November 2012: Business Briefing Series - The power of cashflow based risk metrics

13/11/2012

This year Lacima introduced its new Business Briefing Series. In this series, we intend to provoke your thinking on how the unique attributes of energy and commodities drive risk and valuation issues, and offer guidance for management on how to more effectively manage risks and increase profitability of their organisations in fast changing energy markets of today.

In the first two papers in the series we looked at “Where is the RM in ETRM” and “How relevant is VaR for energy markets”. In this third paper in the series we discuss cashflow-at-risk metrics and note that the risks faced by energy and commodity firms need to be assessed via metrics that allow for longer term outlooks and incorporate risks from asset-backed trading.

If the focus of senior management meetings is typically on the current and forecasted gross margin, earnings, cashflow or profits, then these should form the basis of the “at risk” measure, and not just the value-at-risk. Adopting a cashflow based “at-risk” measure will give greater insight into the business operations, enhance profitability and give insight into the effectiveness of hedging programs.

Key points covered in this paper:

  • Too often there is a failure to address enterprise-wide risk management
  • The “new order” energy company – multiple commodities, multiple markets, multiple instruments and multiple assets
  • A new approach to risk management is required
  • How cashflow based risk metrics differ from VaR

 

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