The Committee of Chief Risk Officers (CCRO), a coalition of 31 energy companies, issued a set of best practices for managing risk and recommended that all companies with significant merchant energy activities adopt the set, which covers best practices in the governance, valuation, credit risk management and disclosure aspects of merchant energy operations.

The best practices were developed after receiving input from regulators, credit rating agencies, securities analysts, accounting professionals and industry trade association financial experts.

“These best practices respond to specific needs of investors, analysts and regulators by increasing transparency, improving comparability and making our businesses easier to understand,” said Rich Osborne, chief risk officer at Duke Energy Corp. at a news briefing in Washington Tuesday. “This roadmap should measurably enhance investor and regulator confidence while boosting the understanding of the critically important role the merchant energy sector plays in securing competitively-priced energy supplies for consumers. Long term this should enhance liquidity and reduce the cost of providing energy, benefiting consumers and investors.”

“We need to implement these recommendations very quickly,” Mike Smith, vice president and global risk control officer at Mirant. He predicted much of it would be underway in the first quarter of 2003.

The committee was founded in March as Duke Energy, Mirant and other companies saw a need to help define the role of risk management in securing reliable and competitively priced supplies of electricity and natural gas. The committee represents companies that account for half of the power and gas transactions in the United States. The current list of the member companies and copies of the best practices documents are available on the committee’s web site at https://www.ccro.org.

“One of the most far-reaching changes we hope our industry will embrace is to settle transactions through a clearing mechanism that allows market participants to ‘net’ positions thereby reducing the overlapping and unnecessary collateral required by individual transactions,” said Bob Stibolt, senior vice president, risk management at Tractebel North America. Some already are using commercial clearinghouses for multi-lateral netting, and Stibolt predicted more would get involved “as they become accustomed to the different procedures.” The committee is advising its members to adopt and implement a clearing platform and multilateral netting agreements. He said companies could reduce their credit risk between 75 and 90% by implementing netting. “No one benefits from credit risk. Reducing the risk will increase liquidity, allowing more players into the market.”

Other key elements are valuation and disclosure, Laurie Langer, vice president, risk management and chief risk officer for PSEG. Companies need to agree on methodologies for valuing assets in the future. For instance to value a power plant in 2014, you have to value the power, the fuel and the spark spread and understand the risk involved.

The committee is suggesting the disclosure of risk management should be comprehensive, consistent, relevant, standardized and transparent, with key information summarized in comparable tables “clearly and succinctly.” The information should include gross margin from merchant energy activities; maturity and source of fair value of market-to-market energy contract assets; merchant energy cash information; credit risk exposure on mark-to-market contracts.

Here are some of the committee’s other recommendations:

Issuance of the best practices documents concludes the initial phase of the committee’s work. The committee now is assessing how it might provide guidance on creating more credible and verifiable forms of market price indices. The committee also plans to help establish a common framework for measuring what constitutes an adequate amount of capital and liquidity needed to support a merchant energy business. For more information: Call either Jim Pierobon, (202) 557-0853, or Greg Stanko, (202) 452-7809.

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