THE RISK MANAGEMENT PROCESSES IN
ELECTRIC ENERGY TRADE IN POLAND
Dąbrowska-Kauf G.
Electrical Power Engineering Institute, Technical University of Wrocław, Wrocław, Poland
Abstract: Participation in the electric energy trade in the competitive electric energy market in
Poland involves exposure to specific types of risks which may cause dangers for business run by the enterprises. In the article, the risk management processes connected with electric energy trade will be described in the object-functional approach. This means that elements of actions connected with the risk management will be determined for all players in the energy market, transfer system operator, electric energy producers and trading enterprises.
1. Introduction
The units dealing with production, transfer and distribution of electric energy, as well as energy operators and trading units run their business in the electric energy market in Poland. The electric energy market is a real time market the characteristic feature of which is delivery of energy at the moment when the demand appears, because energy storing capabilities are minimal. The superior objective of functioning of the electric energy market is to ensure: rational prices for the customer, deliveries of energy with any required quality parameters, and to guarantee market profitability to the units running their business in this market. The level of risk is particularly important in the electric energy market because considerable and fast fluctuation of prices and demand values are recorded in this market. The power engineering enterprises in Poland undergoing privatisation processes run their business in the competitive market in which chances of higher profits from any investments made are going up and risks connected with incurring of financial losses are increasing. The increase of the risk to which power engineering enterprises are exposed is affected by scattered responsibility for maintaining safety of the power engineering system, fast growth of the number of new companies dealing with electric energy trade, and also the possibility of using the principle of the clients’ freedom in choosing energy suppliers. The characteristic feature of the electric energy trade is growing importance of short-term contracts, transactions concluded in electric energy exchanges, and higher differentiation of energy delivery terms depending on characteristics of the client groups.
2. Market risk management
Participation in the electric energy trade in the competitive electric energy market in Poland involves exposure to specific types of risks which may cause dangers for business run by the enterprises. One of the risk types is the financial risk, dynamic in its nature[1]. The basic objective of risk management by the power engineering enterprises is minimisation of potential negative effects of the risk with simultaneous minimisation of costs connected with this. The basic methods used to achieve this purpose are:
controlling the risk, that is minimising, at the lowest costs, effects of these types of risks to which the enterprise is exposed, and as a part of this: avoiding the risk which, however, may at the same time mean giving up a series of chances which appear due to participation in the electric energy market,
limiting the risk which may have the form of preventing its occurrence (reducing
probability of occurrence and potential negative effects),
financing the risk, i.e. ensuring availability of funds necessary to cover any potential losses, used in the case of the following methods:
- conscious and voluntary incurring of the risk,
- transferring the risk to those units which are prepared in the best way for management of a specific type of risk, among other things on the basis of concluded insurance contracts,
- distribution of the risk which is an intermediate form between incurring of the risk by individual enterprises and transferring of the risk to a group of enterprises. Fig.1 presents the risk management methods.
Fig. 1. Methods of market risk management RISK MANAGEMENT
Controlling the risk Financing the risk
Avoidingt
he risk Limiting the risk Transferring the risk
the
risk
Incurring the risk
Actions within risk control may limit its level to a high degree, however the remaining part of risks must be covered by risk financing – risk transferring and incurring -techniques. The main risk transferring actions include insurances which mean transferring of a specified scope of risk from a power engineering enterprise to another unit (insurer) according to stipulated terms and conditions. Incurring of the risk is constrained to ensuring of adequate funds which will enable financing of a potential loss, not losing the ability of further functioning by the enterprise.
The managing boards of power engineering enterprises taking part in the electric energy trade are obliged to ensure execution of all elements of the market risk management process i.e.:
establishing objectives,
identifying various types of risk, evaluating risk level,
evaluating and choosing risk management techniques and tools, implementing and monitoring the risk management system. For the risk management purposes, it is necessary to [2]:
ensure continuity and stability of the company’s functioning, and also its
development,
limit uncertainty with respect to occurrence and effects of any probable events, ensure economically justified financing of actions connected with risk management,
meet any external obligations (including any signed agreements and general regulations).
3. Identification of risk incurred by all or most of the market players
Basing on the analyses of risks appearing in the electric energy market in Poland, it can be stated that nature of a part of these risks is permanent, inherently connected with the competitive market, and resulting from its structure and binding principles, and nature of another part is temporary, resulting from the process of introducing the market with new characteristic features and conditions coming from the period when the centralised market was functioning e.g. effects of any long term contracts concluded previously.
The following types of risks appear in the electric energy market [4]:
risk of changes (fluctuation) of electric energy prices – this risk has an influence on
revenues and profitability of the business, and also on the costs of any additional contract obligations in the electric energy trade. It appears in competitive electric energy markets, especially if the prices are determined in the real time and undergo significant fluctuations in individual settlement periods. Any movement of electric energy production in time may be connected with the risk of obtaining lower prices
and revenues for the production enterprise, although the production will be maintained in a longer perspective,
limited (system-related) risk – is the risk caused by the possibility of not obtaining dues in the trade because of the fact that one of the market players (not necessarily being a party in the contract) is not able to cover their liabilities, and any difficulties in settling of the accounts by one or several trade players are transferred to the others,
risk of losing liquidity in the market – results from the lack of free option of trading basic or derivative contracts in the initial phase of market development, this concerns the energy exchange and balancing market,
contract risk – is connected with the possibility of not being able to settle liabilities by
a direct party of the contract,
operational risk – is connected with the risk of incurring losses just because of
participation in the market and conclusion of transactions,
legal risk – is connected with the lack of possibility of fulfilling contract obligations because of legal reasons,
risk resulting from civil liability in connection with losses incurred by third parties
due to business run by the enterprise in the market.
All participants of the electric energy market are exposed to political risk and regulation conditions. The political risk may appear as lack of consistently followed power engineering policy.
Apart from this, one symptom of political risk is uneven distribution of economy restructuring costs into sectors and individual enterprises. This concerns especially transferring of costs of fuel sector restructuring to power engineering enterprises. Other risk may involve the possibility of differentiating economic situations of individual enterprises on the administration basis, among other things in the sector privatisation processes. The regulations-related risk depends on:
regulatory integration in the areas of developed competition (e.g. approving tariffs for
manufacturing companies and companies taking part in energy wholesale in the case of full competition in this segment of the market),
lack of clear principles of enterprise tariff regulations (considerable area of interpretation ambiguities), including particularly network enterprises,
lack of operating procedures to be followed with respect to regulating bodies, which
may lead to delay of a decision.
The basic actions aimed at control (limitation) of risk for all trading players in the electric energy market include:
implementation of generally binding standards and procedures referring to electrical
power engineering equipment, production, maintenance and operating principles, cooperation with the power engineering network, qualifications of personnel, procedures in the event of breakdowns and risks,
implementation of systems and procedures improving reliability and operating safety of electrical power engineering system,
conditions, procedures and mutual arrangements implemented mainly on the basis of contracts, concerning in particular detailed terms and conditions of connecting to the network or individual terms and conditions of cooperation within the electrical power engineering system.
Internal systems, principles, procedures, standards and conditions referring to players
of the electric energy market implemented by individual power engineering enterprises.
With respect to risk financing, the method most frequently used is transferring of risk in the form of various type of insurance contracts and contracts ordering performance of a specific scope of the enterprise business.
4. Risk management by the transfer system operator
Although the transfer system operator runs the business in the circumstances of natural monopoly and is subject to strict regulations of President of the Power Engineering Regulation Office, he is exposed to a series of risks out of which the major ones are:
risk resulting from responsibility due to rendering of transferring services. Services of
this type are performed by the operator on the basis of a uniform tariff approved by President of the Power Engineering Office to all authorised units,
risk of prices change for quality and system-related services, necessary to ensure
reliable operation of electrical power engineering system and quality of deliveries [3],
risk of losing liquidity in the balancing market and in the market of quality and system-related services,
Risk resulting from civil liability for damage (losses) of third parties, including in risk the ones due to connection to the transfer network and service rendering. It results from terms and conditions of any concluded contracts or general regulations,
legal risk – consists in the lack of possibility to fulfil obligations (for example in the
balancing market, system service market) for legal reasons.
Limitation of the risk connected with rendering of transferring services is performed by establishing a maximum threshold of the operator’s responsibility on a stipulated basis. It means that the operator defines in advance his responsibility for one undelivered unit of energy up to a specific standard amount and this is taken into account in the operator’s transfer tariff.
The transfer system operator may pass on the risk of losing liquidity in the balancing market and in the market of reserves and system-related services by passing on the function of conducting auctions in the energy exchange. On the other hand, the organic and contract risk in these markets can be transferred by the operator to the clearing house which will have systems and procedures of controlling credibility of units participating in
the market, and will also ensure financing of the risk by collecting operating charges and financial security.
Limitation of the political and legal risk can be achieved as a result of actions taken by the Polish Association of the Transfer System Operator which should participate actively in legislation processes in the area of electrical power engineering, defining of power engineering policy of the country and regulations concerning activities of electrical power engineering enterprises.
5. Risk management by the electric energy producers
This group of units includes power engineering enterprises dealing with production of electric energy and taking part in the trade and in the system balancing market. Production units can be connected to transfer and distributing networks. The basic types of risk for electric energy producers may include:
risk of changes of electric energy production volumes which may negatively affect volume and stability of the enterprise revenues, unit fixed production costs, and as a consequence profitability of the enterprise. This risk may have an internal source, when production limitation is caused by technical and process, organisational, social reasons. It may also come from the environment, e.g. it may result from general economic situation, interruptions in fuel supplies or system-related limitations affecting production volume, force majeure events, and even weather changes. It is connected also with domestic and foreign competition,
risk of changes of electric energy prices in wholesale and in the balancing market, in
particular by introduction of systems of establishing prices in real time (energy exchange and balancing market), which may also negatively affect volume and stability of revenues,
risk of price changes for fuels used for production of electric energy.
Evaluation of the producers’ risk should cover establishing of a possible level of loss (or lack of revenues) and probability of its occurrence or frequency of occurrence, which may provide a criterion for developing of a ranking of risk in production company and taking economically justified actions connected with risk management. The evaluation should include an estimation regarding probability of occurrence for events with specified effects for the given producer, normally on the basis of historical data and theory of probability
.
In the case of electric energy producers, volume of capital involved and lack of possibility of undertaking any alternative production precludes the possibility of avoiding the risk (giving up the share in the market). The basic actions aimed at risk control, apart from the general actions indicated as actions of all energy market players, may cover also [3]:
diversification of electric energy sources, including spatial, technological diversification and diversification basing on manufacturing capacity of the units,
diversification of fuels for electric energy production, sources and directions of fuel supply,
plans of actions in emergency and catastrophic situations, recovering production
capacities and limiting negative effects for other units in the market,
actions aimed at transferring the risk to other units.
6. Risk management by the electric energy trading companies
Apart from the listed common types of risk, the power engineering company dealing with electric energy trade should take into account mainly:
risk of energy price fluctuations in the wholesale market,
risk of sale volume changes, which is connected with the possibility of choosing the
supplier between domestic and foreign competitors by a growing group of clients,
regulation-related risk connected with establishing of prices regulated in the retail
trade,
temporary organic risk connected with potential lack of possibilities of fulfilling obligations contained in long term contracts for deliveries of electric energy concluded with producers. Contracts of this type were signed by Polskie Sieci Elektroenergetyczne S.A. (Polish Power Engineering Networks Joint Stock Company) in order to ensure financing of modernisation and development investments.
Risk management in the electric energy trade covers mainly:
transferring the liquidity loss risk by using the services of units supporting market
transactions. These units place offers for contract purchase and sale, and maximum difference between the purchase and sale offer is regulated according to principles valid in the market. This allows other participants in the trade to conclude transactions in a free way regardless of current volume of the trading contracts,
transferring the organic (system-related) and contract risk thanks to using of a
clearing house for settlement of accounts between trading units. The clearing house becomes a party and takes over contract liabilities towards each of the trading units (e.g. in the energy exchange or balancing market). Limitation of level of the organic and contract risk resulting from long term contracts on the side of trading firms will be achieved by introducing the principles of transferring it to other units, including especially electric energy clients. In the case of their liquidation, considerable reduction of this type of risk will be take place,
limitation of operating risk among other things by appropriate employee training,
planning and supervision, development of systems supporting participation in the market and monitoring of the company’s own position in the market,
limitation of legal risk by standardisation of contracts and control of credibility for units approved for participation in the trade, especially by objective licensing. Furthermore, the risk of price fluctuation and sale volume can be limited by introduction of transfer charges the component of which will include costs of maintaining local production reserves. In this way, any costs of modernisation and development of the domestic production sector would be charged to the business of all enterprises making use of the transferring services, thus ensuring equal conditions of competing for energy produced in the country and abroad and preventing the destroying external competition where marginal variable production costs are the basis for short term establishing of prices.
7. Conclusions
Participation in the electric energy trade in the competitive electric energy market in Poland involves exposure to specific types of risks which may cause dangers for business run by the enterprises.
The basic objective of risk management by the power engineering enterprise is minimisation of potential negative effects of the risk with simultaneous minimisation of costs connected with it. In order to achieve this objective, first of all it is necessary to identify the types of risk characteristic for the given player in the electric energy market and use methods enabling: controlling of the risk (i.e. as a part of this, choose risk avoidance or risk limitation strategies), financing the risk (i.e. ensure availability of funds necessary to cover any potential losses) and distribution of the risk. Description of the risk management processes for the risk connected with electric energy trade in the object-functional approach enables establishing of the elements of actions connected with risk management for the energy trading units.
References
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