Delivering on Complex and Innovative Asset Management and Commercial Strategies in the Face of Increasing Compliance Requirements

By Charles Tooman, Managing Consultant, Global Energy Practice, PA Consulting Group

ENERGY COMPANIES AROUND THE GLOBE are facing an array of opportunities – and risks – that challenge even the most seasoned strategic decision-makers in the industry. From multinational oil companies recognizing unprecedented profits (while operating amidst fears of nationalism and growing political risk), to energy utilities realizing growth through mergers and acquisitions (while facing increasingly expansive and undetermined environmental standards), to power companies navigating through evolving market structures (e.g., Independent System Operators (ISOs) /Regional Transmission Organizations (RTOs), the rise of locational marginal pricing (LMP)), organizations across the value chain and in all commodities are being forced to devise innovative business and asset management strategies in the face of a host of unprecedented challenges in a competitive and challenging marketplace.

At the highest level, consistently meeting shareholder expectations (while also staying ahead of changing customer preferences and expectations and actively managing dynamic sources of risk) has never been more challenging. Indeed, the current market environment places a premium on devising and implementing business strategies to optimize not only the current asset portfolio, but also a broader process that enables the identification of asset acquisition or development targets while mitigating significant sources of risk to targeted financial and/or operating metrics.

Successfully meeting these challenges highlights the importance of a comprehensive and integrated asset management and risk management program, focused on optimizing the aggregate asset portfolio and operational decision-making within a strong control environment, and aligning the program with the organization's commercial strategy. For the most progressive energy companies, the successful integration of these critical disciplines is an indicator of relative operational maturity. However, in the context of an asset and risk management framework, energy companies across geographies and industry segments are facing a growing number of compliance requirements from regulatory, political and oversight groups making such operational maturity more difficult to achieve. From meeting internal control standards, to complying with reliability standards, to adhering to evolving accounting rules, the number of regulatory requirements continues to grow. In addition, the adverse effect of "missing the compliance mark" is growing. As evidence of this, Senior Risk Managers and Chief Risk Officers sited regulatory risk as one of the greatest threats to achieving business objectives, according to a recent Economist Intelligence Unit survey.

The question to industry participants then becomes how companies can best ensure that innovative strategies are developed and pursued to form an integrated asset and risk management framework within an increasingly stringent compliance environment.

Status Quo

Over the last decade, many energy companies have successfully implemented the core components of risk management required to actively measure, manage, and monitor complex portfolios of energy commodities. For most energy companies, attention has focused on identifying and managing sources of market and credit risk associated with procurement and distribution activities, as well as operations risks associated with a complex asset-based portfolio. When combined with active regulatory management, approaches to mitigate these sources of risk represent the primary focus of energy risk management operations.

During this same period, much has been made of the concept of enterprise risk management — a holistic approach to risk recognition and measurement that results in the ability to actively assess the significant interrelationship between risk factors. Simply, taken in isolation, discrete sources of risk may often appear contained and well-managed; however, understanding the correlation between risk factors is critical in order to identify the risks to eliminate through risk mitigation techniques, and the risks to actively manage. By definition, this effort is comprised of technological, business process, analytical and internal control methods, which when successfully implemented in combination yield a comprehensive energy risk management program. These concepts are nothing new in the discipline of risk management — the laudable goal of enterprise risk management has been popular in the financial and banking industry for at least 20 years, while the application of the same concepts in energy has been popular for at least a decade.

Similarly, the energy industry has embraced comprehensive asset management as a method of minimizing operations and maintenance spending, while optimizing asset portfolio performance. Like enterprise risk management, asset management is typically viewed as an overarching approach to managing the asset lifecycle – from concept through operations and finally retirement, explicitly recognizing the link between asset investment decisions and the asset physical performance. Comprehensive asset management requires equal attention in operational, organizational, and technological areas reviewed in light of market conditions, market assessment, and commercial strategy. For example:

*An organization builds a comprehensive strategy with an eye toward current market status and future market development, considering factors such as prospective supply and demand characteristics for key markets, sources of transmission and distribution "congestion", product and pricing conventions (e.g., LMP and capacity markets in power markets).

From the strategic view, dynamic asset management is a prerequisite to achieving objectives:

*Operational excellence is achieved when key asset management considerations (including major maintenance, additions/enhancements/retrofits to existing assets, and other operations-based decisions are focused on the requirements of the entire asset portfolio, and not through a process that views assets and related decisions individually.

*Organizational excellence is achieved when key asset management business processes are streamlined and functional hand-offs are clearly defined (including data and reporting), and where a culture of business process improvement is driven across the company, and accountability is driven through clear business process ownership.

*Technological excellence is achieved when decision-making across the asset management life cycle is supported by access to accurate and closely managed data, characterized by automated data flows and efficient and trusted analysis results across all business functions.

As with enterprise risk management, these areas are enablers to an overall asset management framework, in which focus is dedicated on assessing current and future operations vis-à-vis tangible metrics that enable decision making.

Developing the Solution

Neither enterprise risk management nor asset management are new concepts to most energy companies. Some of the most progressive and mature energy companies have developed comprehensive programs that fold fundamental concepts of enterprise risk management into asset management decision making. However, what is new and growing in importance is the requirement to recognize and adhere to the growing number of compliance, control, and operational standards of regulatory groups and oversight organizations. Although a great deal of attention has been paid to the Sarbanes-Oxley Act of 2002 (United States) (and the Turnbull Report (England and Wales) and Guidance on Assessing Control (Canada)), new compliance standards are increasingly impacting decision making and operations of energy companies around the globe. Importantly, a number of energy-specific events have led to increased scrutiny of asset and risk management operating activities and processes. From response time during natural disasters to safety and reliability concerns around pipeline and power transmission maintenance programs, a variety of industry-specific events have forced company executives and Boards of Directors to become more conversant in the linkage between asset and risk management concepts, the adequacy of existing compliance and control frameworks, and importantly, the appropriate method for managing the growing number of current compliance standards.

In addition, the number of compliance and other standards against which energy companies are evaluated continues to grow, in a number of categories, including accounting, operations, safety, and procurement & risk management (among others). Thus, energy companies in today's environment must not only oversee successful implementation of asset and risk management programs and demonstrate effective commercial decision-making, but also meet the evolving standards of oversight and standard-setting organizations to which current operations are compared. This means the migration from oversight groups and agencies that focus exclusively on issue-specific compliance topics to the inclusion of organizations that have the ability to directly impact the achievement of financial and strategic objectives from a more holistic view of company adherence by evolving compliance and industry standards. For example, credit rating agencies now apply a variety of assessment methodologies to energy companies once reserved solely for companies in the financial industry, which focus on sources of business risk, adherence to control and other standards relevant to the company's core business.

While leading companies are applying a project management approach to integrate and drive greater efficiency from efforts to meet compliance efforts, understanding only the "burden of proof" associated with any single or combination of compliance standards is not sufficient. The various compliance requirements that influence asset and risk management strategies must be clearly understood and explicitly linked to the development and implementation of business strategies and operational requirements. Companies require the ability to extend knowledge of compliance requirements to day-to-day operational decision-making and the prioritization of strategic asset management alternatives. Adopting an approach whereby compliance standards are well-integrated into all forms of decision-making results in strong internal controls, without sacrificing the development and implementation of innovative strategies. Further, integration of standards in this way results in a culture of "ownership" for compliance that reaches deep into the organization, and systematically replaces a more limited culture of "policing" with one that recognizes compliance as a fundamental characteristic of "doing business".

Figure 1.

Conclusion

Energy companies across the value chain and in all commodities operate in an environment of tremendous uncertainty, with a significant number of strategic alternatives and opportunities for tremendous commercial success (as well as significant risks to meeting strategic objectives). This environment is made more complicated by an increasing number of complex compliance requirements. Importantly, meeting these standards as efficiently as possible is critical but only half of the story. In an increasingly uncertain regulatory environment, characterized by an increasing number of complex and interrelated compliance standards, companies require not only the assurance that standards are being met but also that they are being considered in strategic asset management decision-making processes, and folded into day-to-day decision-making at all levels of the organization. This assurance is gained through a clearly defined compliance management process that analyzes compliance requirements holistically and relates them directly to the strategy development process and strategic objectives of the organization. This not only requires communication of compliance requirements throughout the organization – including those responsible for setting the commercial agenda through asset and risk management strategies, as well as those responsible for validating day-to-day adherence to compliance standards – but also a variety of analyses to properly evaluate strategic alternatives in the context of compliance requirements. Lacking a rigorous compliance assessment framework, energy companies' strategic decision-making will not rigorously consider compliance impacts on potential business performance, compliance management will not be fully integrated with strategic decision-making, and official company response to growing regulatory and compliance standards will continue to be more "art than science".