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0 Apr 14 2011 @ 10:55am by Matt Smith in Crude Oil, Economy, energy consulting, Global Energy, Natural Gas, risk management, Risk Strategy

What The Wizard Of Oz Can Teach Us About Risk Management

I was off spinning my wheels on an idea for another post this week, when I came across the movie ‘The Wizard of Oz’, and I realized it provided some simple yet sage advice for energy hedging. Believe it or not, via Munchkins, Toto, and the Wicked Witch of the West, we can glean some useful tips to guide us through the minefield that is energy risk management:

Wizard of Oz: ‘Why, anybody can have a brain. That’s a very mediocre commodity’.

There can be few better required attributes when it comes to employing an energy strategy than those sought after by the three associates of Dorothy along her journey on the yellow brick road. The desired traits of the lion, the tin man, and the scarecrow – to be full of heart, courage, and brains – are three key qualities that are needed when deciding when (or when not) to hedge. It takes courage to remain committed to a strategy while realizing the potential risks in both upside and downside movements in price. After all, the yellow brick road makes us mindful of the unforeseen circumstances and danger that can appear at every turn, making it pay to stay on track. A strategy should inspire belief and comfort, and be something a company should take heart in.

Wizard of Oz: ‘You are under the unfortunate impression that just because you run away you have no courage; you’re confusing courage with wisdom’.

No, Elton; the movie not the song

That said, even when armed with these key traits, the perfect hedging strategy may still be like trying to find the Wizard of Oz himself – impossible. Risk mitigation means some gains may be left on the table, but this is the very nature of risk and reward. Just as investing in a risky stock may bring you riches or leave you burned, the same applies to energy hedging. That said, when investing in stocks it is generally a speculative play, whereas a purchasing strategy is about maximizing shareholder value for a company, while minimizing, limiting, and/or quantifying risk (or costs). And as the above quote outlines, even if you do favor a more risk averse approach, it doesn’t mean you lack courage; quite the opposite. A risk strategy is for the wise, and not for the yellow-bellied. By having a defined benchmark – be it mark-to-budget or mark-to-market – you can keep on the straight and narrow…yellow brick road.

Dorothy: ‘A place where there isn’t any trouble. Do you suppose there is such a place, Toto?’

Energy markets remain a most volatile environment. With ever-changing factors and influences – from supply to demand to technology to natural disasters – there are ever more signposts to follow and potholes to avoid. But it is for these very reasons that energy risk management exists; to help you avoid flying monkeys.

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