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CRA Capital Management in
Commercial Optimization
Jack Yeager
GEMI Conference
CHARLES RIVER ASSOCIATES
January 21, 2005
Capital Management – Capital Adequacy in Context
The challenge for every company is to both ensure adequate capital to
sustain the business while delivering returns that grow capital
Grow
Sustain
More Capital vs Risk could:
Taking on too much risk could:

Reduce cash flows and
earnings surprises

Increase profitability from
investments / transactions

Reduce amount of “selfinsured” risks

Increase amount of “selfinsured” risks

Increase Cost of Risk

Reduce quality of credit

Reduce availability of new
investments with acceptable
risk/return characteristics

Increase WACC


Reduce availability of
investments that satisfy hurdle
Reduce ability to introduce
new products to market


Reduce value of equity
Reduce availability of
counterparties willing to do
business

Reduce strategic flexibility

Reduce strategic flexibility

Increase Strategic Risk

Increase Strategic Risk
1
Capital Management - The Competitive Landscape
Energy Trading & Marketing Businesses are feeling increasing
competitive pressure from I-Banks & Private Equity to manage
capital more effectively…
Capital Management Strategy
Private Equity
Investment Banks
•Good deals seek capital
•Capital seeks good deals
•Deal level Transparency
•Competition breed discipline
Divest of
Assets
•Regulatory Assurance
•Compliance breeds discipline
Energy T&M
Transparent
Capital
Discipline
•Business model seeks capital
•SEC Financial Performance
•Ambiguity breeds complacency
2
Regulated
Capital
Requirements
Capital Management - Down & Dirty
The primary competitive advantage of Energy Trading & Marketing
companies is their experience in employing a variety of complex
commercial optimization strategies in delivering value…but this
advantage is only temporary
Hedging
• “hedge everything from
18 months to 6 months
50%, 6 months & in up to
90%”
• “hedge is part of portfolio
strategy & is put on based
on positions rules”
• “hedge is economic, but
distinct from speculative
trading, cost of collateral
is considered”
• “hedge expected
production plus 10%,
rather be over than under
hedged”
Balancing
Speculation
• “if you balance early, you
balance twice”
• “the entire group trades a
single point-of-view”
• “never carry more supply
than your expected
demand into the delivery
month”
• “each trader has the right
to trade their own pointof-view”
• “turn on swing within 2%
of economic price, you
can turn it off if you don’t
need it”
• “never carry an imbalance
into the on-the-day
market”
• “never signal your true
needs to the market until
the afternoon”
3
• “we primarily take large
positions on bets greater
than 150% RAROC”
• “we diversify, lots of small
bets, lots of locations &
tenors, on RAROC of 50%
or more”
• “ we are looking for the
bid-ask spread, the goal is
to close positions in 1 to 2
days”
Capital Management - Down & Dirty
The challenge for energy companies is to learn how to effectively
incorporate capital management discipline into their commercial
optimization decisions
Cum. Probability
S1 represents a speculative
strategy with 150% RAROC
thresholds, while S2
represents a strategy with
30% RAROC thresholds
0.8
0.6
0.4
0.2
0
-100.
0.5
Probability
Capital Comparison
1
-50.
0.
50.
100.
150.
200.
250.
Capital -WACOG
S1
Capital - S2
0.4
0.3
While S1 represents
virtually no risk of capital
lost, S2 provides the greater
expected return to capital
0.2
0.1
0
-60.
-40.
-20.
0.
20.
40.
60.
80.
Delta Capital (s1-s2)
4
100.
300.
Capital Management - Down & Dirty
As availability and cost of capital changes, so does the expected value
of each strategy, so that commercial strategy and capital management
become inter-related in optimizing portfolio value
30
25
20
15
10
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W/O Capital
5
W/ Capital
CRA Capital Management in
Commercial Optimization
Jack Yeager
GEMI Conference
CHARLES RIVER ASSOCIATES
January 21, 2005