THE AUSTRALIAN liquefied natural gas sector is in a period of transition.
The building phase is nearing completion and is entering the production phase.
By 2020, the number of operating LNG trains will grow from nine to 21 and it is expected Australia could become the world’s largest exporter of LNG.
So the LNG sector needs to move – and move quickly – from being experts at building LNG trains to being industry leaders at selling the product produced by these trains.
We must realise the market and the needs and demands of our customers are changing.
To realise the full potential of the LNG market we have invested so much in, we need to ensure as a sector we are equipped to lead the selling, trading and marketing of LNG across the Asia Pacific region.
The evolution of LNG markets, and the increase in sales and marketing activity and complexity, will place high demands on existing and new operations, and their owners.
The need to establish and drive maturity growth in their marketing and trading functions, with a risk management framework a crucial part of meeting these demands, will become increasingly important, if not critical.
Energy trading risk management (ETRM) frameworks are commonly used by companies in the energy and commodity trading arena to assess and manage their day-to-day risks as well as their long term exposure.
The development of energy trading risk management capabilities is paramount to allow companies to ensure that market, credit, funding/liquidity and operational related LNG exposures remain within the accepted risk appetite defined by company boards.
A mature risk management framework should capture the complexity of the underlying portfolio, while the overall risk management approach should be tied to the strategic objectives of the organisation.
ETRM frameworks are, however, a continual work in progress for many organisations seeking to refine practices over time.
The practical implementation, internal organisational and quantitative risk management knowledge requirements are challenges even for those perceiving themselves as well established.
In particular, in dynamic and volatile environments such as the LNG and oil market, risk management becomes increasingly complex and requires dedicated competencies and people, as well as specific policies, processes, tools and systems.
As the market evolves, the capabilities and expertise of sales and marketing teams to deal with these changes across the LNG sector will be continuously tested.
There are 12 principle components that make up an effective ETRM policy framework.
These components are critical to managing risk in the emerging area of LNG marketing and trading operations.
They are as follows:
- Energy risk policy
- Governance and committee structure/charter
- Roles and responsibilities across the three office structures
- Clear segregation of duties
- Authorised transcripts/counterparties (including country risks)
- Approved manual of authorities
- Quantitive risk measurement
- Limit framework
- Regular risk reporting
- Operational risk, legal and compliance reporting
- Breaches register and remediation
- Deal capture system and risk infrastructure
Successful exposure management
Successful companies are the ones that stay abreast of economic trends and market developments and only accept a level of exposure that can actually be managed in case an adverse event or a market shock materialises.
Such companies define risk in a way that is consistent with the strength of their balance sheet and with liquidity ratios/rating requirements.
Failing to manage exposure, or failing to understand the complexity, interplays and potential implications of adverse market movements can lead to catastrophic consequences for companies that were once seen as ‘financially healthy’.
What companies need to do:
- Identify their current level of maturity – from market, credit, liquidity and operations risk perspectives
- Map this level of maturity to their agreed energy trading risk appetite
- Develop an action plan to remediate unacceptable energy trading risk management gaps and mature the approach, ensuring a prioritised portfolio view of energy trading risk and alignment to strategic objectives and capital structure
- For exposures the organisation is willing to bear, understand the enterprise-wide implications. Ask yourselves, for example, if shareholders do not require market risk or price exposure to be hedged, have the cash flow implications of volatility and the resulting capital requirements been quantified?
- Execute the action plan and create a feedback loop into the energy trading risk management approach.
As the LNG sector continues to undergo substantial and disruptive change, drawing on external perspectives and maturing portfolio risk approach will be key to protecting value.
This article is an excerpt from a paper recently published at APPEA 2016 by Deloitte: Sales and marketing of LNG is evolving. Are you prepared?