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Defining Risk and Risk-Adjusted Return

Defining Risk and Risk-Adjusted Return. Price Risk is the risk of financial loss in earnings, cash flow, or fair values that arises due to uncertain future price levels or price differentials.

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Defining Risk and Risk-Adjusted Return

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  1. Defining Risk and Risk-Adjusted Return • Price Risk is the risk of financial loss in earnings, cash flow, or fair values that arises due to uncertain future price levels or price differentials. • Credit Risk is the risk of financial loss in earnings, cash flow, or fair values that arises due to the chance of non-performance (either physical or financial) by a transaction counterparty. • Operational Risk is the risk of financial loss in earnings, cash flow, or fair values that arises due to imperfections in the scope, content, and/or execution of operating procedures within the organization. • Risk-Adjusted Return = ________________Return ____________ Market Risk, Credit Risk, Operational Risk 1

  2. Business Activities with Different Implications (for Process, People and Infrastructure) • Base Supply Driven - primarily by asset requirements and little regard for margin optimization. • Internal Supply Optimizationis driven by an equal focus on asset needs and margin optimization. • External Customer Drivenis driven by the maximization of external customer market share and profit - unconstrained by the needs of the internal assets. • Niche Trading is driven purely by profitability, and executed to exploit inefficiencies where the organization has an information or asset advantage. • Pure TPT Trading is driven purely by profitability. These activities are executed in markets not as a function of an asset or information advantage, but rather on a level playing field (e.g. NYMEX, physical hubs). Market making. 2

  3. Management Issues Related to Activity Types 3

  4. Examples of These Activities Base Supply Driven Physical Grade and Quality Trades Physical Time Trades Physical Location Trades Spot Exchanges Buy/Sells Run Month Crude Pricing Contractually (e.g. CIF, P+) Index Pricing for Refined Product Sales (Platts, Opis) Lease Program Yield Upgrades External Customer Driven Term Pricing Alternatives (e.g. Triggers, Fixed Priced, Floors, Caps, Collars) for: Lease/Crude Commercial Products/Sales Producer Financing Structured Financing Internal Supply Optimization Crude Supply and Hedging Alternatives: Fixed Price (FOB); run month pricing; lock in front/back spreads Inventory Management (Hedging) Forward Refinery Margin Hedging Substituting fixed price intermediates and blendstocks for crude runs Storage Plays Optimizing embedded options in contracts and assets Niche Trading Alkylate/Resid/MTBE/ VGO Trade for Profit Risk Book Market-Making for Profit Market-making, arbitrage or net position taking at hubs where have asset or information advantage Cash Month Crude Grade Trading (Basis Trading) Blending for TPT Storage Plays for TPT Trading embedded options in contracts and assets for Profit (e.g. flexibility according by pipeline interconnect) Pure TPT Trading Physical Trading in liquid hubs for Profit (Crude/Products) Exchange Trading in futures/options for Profit (NYMEX, IPE) Financial Trading in OTC instruments for Profit (swaps/options) 4

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