MorganEnergy

I was up bright and early this morning for a breakfast meeting looking at plans for next year’s IAEE conference in San Francisco, which looks to be coming along nicely. More on that later.

The conference information sheet I got when I signed up said that the dress code was “business casual” and that the wearing of suits was strongly discouraged. This instruction has been almost universally ignored, which may say something about the attendees.

The opening address was by Dennis Lockhart, President of the Federal Reserve Bank of Atlanta, who stepped in at the last minute when his colleague from Dallas, Richard Fisher, fell ill. Most of his speech focused on doom and gloom in the economy, and hope for recovery, which was pretty much as expected. I happened to end up in an elevator with him afterward and we chatted briefly about risk and human nature. He noted that sometimes tail risks do play out, to which I could only add that perhaps next time I give a lecture on VaR and talk about the need for stress testing maybe some of the audience will listen.

Over at the EU Energy Policy blog Bert Willems and Emmanuel De Corte of Tilburg University suggest that the EU should regulate market power in the generation sector by setting limits on capital adequacy as well as looking at market concentration. Being aware of capital adequacy issues is generally a good thing for regulators, if only because most of the major disasters in energy markets have been caused by melt-downs in trading. Also such an awareness might dissuade them from encouraging very small companies to enter retail markets, with predictable results. On the other hand, getting a reliable measure of capital adequacy is not easy. The authors say:

we would allow firms to use their own risk analysis, and base the regulation on a general ‘Value at Risk’- measure, similarly to what is used in the banking sector

While VaR is a well known and commonly accepted methodology, its implementation is very complex. That’s particularly the case in the energy industry where price distributions have such extreme kurtosis. Consequently such a regulation could easily lead to endless disputes about whether the VaR numbers coming out of companies were in any way comparable; and indeed whether the regulation provided an incentive for companies to distort their risk reporting, thereby putting their financial security in danger. Possibly the authors have addressed these issues in their paper, but it is behind a pay wall.