Chapter 3 - Enterprise Risk Management in the Energy and Power Industry

Abstract

Risk management in the energy and power industry unveils and magnifies some of the sensitive and complicated issues inherent in the enterprise risk management practices. There is a gap between the list of suitable instruments that the markets have offered so far and what the energy risk management departments need for an efficient management of their portfolio risk. There are no instruments that would allow the mitigation of counterparty credit risk that the energy enterprises face. The other segment of unhedgeable risks that the energy industry enterprises face is the volumetric risk. In the past, attempts have been made to mitigate this risk through the introduction of weather derivatives. However, these attempts have remained spotty at best.. Energy and power assets may be viewed as rather complex, although readily conceptualizable, portfolios of derivative instruments contingent upon some observable underlying macroeconomic and physical fundamentals. This chapter discusses a methodology for energy and power industry enterprise risk management that marries the conceptual framework of corporate finance with the physical idiosyncrasies of energy and power markets.