Entries for June 2011
There are any number of reasons why firms should take enterprise counterparty risk seriously, and manage it appropriately. A perceived failure will start investors, rating agencies and counterparties questioning an organization’s business processes and corporate governance procedures. The merest whiff of a rumor of default on a margin call, or over-exposure to a downgraded counterparty will start the wolf pack circling.
Failure to manage credit risk across the entire company can put organizations on a collision course with a market, that has shown little forgiveness for both real and perceived mis-steps, and regulators demanding greater transparency. It means that business decisions are being made on incomplete or inaccurate data. It severely blinkers a firm’s vision of the future, and hampers its ability to move forward. And, at a time when cash is king, it can have a very deleterious effect on liquidity.
Constellation – a firm with a previously strong reputation for sophisticated risk management – knows all about credit risk failure. In August 2008, the power producer shocked investors when it revealed that it had made an accounting error and underestimated its potential liabilities in case of a ratings downgrade. Both Standard & Poor’s and Fitch Ratings swiftly downgraded Constellation’s credit. Constellation was so large and appeared to be dependent on multiple lines of credit from various banks that were, at the time, either wobbly or are going under, that the perception developed that it was at risk.
Despite Constellation’s efforts to reassure investors of its excess liquidity, good balance sheet and solid commodities trading business, it got caught up in the spokes of Lehman Brothers’ death spiral.
Over three days in September 2008, Constellation’s stock lost nearly 60 per cent of its value as it was dragged into a world of plummeting share prices and eventual sell-offs.
And yet, post-Constellation, post-credit crunch, even post-Enron, when we know that the wrong numbers can do untold damage, many companies are still using a simple spreadsheet to stand between them and potential ruin. Instead of managing credit risk in a holistic fashion, based on consolidated, auditable data from across the organization, businesses rely on error-prone processes that perpetuate the stove-piping of data sets.
Worryingly, a CommodityPoint survey, sponsored by Triple Point Technology, of energy and commodity executives discovered that 70 per cent of companies are using spreadsheets or internally assembled systems to manage counterparty credit risk. While 60 per cent of the companies surveyed felt the need to upgrade their credit risk systems to manage counterparty risk effectively in the current business environment.
If companies do not wish to follow in the footsteps of Constellation, Lehman and Enron, they must grasp the central tenets of credit risk management which we call the five Cs: counterparty, contract, collateral, concentrations and credit analytics.
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Forget air miles – approximately 90 per cent of the world’s bulk traded goods are transported by sea, making shipping the lifeblood of the global economy. The United Nations Conference on Trade and Development (UNCTAD) estimates that in 2008 the shipping industry transported more than 7.7 thousand million tons of cargo.
Advances in technology have made shipping the most fuel-efficient and carbon-friendly form of commercial transport available. And all current trends and trading patterns indicate that an even greater proportion of the world’s trade will be carried out by sea in the future. Without shipping, the transport of crude oil, coal, iron ore and raw materials, including feedstocks and metals, would simply not be possible. Intercontinental trade in affordable food and manufactured goods would cease to exist in all but the most niche and exclusive areas. International supply networks would break down.
But with approximately 50,000 merchant ships traversing international trading routes, the freight market can be summed up in two words: volatile and complex. Ship owners, operators and charterers have to navigate an intricate, multi-faceted and inter-dependent freight market and are at the mercy of hundreds of events that can impact the cost of transport – and hence profit margins – every day.
The prevalence of piracy off the Somali coast and in the Gulf of Aden is perhaps the most obvious and has caused shippers either to pay exorbitant war risk insurance premiums, or to re-route and add delays and extra fuel costs to the journey. UNCTAD’s 2009 Review of Maritime Transport found that, based on 2007 data, re-routing 33 per cent of cargo from the Suez Canal to the Cape of Good Hope because of piracy concerns would cost ship owners an additional $7.5 billion per annum. These costs will ultimately be passed on to consumers.
It’s not just piracy that causes problems. Even if traffic through the Suez Canal were to be re-routed, other key shipping ‘choke’ points remain. Congestion in the world’s strategic shipping lanes, such as the Panama Canal, the Bosporus, the Straits of Hormuz and Malacca, as well as the Suez, can cause significant delays and add costs to journeys.
But even with a safe route planned out, other challenges inherent to the shipping industry remain to confound its participants and their profit margins. Seasonal differences, whether it is iced up ports, swollen river levels, or the size of harvest, have to be taken into account, for example. But even these fluctuations in weather and climate provide a more predictable framework of operations compared to demand for commodities, which can change rapidly in response to the ebb and flow of the global economy and industrial production in specific countries.
Equally hard to predict is price volatility for bunker fuel – which accounts for at least 25 per cent of the cost of running a vessel. What participants in the shipping industry do know is that climate change restrictions are coming into force. The cost of ships’ fuel is expected to increase by a further 50 per cent as result of the increased use of low-sulfur distillate fuel that will follow the implementation of the new IMO rules (MARPOL Annex VI). These will reduce the allowable sulfur content to just 0.1 per cent in 2015, down from the 1.5 per cent permitted today in prescribed Emission Control Areas (ECAs) – currently the Baltic Sea, North Sea, and certain shipping lanes around the US and Canada. Outside these ECAs, shippers are obliged to reduce the sulfur content of fuel from 4.5 per cent to 0.5 per cent. The IMO rules therefore add to the complexity involved in planning routes effectively, ensuring the right ships make the right journeys and optimising fuel consumption.
Then there is the size of the available fleet that has to be borne in mind: too few or too many vessels directly affects prices, which in turn affects freight rates. And finally, trading finance and credit conditions can positively or negatively affect both investment spending and consumer activity.
Managing all these elements – and many more – is critical for successful shipping operations, particularly as prices of fuel, commodities, cargo, credit and vessel hire continue to fluctuate once a ship has embarked on its journey.
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June 17, 2011 | Jennifer Jones
As part of my series of interviews with Triple Point clients, I recently had the chance to sit down with Thomas Harvey, CIO and VP of Information Technology at The Energy Authority, to discuss industry changes and how they use technology to operate effectively in the energy marketplace.
Q: What are some of the major trends driving your industry and how do you see it changing in the next few years?
Thomas: The Dodd-Frank Act and what's happening with the CFTC is the hot topic. We're looking at our business policies and technical systems across several areas--transaction and position reporting; audit-ability; credit management; and documentation--to ensure we're ready to meet additional reporting requirements.
From an IT perspective, we see technology becoming less about automating routine tasks and processing data; it's more about mining data for information we can act on. Some of what's driving this is the world in which we live and our reliance on immediate information exchange. Technology enables us to capture and access huge amounts of data, and the ubiquitous presence of it in our lives means our workforce is increasingly more technically savvy and astute to analyzing the information available to them. Service providers that quickly provide actionable information to move businesses forward will be market leaders.
Q: What are some of the business issues that keep you up at night?
Thomas: Technology is an underpinning of TEA's ability to operate effectively in the energy marketplace...so we're always questioning where we should be investing our efforts and resources in terms of improving business processes. We are cognizant of how we can provide reliable, cost-effective competitive advantages to our traders, power managers, schedulers, and analysts.
Q: What were the major business drivers in moving to Triple Point's Enterprise Solution?
Thomas: Having trading, scheduling, and risk management functionality on a common platform was key. Triple Point enables us to manage both transaction and decision-making information in one solution: physical and financial transactions for power, gas, and oil; scheduling; and credit risk management.
Q: In addition to your current business, how do you see Triple Point supporting TEA's future expansion?
Thomas: TEA represents 46 Public Power Utilities throughout the United States, and we wear multiple hats to support our partners. Triple Point truly understand the complexities of our business, and this provides great peace-of-mind. With Triple Point, we have the infrastructures in place to support our business strategically, now and in the future. If you really look at what TEA offers, a cornerstone of our business is risk management. The value that Triple Point provides in our risk management practice will continue to be a contributor to our success.
Q: What have been the biggest benefits of implementing the Triple Point Solution?
Thomas: I'd be remiss in not mentioning the exceptional Triple Point staff we work with. Our success with the implementation of Triple Point's commodity management and credit risk platform is built upon the dedication of some very smart, hard-working individuals. Triple Point provides an outstanding implementation team and superior customer support. They've been invaluable in educating our team on the inner working of the Commodity XL product and have been fully engaged in helping craft solutions for our unique requests. It's really the whole package, Triple Point's software and people, which brings benefit.
Turbulent economic conditions combined with stringent and uncertain regulatory reform are bringing dramatic changes to the face of energy and commodity credit risk. Don't just cross your fingers and hope a catastrophe won't happen to your organization.
Triple Point recently hosted a webinar on The New Rules of Counterparty Credit Risk and how you can prepare for potential economic & regulatory pitfalls with a flexible and transparent credit risk system.
In case you missed the live webinar, here is a link to download the webinar
and view at your convenience.
In this webinar, Triple Point’s Vice President, Credit Risk Division, Dan Reid, discussed how Triple Point’s Commodity XL for Credit Risk™ will safeguard against counterparty credit risk failure and growing regulatory demands. Attendees learned how our solution will deliver an ROI to their business through liquidity savings and business expansion, how to reduce reliance on credit rating agencies, the impact of Dodd-Frank, Markets in Financial Instruments Directive (MiFID) and Market Abuse Directive (MAD) on credit risk management, and more.
To learn about the implications of market volatility and financial reform on credit risk, and how you can safeguard against counterparty credit risk failure, download the webinar
June 10, 2011 | Mark Earthey
“May you live in interesting times,” is a traditional Chinese curse that could be applied to today’s energy markets. There is a conflation of events consisting of rising demand, uncertain supply, infrastructure constraints, shifting global environmental policies, and changes in technology. Taken together, they create the conditions for a “perfect storm” in energy trading. So what are these events, and why should they concern us as a CM system vendor?
Firstly, let us consider the supply-demand balance of the main energy feedstock – oil. In a number of market reports, including those produced by the oil majors, there is talk of a permanent return to “$100+ oil” as an increasing shortfall in global supply is brought about by the emerging economies’ increasing appetite for energy. Putting to one side the debate on “peak oil”, it is clear that recession or not, absolute levels of demand are rising and the only short-term response the market can make is to increase price. Adjusting for inflation and currency fluctuation, there is no reason why we shouldn’t see $150, $200, and $500 oil in the near future.
These oil price increases will ripple through the other commodities of the energy complex, with significant real price rises in coal and gas - especially those commodities whose price is directly indexed to the price of oil. We shall also expect to see more bouts of extreme price volatility as various economic sectors suffer dislocations as a result of rising energy prices.
Secondly, the environment is back on the political agenda again after it was announced at the end of May 2011 that Carbon dioxide emissions are at their highest ever, creeping inexorably closer to crisis “tipping point” levels entailing “dangerous climate change.” Even without this extra stimulus, and no firm lead from a “Son of Kyoto”, the European Union is setting more stringent emissions reductions targets. Phase III of the flagship EU ETS starts to bite in 2013, imposing very real and costly emissions reduction obligations. Power generators will suffer a double whammy, as they suffer disproportionately higher reductions targets and have to bid for scarcer Allowances in an auction process.
The European power sector is also being hit with additional Directives aimed at the de-carbonisation of generation. EU policy on increasing generation capacity from renewable fuels is seeing a big rise in power generated from “intermittent” sources, leading to wild swings in the power grid’s supply-demand balance, and causing extra price volatility. Grid operators are expecting to be compelled “constrain off” fossil fuel plant on windy days, and some argue that this will increase maintenance costs of coal and gas stations as they are forced to operate outside their optimal mechanical and thermodynamic performance envelope.
All this points to substantial rises in the prices of Carbon and electricity, and a knock-on effect on the prices of all goods where energy is a significant proportion of their cost-base. To make matters worse, some countries, e.g. the UK, are proposing to give the current price of Carbon “a little helping hand” by setting a floor price. For some economic sectors, this amounts to a double taxation and higher costs again.
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Last month I wrote about three pieces of legislation, one House bill and two Senate bills, crafted to repeal the Dodd-Frank Act (DFA). I went into an analysis of why the passage of these bills really weren’t that likely. Well, this time around it seems that House Republicans are trying a different tactic – delay. Bill HR 1573, sponsored by House Agriculture Committee Chairman Frank Lucas, R-OK, co-sponsored by House Financial Services Chairman Spencer Bachus, R-AL, targets to delay much of DFA’s Title VII, the highly contested derivatives section, until late 2012.
The truth of the matter is that this bill has just as much probability of passing into law as the bills calling for repeal – that probability being zero – due to many of the same reasons cited in my previous article. The broader reality is that Dodd-Frank has become a partisan issue, with the GOP defending HR 1573 as a necessary sanity check to prevent the implementation of hastily thought out rules, while the Democrats cite a delay bill as a Republican ploy to wait for a more favorable repeal environment, namely a Republican held Senate or Obama’s defeat in 2012.
The CFTC hasn’t been silent on this topic either. Chairman Gary Gensler stated that CFTC already possesses the authority to extend dates if necessary, so a law is not required. The CFTC already said it won’t get all the rules engaged by July 16, 2011, of course referring back to its lack of funding as the reason. In a surprising move last month, the agency extended the comment periods on all of their proposed rules, including previously closed comment periods. Essentially, all rule comment periods that were closed as of May 4, 2011 were extended to June 3, 2011. The CFTC also sought public comment on the order in which the agency should finalize the rules.
Trusting the CFTC’s stance that they already possess the power to extend and delay components of Title VII, why would anyone feel it necessary to draft delay legislation? The most compelling Republican argument from HR 1573 supporters has been that the proposed bill is not just about delaying the engagement of the regulator’s rules, but also about delaying some of DFA’s automatic or self-executing rules. These rules are embedded in the DFA and don’t depend on any regulatory body rulemaking, and there are plenty of them. These rules repeal sections of the Commodity Exchange Act and the Commodity Futures Modernization Act of 2000, which creates a kind of legal limbo for certain OTC contracts, and introduces a slew of documentation and registration requirements, expecting all entities to be in compliance within the sixty days after June 16th. All this in an environment where the infrastructure hasn’t fully developed past what many view as a straw man phase.
The CFTC is well aware of the potential issues surrounding these triggered rules, and CFTC Commissioner, Scott O'Malia stated in a Reuter’s interview this week, that they are “working on a document and a proposal right now that creates certain safe harbors for self executing rules, to delay them until the new rules are in place.”
Make sure you are all buckled in tight, because this is going to be one helluva ride.
June 03, 2011 | Michael Schwartz
A new trend is emerging in the manufacture of automobiles. Faced with fundamental changes in the metals, chemicals, plastics and energy market environment, global organizations have begun to look at energy companies and commodity houses and wonder whether they could benefit from the types of technology platforms deployed by these institutions.
For years, the world’s most successful energy companies and global commodity houses have relied on sophisticated commodity management platforms that enable them to proactively manage purchasing, demand/supply balancing and risk management of raw materials and financial derivatives. These systems also provide logistics tools, accounting and decision support that create a complete commodity management platform that enables companies to optimally balance between cost, profit and risk.
Automotive manufacturers and suppliers are now recognizing that these same systems can help manage raw material risk and preserve profit margins in the face of today’s unprecedented commodity volatility.
The new normal: volatility, volatility, volatility
The focus for supply chain groups over the past fifteen years or more has been on efficiency (and speed). Manufacturing and supply chain techniques such as just-in-time, inventory management, demand-driven supply networks and total quality management were introduced to eliminate waste, reduce inventory and improve quality.
These efforts have led to a striking reduction in buffer inventories, bringing them down to the bare minimum. At the same time these leaner supply chains have become more global as organizations look for lower cost suppliers and new markets in which to sell products. A side effect of this is that the ability of businesses to handle unforeseen shocks to the system such as sharp raw material volatility has been significantly limited.
We are experiencing unprecedented levels of volatility in all kinds of commodity markets. The vehicles that roll off today’s assembly lines contain hundreds of raw materials – as do the machines that make them. Automotive companies therefore have some of the most diverse and complex procurement portfolios, which represent equally complex supply networks and a broad series of commodities markets – any one of which can be experiencing severe volatility at any given moment.
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