RISKMANAGEMENT
TABLE2: IMPACT OFVARIOUSCRUDEOILPRICERANGES
US$50-100 US$100-150 US$150-250
Market Volatility
15-30% Range 30-50% Range 50-75% Range
• Counterparties that have • Tight limits and • Counterparties with short
Credit
hedged their fuel costs collateralised trades. natural positions in oil go
Considerations
experience liquidity under (unless fully hedged
problems (‘hedger’s ruin’). for long terms).
Impact on
• Airlines, car manufacturers • Consolidation in industries • Financially weaker firms
stock prices jump. Energy where oil is an important cost with cost structures highly
Energy Intensive
stocks down 20-40%. factor. Energy stocks down dependent on oil prices
Industries
from recent highs. go bankrupt.
• Natural gas prices and • Natural gas prices decrease • Natural gas prices rise
Impact on Other product prices follow lower
to US$6-10 MMBTU. Product to US$10-20 MMBTU.
Energy Markets
oil prices. prices decrease a similar
percentage as crude oil.
Producing
• Oil exporting countries see • No major changes. Country • Iran, Venezuela, Nigeria
Countries Impacts
revenues decreasing and risk remains at current levels. dictatorships gain power.
economic problems. Country risk increases.
Market Liquidity
• Lower as ‘speculators’ • Stable, pending on • Lower, and also dependent
gradually leave market. regulatory initiatives. on regulatory initiatives.
Probability
Medium High Low
Source: NQuantX LLC..
DesigningStressTestsforOilMarkets results of the stress tests, the firm
In order for the stress tests exercise to be successful, the starting could be underestimating the risk of
pointisthedesignofplausible,forwardlookingscenariosofpossible experiencing large losses, so a natural
energypricesonthehorizonbeingconsideredintheanalysis. use of the results of stress tests is to
Itisimportanttopointoutthatbeingabletoanticipateageopo- complement VaR measures. However,
litical,macroeconomicorregulatorydevelopments,doesnotalways theendresultisthatfirmsareleftwith
mean that we are going to be able to predict the market direction a set of risk measures that are calcu-
accurately. Financial and energy markets move according to lated from a series of hypothetical
changes in expectations rather than in response to particular portfolio profit and losses that rely on
events, and therefore, price behaviour is particularly complex to too many simplistic assumptions
anticipate. In Table 1, we provide a set of sample scenarios and about market and portfolio behaviour,
resultingoilprices. particularly with regards to extreme
Stresstestsshouldalsobemulti-dimensionalandattempttofore- market conditions.
castpossiblecross-marketeffects,impactonmarketliquidity,coun- The inherent subjectivity in the
terparty risk considerations, etc. For example, in Table 2 we provide choice of stress scenarios creates a
serious problem in order to conduct
Scenario analysis and stress tests lie at the
an objective assessment of the value
heart of modern financial risk management
of a stress test, and therefore poses
obvious problems for senior manage-
asummaryofthepotentialcross-marketeffectsofvariousoilprice ment, regulators and other interested
rangescenarios. parties trying to assess a firm’s stress
Stress tests can also highlight portfolio ‘hot spots’ resulting from testing procedures.
excessiveleverageandconcentratedbets.Stresstestsshouldmodel A natural solution to this problem is
portfolio ‘liquidation strategies’ and include a set of rules to tobringseniormanagementrepresen-
attempt to reduce leverage as markets significantly move against tatives into stress test committees,
thefirm’spositionsunderdifferentliquidityscenarios. therefore making them accountable
for the scenario design process used
WhatToDoWithStressTestResults? for risk analysis. A summary of the
Iftheriskmeasuresusedbytheinstitutiondonotincorporatethe most relevant stress scenarios should
COMMODITIES NOW SEPTEMBER 2008 13
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