Introduction
Energy commodity trading is a risky business. Energy prices are volatile, over-the-counter (OTC) trading is the norm, commodities are non-standard, and Back Office processes are not fully-automated throughout the life cycle of a deal. Any company trading energy commodities is likely to need deep pockets and effective risk management controls if it is to survive.
The main risks associated with trading any commodity are:
- Market risk – the impact of adverse changes in the level or volatility of prices,
- Credit risk – the risk that a counter-party cannot meet contractual obligations,
- Operational risk – the failure of internal processes or impact of external events,
- Liquidity risk – the risk that the company cannot meet its payment obligations.
Other, wider business risks include:
- Systemic risk – the risk that the market or institutional framework fails,
- Regulatory risk – the risk that the regulator changes the market rules,
- Political risk – the risk that political changes affect the business,
- Reputation risk – the risk that a bad reputation affects business,
- Legal risk – the risk that contracts are no longer enforceable,
- Disaster risk – the risk that a disaster threatens business continuity.
But some risks are specific to energy commodity trading:
- Delivery risk – the risk of force majeure or other delivery problems,
- Imbalance risk – the risk of imbalance charges in balancing markets.
The Back Office plays an important role in reducing and managing risk by checking the details of deals done by traders, ensuring the prompt confirmation of contracts with counter-parties and managing the timely settlement of accounts due.
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