Five Steps to Building an Energy Risk Management Framework

Your company’s energy portfolio is catered to its specific needs, goals and long-term ambitions. As such, it has its own set of vulnerabilities and inherent risks that are all its own. How are you currently managing yours?

Most business leaders in this sector opt to employ a Value-at-Risk (VaR) or Cash Flow at Risk (CFaR) methodology when quantifying and reporting on risks to upper management. Yet, while these metrics can help fill out periodic reports, how actionable are they? In other words, if your VaR jumps dramatically in a given timeframe, are you confident that you can respond successfully?

Today, we’re sharing five steps to take toward implementing a more proactive and informed energy risk management framework.

Ready to learn more? Let’s get started.

1. Correctly Identify Your Risks

The energy events that affect your portfolio will likely differ from those that concern your competitors. Weather instability and price volatility might rank high on your priorities list while others might feel a stronger impact from industry congestion or tightening government regulations.

Before you can correctly model your associated risk level, you’ll need to uncover which areas of your portfolio are the most vulnerable. Which events will cause the greatest amount of financial impact if they occur? Begin with this strong framework foundation and establish a process for keeping the review steps consistent as the energy industry ebbs and flows.

2. Set Your Risk Metric

While some companies benefit from a strict VaR or CFaR-only risk metric approach, many are melding the two strategies to get a more comprehensive view of their portfolio performance.

This is because a majority of portfolios include assets that are diverse in nature and include both short-term and long-term elements. While VaR is traditionally used to identify risks within a given, shorter timeframe, there are many companies that also count physical assets or complex transactions among their holdings. These elements are more easily measured with a CFaR analysis.

To provide overarching visibility, strategizing a combination of both VaR and CFaR into risk management analysis can ensure that every asset is accounted for appropriately.

3. Invest in Quality Simulation

To correctly analyze how your company will respond to a given risk, you’ll need to simulate the occurrence first. There are myriad resources available for creating and implementing a simulation model, ranging from basic spreadsheets to sophisticated software.

You may be tempted to cut corners and save money by selecting a low-budget modeling solution. Yet, this can be even more harmful to your risk management methodology than failing to utilize such a model altogether.

Why? Unless the simulation engine is robust and top-quality, it could generate feedback that is inconsistent at best and incorrect at worst. As a result, you could put responsive actions into place that fail to meet your business’ core needs. Before investing in this space, test the model against real market data to see how it responds.

4. Create a Comprehensive Model

Does your energy risk management framework account for 100% of your portfolio? Yes, even the outlying transactions that are nowhere near as routine or simple as a majority of your activities?

If the answer is “no,” then it’s time to reevaluate your approach. In reality, even the most minute fraction of your transactions could carry a huge amount of risk. If you’re failing to include it in your analysis because it is too complex, then you could be missing a significant piece of the puzzle.

5. Get All Key Stakeholders Involved

Especially if you aren’t seeing the results you expected from your framework makeover, a lack of communication could be the culprit. Data isn’t actionable unless it’s shared.

Once you have taken another look at your energy management framework and made the necessary tweaks, establish routine refresher meetings to ensure all key stakeholders are aware of the new steps and what they mean. That personnel should include decisionmakers in your financial, asset and trade realms. Periodically discuss all strategy changes and how they affect the overall approach.

Acing Your Energy Risk Management Approach

Ultimately, a successful risk management portfolio relies on taking a comprehensive look at your current portfolio, identifying weak areas and putting steps into place to defend your company against a potentially devastating setback.

In terms of energy risk management, these steps remain the same, though special emphasis should be given to the market’s overall volatility. What seems like a threat today could be virtually indiscernible in a few months, and vice versa. Being ready to respond as necessary and keeping a close eye on market activity is key to staying proactive and protected.

Want more information on how to adopt a comprehensive energy strategy at your organization? We offer in-depth commodity supply management services that help you manage risks and optimize efficiencies. Learn more here.