«No free lunch»
Managing risks in the energy business – an Axpo strength
Everything has its price. Profits cannot be generated without taking on risks. This truism also applies to the energy business. However, when they are well managed, risks can also create added value. How does that work? Hmm! A clarifying conversation with Vlatka Komaric, Head of Quantitative Risk Management, about "PnL" and a not so simple topic.
So you always wanted to know how things work in Risk Management and Quantitative Risk Management at Axpo. Do you like mathematics, particularly statistics and probability calculations, and the constant change of the energy market? Are you interested in terms like mark-to-market, profit-and-loss (PnL), value-at-risk (VaR), cash flow or Greeks (see box)?
But you should be. According to Vlatka Komaric, Head of Quantitative Risk Management at Axpo Trading, the topic is "extremely interesting". Risk management means: The methodical, future-oriented handling of risks and ultimately creating customer benefit. It's about "managing risks, portfolio management and hedging, reducing/eliminating risks, as well as about controlled maintenance of risks as long as the company's risk appetite is not exceeded," explains Vlatka. Her team of eight comprising mathematicians, physicists, and econometricians is "responsible for everything having to do with quantitative models to assess and measure risks in various areas."
Measuring with models
This not only includes market risks, power price development, price or volume risk, but also currency, interest and credit risks. It is crucial that one "really totally understands" the product or complex deal that the originator or trader wants to process, says the woman from Croatia.
This is the only way to ensure "that everything that is traded at Axpo Trading can be reasonably assessed, and only things that can be measured can be managed properly."
Suitable probability distributions or stochastic models, methods and concepts are used for the modelling, assessing, summarising and analysis of risks. For example, one uses a forecast model that is based on historical data (time series analysis) from which one can a read out patterns and behaviour to apply them to the future. "Knowing full well that the future might not develop the way the past did," says Vlatka. "No one knows what's going to happen in five seconds."
Not too optimistic, not too conservative
Models like the Monte Carlo simulation that works with a random generator are used in quantitative risk management. However, that doesn't mean that one simply throws the dice and whatever happens happens. On the contrary, these models also follow a certain pattern from the past or other, additional determinants.
It is important that the common models from literature are very precisely adapted to our own products and projects, "and one has to be innovative here and have a great deal of knowledge," comments Vlatka. Quantitative modelling leads to a prototype. The prototype is tested ("Does it calculate what I want? Does the result make sense? How can I report results?") and its stability verified. Ultimately the model must function day in and day out and deliver possible profit-and-loss prognoses, and risk indicators such as value-at-risk.
The aim of the work is to achieve a solid assessment. "We do this with a realistic analysis. Our view must not be influenced by the front, but at the same time it should not be too conservative because we don't want to hinder business development," says Vlatka. And everyone knows, profits can only be achieved if one takes on some risks and as the saying goes "There ain't no such thing as a free lunch." It's important to be able to assess what risks in what magnitude are being carried by Axpo. If risks are high, the Axpo Trading MB or the Axpo EB has to decide whether the business should be pursued based on the quantitative analysis and assessment.
How does the customer benefit from Axpo's first class risk management? The customer benefits from a more favourable price or innovative products that generate added value. This is how the "Exit Option" product came about. The "Exit Option" allows the early termination of a contract against a fee, for example in the case of an unforeseeable market change. That's also risk management - an exclusive Axpo service.
With the company for a long time
Vlatka Komaric has been doing her job for over 10 years after completing a mathematics degree at the ETH Zurich where she discovered her penchant for statistics and stochastic analyses. She first worked for the former EGL and today she's with Axpo. Right after completing her studies she worked at Credit Suisse in credit risk portfolio management for five years.
She finds the energy market particularly interesting – the daily work is determined by the front (traders, originators) and is "demanding and challenging". Critical, constructive discussions and sometimes even a fight that moves both sides forward are part of the process. Today the products are much more complex than ten years ago. As a result, the work changes constantly and that's why she enjoys it so much.
Axpo Trading is considered strong in risk management. Vlatka knows why: On the one hand, Axpo is strong in risk hedging, and on the other hand in quantitative risk assessment. "We are fast, we are flexible, we understand what we're doing and can adapt quickly. And: We have a lot of know-how in the area of models and markets, and good cooperation among colleagues!"
The list of terms that risk managers must know inside out is a long one. Below you will find a few of them explained briefly.
Risk: The term risk has its roots in Greek and stands for cliff/danger. It is defined differently depending on the scientific discipline. A risk is considered an uncertainty in connection with an event in the future that in the negative case (danger) can result in damage or loss of value, or in the positive case (opportunity) in a benefit or profit.
Risk management is the methodical, future-oriented handling of risks. This can involve general business risks or special financial risks. Risk management includes the following tasks: Identification of risks (exposure), establishing a strategy for handling risks, assessment/measurement of risks, reporting, monitoring and controlling, as well as allocating risks.
Stochastic analysis: This is a part of mathematics, the generic term for statistics and probability theory.
Mark-to-Market: This is the cash value of a transaction or portfolio and indicates the total value.
PnL, also known as P&L: Profit-and-Loss, the profit and loss of a transaction or a portfolio. PnL = value today - value yesterday. PnL is calculated for Axpo products on a daily basis. A "PnL Explained" is a report that associates the daily value fluctuations of a portfolio of trading transactions with the possible causes.
Value-at-Risk represents a specific risk measurement for an individual product or portfolio comprising several financial positions. Based on the risk measurement, it is possible to deduce the maximum loss within a fixed time span under a certain probability. Residual probability indicates how often the loss will be higher on the average.
Greeks: The Greeks (delta, gamma, vega, rho and theta) are indicators used in options trading. They measure the sensitivity of changes in price, volatility, interest or term. In the power business, delta is primarily important and is, simply put, the indicator for the dependency on price changes.