Global Energy Advisory Explain Why Energy Risks Are Uncertain But Not Unmanageable for Forward Thinking Businesses

London, United Kingdom, May 27, 2008 --(PR.com)-- The Energy market is presenting businesses with a virtually unique combination of pressures in uncertain supplies, huge price instability and a punishing credit regime. Global Energy Advisory - a specialist energy think tank and advisory business - see the adoption of a new credit risk product as a solution.

The Globalization of Gas.

Geopolitics, finance and geography will determine future commodity flow. Russia and Iran currently have over 50% of the world’s gas reserves. However, Russia, already the largest exporter, could continue to have the leading role in controlling energy supply for the next 40 years. On the demand side, the largest gas markets are Europe and the.USA whose energy supply options tighten as interim gas power generation grows. LNG (Liquid Natural Gas) is not only sourced to offset declining domestic production but to increase security of energy supply. Soaring costs have currently stopped the development of new LNG projects. This could lead to a shortfall in global LNG as soon as 2012. When this happens it could bring extreme price volatility to the European energy markets by affecting the security of energy supply. The global energy watchdog, the IEA, said last year that global gas security can only be expected until 2015... this is hardly a comforting message for the energy industry. Energy trading has never been more unpredictable and securing energy supplies more difficult.

However, Global Energy Advisory are able to predict what will happen as the commodity plays unfold: in the same way the credit contagion of the global financial markets could have been foreseen. Energy credit risk is just as real as the global monetary crunch. As global energy markets become more integrated, the ripple effect can be spread from one market to another. As Figure 1 shows, most of the major economic regions of the world will be net importers of natural gas; crucially Europe is entering a new era of energy insecurity and if we are honest the energy supply industry have not planned well for it. With deep and liquid markets there is every chance that the utility companies could manage potentially very difficult energy trading situations with security of energy supply compromised. Without them, companies could suffer heavy trading losses and either pass these on to the long suffering customers or fall into liquidation. It is possible that Enron style bankruptcies could be a sustaining feature of future energy markets – energy credit risk is no fairy tale.

Figure 1 (Attachment) Net Imports of Natural Gas by Region IEA 2007 Reference Scenario.

Limited Economic Capital and Increasing Price and Credit Risk.

How should energy companies ensure adequate energy risk management? Ideally companies should hold reserves against unexpected losses and ensure they have capital adequacy to withstand any catastrophic risk that could result in insolvency inducing losses. Such risk capital should also be controlled within a Board approved risk framework, which allows each part of the company to understand the risk and reward of every transaction. With the commodity business becoming increasingly complex and punishing volatility imminent, enterprise-wide energy risk management and contingency planning should be a priority item on every Board agenda. Looking ahead, to ensure longer-term survival, companies and their employees will need to become ever more focused on energy risk or at the very least seek advice from experienced technicians such as Global Energy Advisory.

With increasing price volatility ensuing energy credit risk could be problematic. Energy markets have relatively unique market conditions: extreme price volatility, which causes credit risk and there are times when concentration risk can be severe. I believe as an energy trading industry we need to be innovative in managing this specialised credit risk with an effective energy strategy.

But Just What Are The Tools For Trading Companies to Manage Their Energy Credit Risk?

The main problem with the current arrangements within the energy industry is that they are relatively static and inflexible. Traditional funding availability is not linked to commodity price increases and volatility. In simple terms when the oil price doubles, a company’s financing facilities don’t automatically increase, which means that when credit or cash lines are full, energy traders stop trading with each other. This is not ideal as it prevents highly skilled personnel getting on with the very important task of hedging and ensuring company profitability.

Currently energy traders will post cash or provide a Letter of Credit (LC) to cover an energy credit risk. Over the years there has been much discussion of the Credit Default Swap market and the use of insurance as credit risk litigants. Credit Default Swaps strip the credit risk of a transaction and sell them to third parties. However given the current credit crunch, estimated at $300 billion, banks have put non-performing assets on their balance sheets: the availability of cash and lending capacity has got slimmer and the price for such services has got higher.

Parent Company Guarantees (PCG) are also often used as a form of credit risk tool; however it has to be remembered that the correlations between defaults of parents and subsidiaries can be quite high, so trading businesses need to be careful in relying on these measures alone. No reminder is needed of just one spectacular example of credit risk within the energy sector that resulted when the parent company TXU cut loose their whole European operations in late 2002, resulting in the break-up of their UK based utility.

There is a Better Way

Against a backdrop of the current credit crunch and impending energy shocks, it may be said that, ideally, companies should hold reserves against unexpected losses and ensure they have capital adequacy to withstand any catastrophic risk that could result in insolvency inducing losses. Working Capital efficiencies and financing flexibility should be key areas of focus for all businesses in these markets.

Global Energy Finance, a collaboration between Global Energy Advisory and Orbian Corp of the USA, can support the Industry needs through providing alternative liquidity including, contract monetization, traditional supply chain finance and Center – a credit risk product for energy trading.

Center, An Innovative Approach to Financing and Risk Management.

Where there is a price risk there is a credit risk and the energy market can sometimes have a concentration risk which can be severe. Managing energy credit risk and having effective finance to keep a business solvent are two of the most important issues facing energy companies at the current time. As Figure 2 shows Center makes use of the Orbian financial markets proprietary financing and settlement solution which can dissipate energy trading credit risk into the wider financial markets while improving working capital of a company. Why dissipate the risk in to the wider financial markets? The answer is simply while bank lines are constrained the capacity of the global financial markets is huge.

Figure 2 (Attachment) The High Level Credit Enhancement Mechanism.

Too Much Cash?

It is common for counterparts to post cash against agreed credit exposures. Indeed some counterparts contend that they have so much cash that they are trying “to hide it under the mattress”. That may well be, but a risk manager would probably have to say three things;

1. Great - let's hope this good fortune will last, but these energy markets are tricky and will the company always be so fortunate? Remember, finance lines don’t double in line with commodity prices;

2. This solution is not only about cash but also good energy credit risk management and a way to dissipate these large systemic credit risks into the wider financial markets.

3. The early adopters intend to make use of this product as a useful addition to the credit tools already in their armoury. As the “going gets tough” and counterparts scurry into the distance, it would be futile to try to begin using it when a credit event has already occurred. It is therefore responsible to make use of this product now for good energy risk management and a number of other good reasons.

Credit Where Credit is Due.

With soaring commodity prices and a global credit contagion, it’s inevitable that not all energy companies will be able to meet their payment obligations. A credit default to any company, of any size, can be very costly, both in monetary and reputational terms, and a time consuming experience. Although using this type of solution is a relatively new concept within the UK and European energy industry, the service is well proven in many other sectors and it’s only a matter of time before the benefits are grasped here.

There is a punishing future ahead in the energy trading market Any risk competent company would use this credit product to enhance collaborative relations between all its counterparts. Energy trading activities are co-reliant and a key objective of any market should be to build strong and liquid markets as they benefit all participants involved in safeguarding the security of energy supply. Furthermore, as the volatility within the energy industry becomes ever more punishing, businesses are going to require superior credit risk management products to support their complex supply chains.

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