Risk management refers to techniques used to control and limit an organization’s exposure to financial risks. Risk management is often used to refer to hedging, which is using techniques to limit risk exposure. But it may also include using techniques to attempt to enhance profits by taking on additional risk either by speculating on market outcomes or by accepting a shift of risk from a counterparty in return for a fee.
Major risks in the energy business include:
- Price risk — Prices move in the opposite direction to what the participant desires.
- Volume risk — A specific customer, a group of customers, or the market as a whole use more or less gas or electricity than forecast
- Basis risk — Prices at the point of purchase move differently from the index used to hedge risk, or differently from prices at the location used to set the contract price.
- Counterparty risk — A party in a transaction fails to honor its commitments.
- Execution risk — Internal failure to execute a transaction properly (e.g., a contract is not signed or a contractual condition not met).
- Tariff or regulatory risk — A regulator or governmental entity changes the rules for a business transaction in an adverse manner
- Operational risk — An asset fails to operate as expected
- Financing risk – Inability to attract sufficient capital or debt to implement business plans
- Interest rate risk – The cost of debt moves in an adverse direction
- Currency risk – The relative value of different currencies changes when financing is tied to multiple currencies.
All participants in the energy business must manage their risk exposures. This includes continual measurement of risk exposures and implementation of techniques to manage risk levels using procedures approved by corporate management. Risks may be managed through use of physical contract structures or financial instruments.