ERC has extensive experience working with clients to translate their strategic vision into actionable hedge strategies that are aligned with their trading and risk management objectives. Unfortunately, ERC has observed many entities whose hedge strategies are not aligned with their risk reduction objectives, and who consequently struggle with unsatisfactory results from their hedging programs. These entities may have conflicting risk management objectives, or an unreasonable expectation of the efficacy of certain risk reduction approaches.
For example, ERC has observed many entities that employ fixed price financial hedging strategies who fail to understand the potential for substantial negative cash flows in certain market environments. Many natural gas hedgers with hedge targets driven by value-at-risk metrics executed large amounts of hedge transactions during the price increases following Hurricanes Katrina and Rita, only to experience substantial negative cash flows in the ensuing months. And in many cases their subsequent actions to avoid future negative cash flows have had a counterproductive affect on their risk reduction results. In an increasingly volatile world, rational hedge strategies coupled to achievable risk management objectives are vital to the successful implementation and operation of energy risk management efforts.
ERC’s work to foster understanding of the full spectrum of consequences of various strategic alternatives is at the heart of developing an organization’s risk tolerance and subsequent hedging and asset optimization strategies. Rather than “eliminating” price risk, risk management is really about risk shifting. All organizations with exposures to uncertain prices are faced with warehousing of risk in some form. Price risk hedging programs do not eliminate price risk; price risk is transformed into credit risk. And warehousing credit risk can be expensive. ERC works with clients to find the proper balance between acceptable levels of price risk mitigation, residual credit risk, and the cost of risk reduction. This balance then leads to a choice of risk management alternatives that are better aligned with the expectations and resources of the organization.
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