What credit crisis?

Louis Caron,RiskAdvisory, Calgary

The credit crisis is not over. It's never over. The lesson of 2008 is that crises revolving around credit constantly loom on the horizon, especially for companies engaged in the production and trading of oil and gas. Given the unprecedented speed and economy–wide reach of the last event, prudent companies should prepare today as though the next credit crisis will occur tomorrow, next week, or next month.

While the current benign environment of sufficient liquidity may be a temporary lull of indefinite length, the factors that contributed to the recent crisis — and indeed the Enron meltdown before it — should continue to be a chief concern for risk officers and senior management at companies up and down the oil and gas value chain. Those factors were global, not local, and the economic domino effect experienced around the world only served to further spotlight the number of exposures energy companies should regularly measure.

The good news is: energy companies seem to get it this time around. They must be acknowledging the speed with which the dominos can fall in this highly interconnected global industry, because our company's new business pipeline has never been fuller. Energy producers and industrial users seem to be calling us almost daily to discuss how their information technology systems can be utilized to get a better handle on credit issues. Indeed, oil and gas companies are prioritizing credit as the key concern for their energy trading and risk management platforms.

These discussions give us some unique insight into methods for softening the potential negative impact of the next outbreak of worldwide liquidity problems. We'll call the solution the credit risk two–step.

Step one: data integration

Oil and gas companies know they are data–heavy and information–light. Over time, they've added various systems that were intended to manage different business operations, from production to shipping to regulatory compliance. The result is a hodge–podge of data inputs and data outputs that, if integrated and managed properly, could generate insights, analysis, and forecasts to help the company manage its credit exposures and mitigate the impact the next time a domino falls.

Unfortunately, most of the calls we receive suggest companies don't have much confidence in their current systems' ability to create a holistic view of their organization's exposure to its enterprise–wide trading positions. They have difficulty bringing the data into one common framework that would provide a net position. Without a singular view of the truth of the company's financial situation, there's more at stake than an accurate assessment of risk: Without the full picture, profitable opportunities are also sliding by.

A holistic view would bring all credit risks — all exposures to one or more trading partner and any other economic factor — into a single system, allowing the company to run an array of credit analytics in real time. The sure–bet trading opportunities can be acted on, the aggregated risks can be contained.

For example, a company might have multiple contract exposures to a single trading partner but not have a complete picture of all those contracts, since they are handled in different silos of the organization. These are multiple, separate contacts with the trading partner, but they all feed into a single risk profile that's dependent on the partner's overall financial well–being as well as the timing and fulfillment of the various contracts. That's precisely why tabulations of risk using internal data sources aren't sufficient in today's business world.

To be truly holistic, a company's risk exposures have to include data and information from external credit risk resources, like Moody's Investors Service, Standard & Poor's, and Fitch Ratings, to name but a few. Combining internal and external views of credit exposure at least gives a company the confidence to say it knows what is going on. What it can do with that knowledge requires another step, into the realm of analytics.

Step two: business analytics

Integrating internal and external data in one place allows management to gain a holistic view of the enterprise's risk. But then the real challenge begins: converting data into information.

The companies we hear from today are more focused on dashboards, reporting modules and cubes than ever before. Many of those were deployed before the recent credit crisis and they worked in nominal fashion. The flaw might be that there's been too much focus on gaining an overview, and too little emphasis on gaining insight.

That's where analytics — real–time analytics in particular — can play a critical role, especially if the oil and gas concern operates under the assumption that the next credit crisis could occur overnight, in the domino effect fashion we saw in 2008 and early 2009.

Analytics give you the ability to conduct a wide variety of what–if analyses, including simulation–based at–risk metrics, risk factor sensitivity, market scenario modeling, portfolio stress test, and the full range of exposure, portfolio, and liquidity tests. There's no shortage of insight that can be gained from these sorts of analytical tests.

Today's oil and gas markets are characterized by sufficient but relatively low liquidity, so companies must stay focused on credit analytics. Credit risk managers must understand new measures of credit worthiness for their counterparties. Receivables, mark–to–market, and potential future exposure tests are the standards and should still be used regularly, but new measurement should focus on liquidity and counterparties' ability to raise money.

Think of the largest industrial purchasers of energy, especially capital–intensive utilities. If they can't access capital for their purchases, that creates a serious problem further up the production chain. We've already seen this dynamic at work. Remember when the LIBOR rate jumped to 2.9% in April 2008?

Past measures of credit worthiness like receivables and mark–to–market are good, but when liquidity is the concern, cash is king. Credit spreads, open interest on exchanges, and other measures offer more insightful alternatives for taking the temperature of your counterparties and the traded market as a whole. The task is whether the oil and gas companies' IT systems are up to the task of consolidating all those measures into one consistent analytical picture that can inform decisions that, in today's market, have to be both timely and prudent.

Avoiding missteps: the technology solution

It's true, today's trading and risk management concerns are more complicated than the issues the industry has had to manage in the past. To handle that complexity, companies need to invest in more sophisticated risk solutions in order to gain a full picture of what's going on inside and outside the organization, and have the confidence to act nimbly when that next domino begins to tip. It's time for the industry to truly absorb the painful lessons of past crises, from Enron's rapid implosion to Constellation Energy's hapless overexposure to international credit failures.

Ideally, the oil and gas company challenged by today's low liquidity or tomorrow's looming crisis will seek out a technology solution that combines in one platform all the data from counterparties, markets, prices, volatility, credit risk reports, receivables and potential future exposure. Then, by taking the final step towards embracing grid computing for real–time number crunching of billions of data inputs, that company can react quickly and appropriately to the next crisis, whatever it might be, whenever it might come. OGFJ

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