Energy Risk Management: The art of value protection


Few industries have comparable levels of inherent risk as the energy industry. All businesses, whatever their sector or target market, need to manage their brand, their communications, their people, their products and pricing, IT, operational delivery and customer service. These, in themselves are enough to give most business executives plenty to focus on.

In the energy sector however, the big risks do not even feature in this list. No other industry I can think of is based on the purchase or sale of a product where the price and volume bought or sold crystallises after the point of sale. Forecasting either price or volume is complex and largely influenced by people or events outside of the business' control. After the event, reconciling what has been bought or sold needs to be done at industry level and allocating the cost of any unders or overs and balancing the overall system is a long and complex process. It's not just the wholesale costs, many of the associated costs of delivery such as transportation are volume driven- and each charge type has their own methodology for calculation. At the end of it all, all that has been established is who owes what to whom- which needs to be reconciled with business forecasts.

Managing associated cashflows is another game altogether. Industry design and associated policy and regulation, in many cases dictates terms and timing relating to cash management- whether in the form of credit cover, collateral or payment terms. Most businesses operating in the energy market are recovering value on slim margins associated with large cashflows flowing through the business. Failure to tightly manage all cashflows can quickly become catastrophic.

Accessing the market at all, can be a major issue if not well understood at the outset. Market design and licensing defines who can directly access the market. The upside of avoiding the risks and obligations associated with being a licenced entity, needs to be balanced with the downside of finding an appropriate route to market via a licenced entity without eroding the value inherent in your business.

Policy and regulatory risk is another area where businesses operating in the energy industry have to be on the front foot. Unlike other regulatory regimes, energy is subject to constant change and uncertainty, and will ever be thus. Lack of clarity on, changes to, or even lack of changes to, policy and regulation can have a fundamental impact on business models and operations. Failure to really understand the implications of regulation and policy on a business can have catastrophic effects. Not having an active Plan B in the case of policy or regulatory shifts can be equally damaging.

With the explosion of new, generally smaller, businesses operating across the energy market, whether in supply, generation or technology lead demand side management, it should not be a surprise that much of the recent headline news is underpinned by a failure to manage energy risk effectively. Publicly, Future Energy's demise, Iresa's cash call on customers, OVO's investigation by OFGEM, or E's fine by the same body all come down to risk management weaknesses. Anecdotally, the issues are much wider, with businesses struggling to secure valuable routes to market for their core assets or struggling to deliver forecast value built into investment cases.

It is complex and can often be tedious, but to operate effectively in the market, energy risk management in its widest sense, needs to be given at least the same focus and attention by Boards as commercial models and profit generation. Those businesses that are winning, nearly always have tight governance, processes and controls in place to protect value.