Will traders finally wake up to the danger?
Brett Humphreys and David Shimko are founding partners of Risk Capital Management Partners, a consulting firm that focuses on energy and credit risk management. Related research is available at the company’s Web site, www.e-rcm.com.
During the Midwest power crisis and the defaults of the summer of 1998, we were sure the energy industry would wake up to credit risk. But the urgency passed with the heat wave. During the California crisis and defaults of 2001, credit risk rose to prominence again, only to be forgotten after the California markets cooled off. Now as we experience the Enron crisis, the question is, will the energy industry forget about credit yet again?
Regrettably, the recent developments within the power market highlight the risks associated with credit exposure, even with companies that were thought to exhibit pristine credit. Two years ago, trades with both Enron and PG&E were viewed as having little if any credit risk, but as of today divisions of both companies have filed for bankruptcy. These reversals of fortune reinforce the need for a solid understanding of credit risk within corporations and an active credit risk management policy.