From the perspective of published author in risk management and CEO of Lacima Group, Chris Strickland – find out more.
The first group can be characterised by being asset heavy commodity players such as utility type companies. These companies own and operate physical assets (such as thermal & renewable power plants, gas storage facilities & pipelines or transmission lines) and have established asset-backed trading groups whose objective is to enhance the risk adjusted profitability of the physical assets based on market variables, their uncertainty, and the physical characteristics of the assets.
To understand the needs of this group, you have to understand that these companies typically have 3 main components to their portfolios. The first is the physical assets themselves with their unique flexibilities and operational constraints such as injection and withdrawal rates and costs, minimum up and down times, ramp up rates etc. A second component is the longer term complex financial transactions linked to the physical assets such as power and gas off-take agreements, tolling agreements, power purchase agreements etc. The third component is standard financial hedge contracts, such as futures & forward agreements, swaps, and options. In addition to financial price variables, they are exposed to uncertainty in non-price variables, such as temperature, wind, customer loads, hydrological flows, snow melt, etc. Traders and managers therefore transact in and manage across multiple commodities, geographies, currencies, instruments, and assets.
“To understand the needs of this group, you have to understand that these companies typically have 3 main components to their portfolios….”
Changes in behaviours of this group are being driven by the increasing demand for transparent reporting and an objective display of a company’s enterprise risk (i.e. across the wide ranging portfolio described in the previous paragraph) by investors, customers, credit rating agencies and legislation. Therefore, this group is demanding more sophisticated analytics to help them to manage these increasing internal and external demands.
We start by understanding the risk framework our customers work within and it quickly becomes obvious if their risk measurement efforts focus on only a part of their organisations’ activities, rather than the full business. For example, a typical scenario we see is the risk management function producing a VaR metric on their trading book, but the calculation excludes the one thing that the trading book exists to hedge - their physical asset portfolio. Further, there are often risk limits imposed on the trading book – even though the trading book is not linked to the physical asset portfolio. This is where Lacima can step in and provide the linkage between the physical and financial portfolios and treat the portfolio as a whole. In addition, we are able to bring focus to more relevant risk metrics for the operations as a whole, such as current and forecasted gross margins, revenue, earnings, cash flow, or profits, and this helps risk management to better understand the impacts on operating cash flow and the ability to service debt and pay dividends.
The global multi-commodities
The second group that Lacima deals with are global multi-commodity trading organisations. These types of customers need to cohesively manage the risks of all the assets and commodities in their portfolios (including oil power & gas, agricultural products, metals, etc) each of which have unique attributes. It is interesting to observe that although most of the larger Energy/Commodity Trading Risk Management (E/CTRM) systems vendors advertise themselves as being relevant to the full range of these energy and commodities markets, they are generally only the ‘best in breed’ in one specific area and are invariably much weaker in the areas that they have branched out into. As a result, we see many customers using a separate E/CTRM system for each commodity area (oil, gas, ags, metals, etc). Changes in behaviours of this group are driven by the need to improve the consolidation of their risk results – with multiple E/CTRM systems, each with their own (inconsistent) risk calculation, it is nearly impossible to provide a meaningful global consolidated risk view.
“Changes in behaviours of this group are driven by the need to improve the consolidation of their risk results – with multiple E/CTRM systems, each with their own (inconsistent) risk calculation, it is nearly impossible to provide a meaningful global consolidated risk view.”
For global multi-commodity trading organisations with multiple E/CTRM systems, they often make the mistake of trying to get a risk number out of each E/CTRM and then simply ‘rolling’ them up into a consolidated risk number. This however produces a result with very limited value as different E/CTRM systems use different methodologies for VaR or exclude certain contracts in their calculation. Lacima’s system works agnostically with all E/CTRM systems to produce a single consolidated risk calculation using a single risk engine framework. Our customers win because they don’t have to throw out their legacy “best of breed” systems and they can point to a single source of risk truth with a consistent modelling methodology. Our solution also allows users to take into account all the cross relationships of commodities – leading to greater transparency, as well as the flexibility to drill down into the individual commodities or down to country or even by individual trade to see where the true exposures lay in their portfolios.
The rest with “exposure to commodities in some form”
The third and growing group of customers we deal with have exposure to commodities in some form or another, either as a producer or a consumer of one or more commodities. However the managing of this exposure is generally not their primary business and as such have no or minimal risk measurement tools in place to properly evaluate their risks. This group includes large industrials and manufacturers who buy direct from suppliers, trade on exchanges, or via price indexed bilateral contracts. Entering in to these agreements will inherently affect their future cash flows and margins and understanding how purchasing these types of contracts will affect the company is a board level priority. The behaviours in this group are driven by a need for software solutions that can give them these types of answers.
We are helping them to meet their needs by offering products which are modular and scalable. Customers need only take on the part of the solution that is relevant to their business but they can add functionality as their needs change.
In addition, all of our customers are able to benefit from our new tools for Front Office. These products are stand-alone but interface seamlessly with the same numerical engine used by Lacima’s application for energy risk management and optimisation, Lacima Analytics. We are excited that a trader will be able to use our tools to initially analyse a deal and then optimally monetise an asset by easily identifying the trades needed to rebalance their portfolio. At the same time, risk managers will have confidence that they will be able to use the same underlying numerics to perform their risk management functions.
Hear more at Comrisk 2017!
Working with a multitude of traders for so long gives Chris an excellent vantage point on some of the meta-issues to affect the industry.
As such, he’ll be Addressing the Top 5 challenges faced by risk managers every day – from how to explain VaR changes to traders and senior management to handling the disconnect between analytics used in the risk engine and the pricing desk.
Get your free ticket to ComRisk here (whilst they last) »