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Posts Tagged ‘Risk Strategy’

2 Mar 25 2010 @ 9:50am by Matt Smith in Biofuels, Capital Markets, Crude Oil, energy consulting, Global Energy, Natural Gas, risk management, Risk Strategy

Ten reasons why energy commodities absolutely rock

My name is Matt Smith and I am a financial market junkie. Having left London and the warm bosom of investment management some 1,312 days ago, all could have gone very wrong. However, I have fallen into the arms of another – the world of energy commodities. So henceforth, my reasons for their stardom is tenfold:

1. Markets are all interlinked. Although some energy commodities may spend some time way out in left field, led by their own own fundamentals (step up to the plate, US natural gas), energy commodities take their lead at various times from other commodities, or other asset classes. So the more you know about general markets, the more you can apply that knowledge to the movement in specific commodities.

2. The word fungible. Commodities have fungibility, which means their units can be substituted for another – they are interchangeable, like a dime. Hence why a pipeline attack in Nigeria or geopolitical tension in the Middle East  matters to the price of your gas at the local gas station. It is also a fantastic word.

3. How commodities latch onto other commodities at various times. For example, European power markets pick and choose which price driver to follow, seemingly like picking a jelly belly from a bag (exaggeration for embellishment). At various times, power is led by coal, natural gas, oil or carbon permits, or varying combinations of these four. It keeps you on your toes.

  1. 4. The global reach of commodities. Trying to get your head around a domestic commodity like US natural gas is hard enough, let alone trying to determine how rampant Chinese oil demand weighs in with weak US oil refinery margins to influence UK Brent crude pricing. It surely can never be wholly mastered, but it sure is fun trying to decipher all these contrasting factors, from Corpus Christi to China, via Chiswell Street.
  2. 5. While leading participants in other markets try to hide their misdemeanors through a charade of smoke and mirrors (step up, Lehman Brothers and your Repo 105’s), the largest and most influential participant in the crude complex (Opec) continue to defy their own mandates (official quotas), while fully aware they will be called out on such dissention on a monthly basis. Refreshing.

6. How can you tire of a commodity such as US natural gas, when despite having all the sophisticated financial modeling and valuation tools in the world, prices remain at the mercy of the gods with hurricanes, heat, storms, and snow?

7. Technological advancement. Energy markets are constantly evolving through technological breakthroughs, and this will only continue through developments in such areas as LNG, smart grids, biofuels and green energy.

8. Forward curves. Not only do you have the ability to analyze commodities on the cash market or the front month contract, but you get to analyze the movements of the whole forward curve, going out for years to come. They are like a 3-D version of equities. And the forward curve is just as important as the prompt (or more) to energy risk management.

9. How markets in completely different geographical areas influence each other. Case in point, UK and US prompt natural gas prices have recently converged, due to their increased competition for LNG supplies. Fungibility + transportation links = an ever shrinking world.

10. Commodity markets are like equity markets are like bond markets are like currency markets. No matter how much you analyze a market, you will never master it. But we keep trying our darndest. And that’s why they rock.

2 Mar 4 2010 @ 9:04am by Matt Smith in Capital Markets, Crude Oil, Economy, energy consulting, risk management, Risk Strategy

Equities and Bonds = Pinky and the Brain

Last week I was up in arms about inflation (or its lack thereof), and how it could affect our dearly beloved commodities. This week (is no different from any other week in that) I’m trying to get my head around what’s happening in general markets, and am currently pondering equities and bonds. 

My interest is piqued by the aforementioned two tinkers, because if I can figure them out, I can color my paint-by-numbers portrait of the economic landscape, and join the dots on my canvas of commodities. There is method in my madness: equities have recently been a shepherd to commodities, specifically crude oil (for the last year, everywhere that equities went, crude was sure to go). As for the bond market, it is a barometer of both risk appetite and inflation expectations – both key influences on commodities.   

So here’s the scoop; while equities are looking like they are topping out (=risk aversion rising), I look to the bond market (and specifically Government debt) – which historically has an inverse relationship with equities (equities = risky, bonds = safe) – to give some indication for future growth and inflation. So hence in this current environment, equities and bonds = Pinky and the Brain.  

The Brain: Are you pondering what I’m pondering?
Pinky: I think so Brain, but burlap chafes me so.
    

The bond market - more intimidating than Mr T.

‘So what’s the big deal about the bond market?’ I hear you ask. (I will now try to avoid being super-dull and muzzle the market-nerd in me). Essentially the bond market is considered to be the wisest of all asset classes. The Brain, if you will. One of the most famous quotes about the bond market was made by James Carville, who famously quipped “I used to think if there was reincarnation, I wanted to come back as the President or the Pope or a .400 baseball hitter, but now I want to come back as the bond market. You can intimidate everyone.” This is because the bond market tends to be the voice of reason when other asset classes are losing their heads. For example, the change in 2-yr Treasury yields is a good way to gauge economic sentiment; they will rise as optimism grows (because expectations increase for a higher interest rate), or vice versa. As for 10-yr Treasury yields, they provide an indicative view on longer-term inflationary expectations. There are many factors that go into the bond market – too many to put onto the chopping board right now (quantitive easing and gaping budget gaps are current quandaries…while bond guru Bill Gross highlights further problems here) but my main take-away is that the bond market is a tool to assess the outlook for near-term growth and inflationary pressures, which we can then apply to our outlook on commodities.       

The Brain: Pinky, are you pondering what I’m pondering?
Pinky: I think so, Brain, but if they called them “sad meals” no one would buy them.
  

I have faith in the bond market. Like the Brain, it is deadpan, composed and smart. As for equities, all I have to say is P to the I, to the N-K-Y. They are scatter-brained, emotional, and seem to enjoy being hit over the head. And as life imitates art, the bond market is always teaching equities a lesson, time and time again.    

The Brain: Pinky, are you pondering what I’m pondering?
Pinky: I think so, Brain, but how will we get the Spice Girls into the paella?
 

So to draw this tail (I tried to resist) to an end, both of our heroic characters in today’s story could be bearish influences over the coming months. Equities could potentially scurry lower, while bonds yields are resisting the apparent urge to scamper higher (=prices lower) as deflationary or double-dip fears could develop. With these potential headwinds, commodities are likely to find it increasingly tough to take over the world, tonight, or any time soon.

0 Jan 21 2010 @ 10:55am by Matt Smith in Capital Markets, energy consulting, Natural Gas, risk management, Risk Strategy

What’s the worst that can happen?

bang!‘A cynic is a man who, when he smells flowers, looks round for a coffin’ – HL Mencken

There is nothing wrong with being cynical, and there is nothing wrong with preparing for the worst. And it shouldn’t be a surprise to see this written by someone in risk management; after all, we spend more time assessing downside risk than a professional bungee jumper. 

One of the key drivers of energy risk management, or of risk management of any kind for that matter, is to mitigate risk.  But how do you quantify risk? And why? Lacking a better way to quantify the unquantifiable, a rather unhiply-named gent called Eugene Fama coined the empirical measurement for risk – volatility.

Accurately and consistently quantifying risk (or volatility) in commodity markets is as easy as doing a cartwheel underwater (impossible – just try it), as the extreme movements in natural gas from $13.69 to $2.40 in little more than a year, so dramatically proves. But by equipping yourself with a Batman-like utility belt natureof tools for assessing the potential evolution and volatility of a market – from macroeconomic models and Value at Risk (VaR) to technical analysis – means you can come up with a plan with which you are comfortable. And this plan will be guided by your own tolerance – i.e.  how much risk/reward you are willing to and able to accept when taking a position (or not)  in a market.

So back to the original question: what’s the worst that can happen? The simple answer is we don’t know, because no-one is able to exactly predict the future. But if you have a robust enough risk strategy in place that prepares you adequately for the worst, it doesn’t matter as much what the worst-case scenario will ultimately be; you will be in a strong enough position to defend against whatever the market may throw at you.

0 Dec 10 2009 @ 9:45am by Matt Smith in Crude Oil, Global Energy, Natural Gas, Risk Strategy, UK natural gas

On the twelfth day of Christmas….

On the twelfth day of Christmas,
Summit Energy gave to me –

dashboarDView

Twelve CarbonMaps™,

Eleven consumption workshops,

Ten special market updates,

Nine budget projections,

Eight thousand bill validations,

Seven rates analyses,

Six hedging strategies,

Five new site rollouts,

Four renewable energy portfolio optimizations,

Three French RFPs,

Two Summitized contracts,

And a password and access to DV*!

 


 

In addition to the above ditty, please see below our efforts to keep in Santa’s good books. This year we must be odds on favorites for good presents as we have helped him go green. Click on the image below to see us making sure we don’t get coal the fruits of our labor:

Santa's Energy
*DV is DashboarDView, Summit Energy’s online sustainability and energy reporting platform.
2 Oct 27 2009 @ 4:15pm by Matt Smith in Risk Strategy

Clichés that apply to energy risk management

A stitch in time saves nine – we dive straight in with a classic cliché, and perfect energy consulting risk management lingo: a good hedging strategy ultimately protects. Saving stitches is what it’s all about.

Getting all your ducks in a row – whether you are hedging or simply managing your energy usage, data collection and verification are key. Having correct data is the first step to implementing any type of strategy – from bill verification to budgeting or risk management.

Don’t put all your eggs in one basket – a good risk strategy involves layering in, not jumping into a market 100%. You never know what is going to happen in the future, although identifying and mitigating some of that risk is vital. It is also against cliché law to count your eggs before they are hatched.

Diff'rent strokes

Diff'rent Strokes

odd

Diff'rent Folks

Different strokes for different folks – admittedly this may immediately make you think of Gary Coleman, but is nevertheless a key point in energy consulting. Defining a client’s risk tolerance is the first step to risk management. Understanding a client’s risk capacity and financial adequacy to take on market risk is vital. Without establishing a risk strategy, you do not know whether your client’s goals are to beat their budget or beat the market – two very different things.

Closing the barn door after the horse has bolted is a classic occurrence when clients ignore advice and believe they know better. While we never profess to be able to call the bottom of the market, if we recommend taking coverage and you don’t, please do not complain when prices run higher. Of course we won’t say ‘we told you so’, but please be aware that our inner voices are screaming it in our heads.

Every dog has its day – yes it does. Complacency is a terrible thing. What’s it good for? Absolutely nothing. Even the most beaten-down commodity has its price level at which to entice bargain hunters. We will try to stop you falling prey to one of the oldest tricks in the book. Say it again.

A bird in the hand is worth two in the bush – once again, perfect risk management lingo. Hedging out some of your uncertainty at a price you are comfortable with should leave you feeling safe and cozy and free to focus on value-adding pursuits for your firm. It’s all about having birds in a hand to save stitching nine of them (or something like that).

You can pick your friends, you can pick your nose, but you can’t pick your friend’s nose – am still trying to work the angle of this one for energy consulting.  But take heed, it is wonderful advice nonetheless.