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How the best get better

February 2017

Aegent was asked recently to make a presentation on risk management to the monthly Management Committee meeting at a chemical processing company. The company is exposed to several different commodity price risks, plus foreign exchange risk as it sells in North American markets.

The company is among the “Gold” list of Canada’s Best Managed Companies (having been so honoured for at least 4 years in a row).  Being a sophisticated, well-run organization, it knows a lot about risk management already. But one particularly notable characteristic of this company is its open-mindedness – a willingness always to consider new ideas and new approaches and evaluate them on their merits.

So we jumped at the chance to lay out our natural gas risk management methods and philosophies for this group. Our key messages:

  • Make sure the objectives of the risk management program are clear to all members of the risk management committee.  Risk management is primarily about narrowing the range of likely outcomes, not about making the right guess on market movements. Is everyone on side?
  • Risk management costs money, so do only as much as you need to do. What is the risk tolerance of the organization? A quantitative approach to risk management removes ambiguity and enables the organization to know how much risk management is needed and when, in order to stay within its risk tolerance at lowest cost.
  • Simple risk management methods can be very effective.  Simple tactics like diversifying the portfolio are easier to understand and use and can be more cost effective than more exotic methods.

As an example of the latter, consider the diversification that is easily achieved by dividing up any hedging transaction into smaller parts that can be done at different times. If I bet a dollar on one flip of a coin, I have a 50% chance of losing my dollar. If I bet 50 cents on each of two coin flips, I still have a dollar at risk, but I only have a 25% chance of being completely wrong and losing it all.

So, instead of trying to answer “should I buy now or buy later?” consider instead buying some now AND some later.

The best managed companies are always challenging their current thinking, remaining open to new ideas and new approaches that can improve results. Evaluating your approach to energy price risk management against some proven effective methods can help to identify opportunities to better control risks and lower costs.