Are You Exposed?
No-one wants to be the captain of the next corporate Titanic. Yet many energy market players are
skating unsuspectingly close to a metaphorical iceberg.
ByIanSloggett
EARLY THIS YEAR, Financial Objects energy.Whereliberalisationhasoccurred,ithasopenedupaswathe
metwiththeheadsofcreditatamajor of new opportunities for market participants – but it has also taken
asset-centricenergymarketparticipant. away many of the safety nets. New market entrants, new products
Halfwaythroughlunchoneoftheircol- andnewgeographiesareaccompaniedbynewrisks.
leaguesappearedwithanashenlookon Participants need to ensure that each new counterparty is credit-
his face. A senior board member had worthy, that each trade is financially viable, and that internal risk
called him that morning: rumours were parameters are not breached. The particular complexities of the
beginning to circulate about Bear globalenergymarkets–managingthelogisticsofphysicaldelivery,
Stearns. The board wanted to know and the ubiquity of futures contracts for example – only add to the
exactly what their exposure to the risksposedbyunknown,orinadequatelyunderstoodcounterparties.
beleaguered bank was. Individual and More recently, the arrival of non-traditional counterparties and
corporatereputationswereontheline. speculative traders has added more sharks to waters that were
But no-one had that kind of informa- alreadytreacherousfortheunwaryandunprotected.Asidefromthe
tion off the top of their head. And it structural issues of liberalisation, there is now the specific risk of
would take weeks, if not months, to cross-contaminationfromthefinancesector.
work it all out. But by then it would be Counterparties are often financial institutions that have entered
far too late. As we now know, Bear themarketwithenthusiasm,attractedbyhighlevelsofvolatilityand
Stearnsdidnothaveweeksleft. thereturnstobehadfromcommodities.Manyofthesebanks,insur-
The collapse of Bear Stearns, a vener- ance houses and hedge funds have advantages over incumbent
able Wall Street institution with an 85- energy players in the form of sophisticated technology and analyti-
year pedigree, sent shockwaves round cal capabilities – notwithstanding the fact that many have become
the banking community, further cau- energyassetbuyersaswell.
terised liquidity flow and created a
mood of collective introspection and
The collapse of Bear Stearns ... further cauterised
internal assessment. More than that, it liquidity flow and created a mood of collective
led to another round of depressing
introspection and internal assessment
resultsandwrite-downs.
But that was the financial sector. It Evenwherefinancialinstitutionsarenotdirectlyinvolvedinatrade,
couldn’t possibly affect the energy the letter of credit that acts as collateral will almost certainly origi-
market,couldit? nateinthefinancialsector.SowhenUtilityAtradeswithUtilityBand
relies on Utility B’s letter of credit from Bank Z as collateral, it is
WhyEnergyMarketsare deeplyexposedtobothorganisationsifeitherdefaultsontheirobli-
Vulnerable gations. What’s more, if 50% of your counterparties only bank with
Energymarketsarevulnerabletosim- BankZandBankY,thenyourexposuretothosebanksisalmostcer-
ilar risks and any energy player who is tainlytoohigh.
looking at the turmoil in the global Similarly, if the value of the collateral from Bank Z changes, both
financial markets with either relief, Utility A and Utility B are negatively affected. The result could be a
Schadenfreude,orbothisindulgingina shortage of the funding needed to trade or lack of capital to meet
misplacedsenseofsecurity. obligations. Worse than that, it can lead to serious financial loss or
The global financial markets play a evenbankruptcy.That’sobviouslyashareholderissueandonethat
vulture’s game. Once their victim had anyboardneedstotakeseriously.
beenidentified,andasignofweakness
exposed, Bear Stearns’ counterparties TheCreditRiskMeasuringChallenge
ruthlesslycutlinesofcreditandceased So how do you make sure that you are not the next Bear Stearns?
trading. It doesn’t take very much for How do you ensure someone else’s corporate collapse or write-down
the circling pack to descend. When the doesn’tbringyoudownwithit?Thesolutionisinmeasuring,monitor-
Carlyle Group missed a margin call ingandunderstandingyourexposuretocreditandcounterpartyrisk,
(which may have been a slight over- andusingthatinformationasabasisforeffectivedecision-making.
sight)itwasenoughtostopthemarket That requires an up-to-date, accurate measure of your aggregate
tradingwithitandlendingitmoney. exposure to each counterparty, calculated on a daily basis. If last
This is what happens in any market week’s numbers won’t do, last quarter’s are certainly not going to
basedontradingandlending,including cut it. Yet calculating exposure is no straightforward task. Global
78 SEPTEMBER 2008 COMMODITIESNOW
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