Two to three years after the crash of the wholesale energy marketers the results of a new Standard & Poor's survey of today's market participants are "troubling," to the ratings agency, which found that not all had learned the lesson of sound risk management practices regarding liquidity. Some also harbor the mistaken belief that it can't happen again.
The major findings of the S&P survey were that many companies had inadequate infrastructure to measure risk and the "industry generally underestimates liquidity risk."
Those scoring the lowest on the S&P scale of adequate liquidity were local gas distributors with large natural gas marketing operations, midstream and refinery operators, and diversified utilities with some unregulated natural gas operations. Exploration and production companies and the few remaining pure merchant energy companies were the highest on the liquidity scale.
What the compilers of the nine-month long S&P study found "really disturbing" was that besides not having the infrastructure to measure risk, some company officials didn't even understand the terminology of risk management, and others responded that they were not traders. "Just because trading is not a profit center, it doesn't mean you don't have liquidity risk," said S&P analyst Tobias Hsieh during a conference call on the report.
As long as a company buys and sells under agreements that have collateral clauses, it has liquidity risk. "It really doesn't matter if you're procuring commodities for a regulated entity or you have physical assets to back up trading." The bottom line is if a company has contracts with provisions for collateral calls under certain conditions, such as material price or credit rating changes, then it has liquidity risk, Hsieh said.
"Even a regulated utility that simply buys from the wholesale market to hedge its native load obligation could be exposed to large calls on liquidity if its contracts contain collateral clauses," the S&P report said.
Some companies just don't believe they will ever go below investment grade, thus triggering collateral requirements in contracts, but the risk is still there for individual companies, even though the overall energy market is going up.
The S&P research team said that some companies, "including some of the bigger ones with market exposure, told us that to respond to the survey they would have to turn their shops upside down and it would take a few months. That was quite shocking to us because we think companies should be able to measure risk on a daily basis, if not a real-time basis...How do you manage your risk if you can't tell what that risk is?"
"It is critical to have systems that can perform exposure calculations across markets and commodities, automatically and simultaneously," integrating contractual provisions and comparing exposures with counterparties. Stress tests focusing on possible credit downgrades and market price movements should be performed.
Some companies confuse market risk with liquidity risk, believing if they are adequately hedged, that takes care of the liquidity risk. Not so, said S&P. In fact, hedging increases liquidity risk. "Some of the most spectacular collapses during the last downturn had very little to do with market risk that comes from lack of hedging, but rather with the large collateral calls that arose from a large hedge book or from rating triggers on loans and capital calls on equity, both triggered by the company's own credit deterioration."
While the S&P report did not name names of the more than 100 companies surveyed, those names are known to S&P analysts and the individual results will be incorporated in credit rating reviews, the team said. As a result of their survey participation many of the companies that had been deficient stepped up their risk management activities and some increased their credit lines.
The report is available at www.standardandpoors.com under "Credit Ratings."
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