities relied on regulators as their risk managers," the Savages write. "So it is not surprising that regulated utilities, who relied on guaranteed rates of return on virtually all of their investments, did not consider risk management as a core competency."
In the new guide-a followup to the same authors' -the authors take a soup-to-nuts approach, beginning with a definition of risk management ("a practice of identifying the risks affecting your business and finding ways to mitigate the impact of those risks") for those who don't understand the concept; guidance on how to establish a risk management program; a backgrounder on futures, derivatives, and indexes; an overview of credit risk; and the fine print of accounting and legal issues. And that's just the first half of the book.
The authors intersperse quotes from actual risk managers throughout their engaging book, supporting their findings with case studies. American Electric Power risk manager Scott Smith gives his own account of how the company survived the fallout after the collapse of Enron.
"Enron was our largest credit exposure," Smith recalls. "When the risk management committee, consisting of the chairman, the CEO and others across the corporation, met in September before Enron went down, we collectively said, 'The ballgame's over. We're done. We are going to start reducing our risks.'"
As a result of that meeting, the company was able to dodge a heavy-handed attempt by Enron to extract money from AEP. "This was a strategy set out by [AEP's] front office, legal, and risk management. The Chairman, the CFO, and COO were all onboard," Scott says. "It really worked effectively when on the Friday before Enron declared bankruptcy, Ken Lay called up my Chairman and said, 'You owe me money.' My Chairman turned around and said, 'No, you owe me money,' because he had the information."
If there's a drawback to , it's poor copy-editing.
A couple of typos early in the work distract from the important information contained therein. Nevertheless, the few dollars invested in this paperback could pay great dividends for energy companies trying to get a better grasp on how to manage risk.
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