Energy companies need to embrace trading as a necessary core component of their energy operations and must develop a trading strategy that “encapsulates effective governance and active risk management” in order to survive, according to a new report by PricewaterhouseCoopers titled “Energy Trading – Re-establishing Sound Foundations.”

The report warns that further difficulties could be on the horizon and many existing players may cease to have a viable independent future unless they adapt effectively to the changing market.

And there could be a big reward if they adapt successfully. The energy trading market is worth an estimated US$700 billion globally. It is currently suffering from a lack of investor confidence that has downgraded the credit ratings of some companies to junk status, but PricewaterhouseCoopers suggests many companies may be underestimating the future value of energy trading, especially its potential to build stakeholder value.

“Despite the uncertainty that surrounds it, the case for energy trading is unchanged,” said Fred Cohen of PricewaterhouseCoopers global energy risk management. “Companies need to ensure that they have the strategy, skills and knowledge to integrate trading into their core business if they want to prosper in the post-Enron world. Companies must clearly determine how they will manage the risks inherent in their energy operations.”

Trading companies face four particularly critical challenges, according to the report: evaluating and managing price risk, volume risk, capital adequacy and putting effective credit risk procedures in place. Many companies are still failing to adequately manage these risks. Price risk is especially critical in liberalized markets where costs were previously borne by the consumer through increased prices.

The report argues that an energy trading unit acting in isolation within a utility is not sustainable, and that trading must be fully integrated with the rest of the business and its core strategy. Convincing the markets will also be key, especially following the collapse of Enron and recent U.S. trading problems.

“Given the damaged environment that now exists around energy trading, the importance of companies being able to easily convey their strategies and give reassurance to the capital markets cannot be overstated,” said Manfred Wiegand, PricewaterhouseCoopers global utilities leader. “CEOs and boards must first convince themselves that they have a successful model to deliver a satisfactory risk-adjusted return on capital. Then they must engage stakeholders and convince them that they have a strategic, controlled approach to energy trading.”

The energy trading segment is still undergoing “growing pains” as it moves from trading physical energy towards a more financially based environment. Fusing the experience of energy forecasting, management and supply with new skills from the financial trading world is a key challenge that must be met. Larger players are choosing the in-house route, but alliances with financial and banking organizations may also be a viable option, according to the report. The full report can be viewed at

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