Risk Management - Liquefy Natural Gas Trading Business - Case Study Example

Risk management LNG trading business Name Course Name and Code Instructor’s Name Date There are a number of risks that are associated with the LNG trading business like market risk, prices risk, liquidity risk, operational risk, Counter-party and credit risk, Technological risk, Currency risk, Main sources scale and timing of risk and Country risk. This explains the need for risk management. Risk management refers to the activities associated with identifying, assessing and prioritizing the risks. This is then followed by the coordination as well as the economic application of the available resources with an aim of minimizing, monitoring and controlling the probability of the impact (Satyajit, 19). Risk will always be there in markets due to the uncertainty in the financial aspects, failures of the projects, legal liabilities, accidents, credit risks, disasters, natural causes and other causes with unpredictable root causes. Every business must come up with risk management standard against which it can be able to monitor and evaluate its systems (Dorfman, 60). The risk management systems and methods vary depending on the goals and the kind of business a company is dealing with. There are a number of strategies to manage risks in any business namely; transfer of the risk to any other party, reduction of the negative effects or even probability of risk occurrence, avoiding risks and acceptance of the consequences posed by the risk. It should be noted that for any strategy used for risk management accompany or organization should ensure they handle the risks, which have a greater probability of occurrence first followed by the risks, which have a lower probability of occurrence later (Michel et el, 20). All of the methods that are involved in management of risks the following are involved Identification, characterization and assessment of threats Assessment of vulnerability of the most critical assets but to some specific assets. Determination of risks that is the consequences that are associated with specific attacks on selected assets Identification of the ways in which risks can be reduced Prioritization in the plans and efforts of reducing risk Key risks associate with LNG (Liquefy natural Gas) trading business Liquefied natural gas is a kind of business that deals with an odourless, non-toxic, non-corrosive, colourless gas. Some of the main hazards associated with it include flammability, asphyxia and freezing. Like any other business, the companies dealing with this product associated with great risks (Culp, 45). Being a business it has a number of risks that are associated with it like market risk, prices risk, liquidity risk, operational risk, Counter-party and credit risk, Technological risk, Currency risk, Main sources scale and timing of risk and Country risk. The following are the main principles that are used in risk management: Creation of value Ensuring the strategy for risk management is an important part of the processes of the organization Should be part of the decision making Should explicitly address all the assumptions and uncertainty It must be well structured and systematic Should be based on accurate information Must be tailourable Must take into account the issue of human factors Must be inclusive and transparent Must be iterative, responsive and dynamic to change Must be capable of a continual enhancement and improvement Must be periodically or continually re-assessed Market risk Market risk refers to the risk that is associated with the value of any particular portfolio either the trading or the investment portfolio decreasing as a result of changes in the value of some of the market risk factors (Satyajit, 99). The following are the main market risks associated with the Liquefied natural gas: interests’ rates, stock prices, commodity prices and foreign exchange rates. There are also a number of associated risks in the market of Liquefied natural gas, which are as follows: Equity risk: This is the kind of a risk that the companies stock or even the stock indexes, prices as well as the implied volatility will be changed. Interest rate risk: the company may suffer this kind of risk in that it may occur in the company as a result of the interest rates like Euribor, labour and inflation. This also includes any implied or assumed changes in volatility Currency risk: the risk as a result of the currency exchange rates like the EUR/USD, GBP/USD as well as any implied changes in volatility. This may occur when the country’s currency is exchanging at a lower rate as compared to the international currency. Commodity risk: this is a risk that is likely to occur as a result of prices in commodities as well as the changes in their volatility. This is especially when the gas being the commodity gets saturated in the market due to many companies venturing in the business. There are ways that can be used to measure the potential loss in amount of the risks which the company has applied. The methods are both conventional and traditional. Traditionally, the main used way was the use of value at risk, which is established and also accepted as a short-term system of risk management (Michel, 95). It is also associated with a number of shortcomings, which makes it less accurate. One of the shortcomings is due to the assumption it takes. This is whereby it is assumed that the portfolio composition measured will have to remain unchanged but over only a specific period of time. In some of the portfolio the assumption is reasonable and especially when the horizon is a short period of time. In case, the portfolio is of a longer time horizon, and then the changes may have occurred making it very inaccurate. Price risk Price risk refers to the decline of in the products or service value of its security or the portfolio. This is one of the greatest risks that are experienced by all the investors and business people. it is unavoidable but it can also be mitigated or controlled by the use of the hedging technologies (Moteff, 58). It is also dependent on the volatility of securities, which are held within any portfolio. The price risk in the company may be experienced when the company is dealing with fewer products in the market like during the times the gas production is low or in its capacity of production; hence its portfolio is exposed to the price risk. It is obvious that when the market is dominated by some monopoly kind of businesses the demand sometimes may be greater than the supply of the products. Thus, there will be increased prices and the increment is not constant because the business owner are at liberty of changing the prices the way they want an example of such kind of business is the stamp selling company. Profit can only be normal in a given industry when they resemble the profits of the profits of the other industries. This means that in a situation whereby the numbers of the firms in a particular industry are not likely to be changed then the profit margin will be normal. In case there is abnormal profit margin a change may occur in the sense that the firms will increase or decrease (Michel, 198). If the gap existing between the normal and the supernormal profit becomes persistent, then there will be imperfect market but there is likely to be a perfect form of competition due to the costs incurred in moving from one industry to the other. On the other hand, imperfect competition will occur when there is no cost incurred in moving form one industry to the other one. Such costs of movement include the licenses Liquidity risk Liquidity risk refers to the risk that are an asset or a security can not be able to be traded very quickly in the market for the purpose of preventing loss and to attain a given set profit. The following are the types of risks associated with the company; market liquidity, which refers to the point at which the company is not able to sell it products as a result of liquidity lack in the entire market (Hopkin, 134). The main reason includes widening of bid or the offer, explicit being made for the liquidity reserves, lengthening of the holding period for the VaR calculation. The funding liquidity includes the risks that are liabilities and they cannot be met once they are due, they are only met by the uneconomic price and can be very systematic and name-specific. Competition can be a causal factor for this kind of risk and especially when there is an asset and no one is willing to trade it yet the company needs it. According to the Australia theory, the following are the five environmental factors, which influence competition: public decisions on policies, consumer behaviours, competitor and supplier’s actions, the societal resources from where the firm draws and institutions in the society (Hopkin, 170). The entrepreneur is said to exploit opportunities in the market, which brings about the aspect of competition. In such a situation, if the competing firms discovers they are at an inferior level as far as competition is concerned which leads to their disadvantages in competition then they are motivated by the need for superiority to neutralize the superior firm through the process of innovation and resource acquisition. They do that through resource imitation or investing in some more superior resources. The meaning of superior resources is the investment of the resources, which are far much better than superior firms in existence in terms of value and technology to increase its competitiveness. According to the theory, the following are the main four factors that lead to the perfect competition with reference to the command economies and market base (Moteff, 143). The fact that competition can be caused by shifting equilibrium, productivity or efficiency problems may be defined by equations. In addition, innovations in productivity enhancement and knowledge discovery may be believed to be the exogenous competition process and the fact that the societal institutions are believed to be superfluous to having efficient producing characteristics as far as the competition is concerned. It is the aspect of competition that motivates different firms to be involved in innovation so as to increase the productivity according to the neoclassical theory. The firms that are disadvantaged as far as competition is concerned are forced to use their little existing resources efficiently and effectively to yield maximum profits or rather increase their resources. Perfect competition is considered to be the use of all possible knowledge of production in the area of competition. By doing that, the firm is able to maximize its profit irrespective its market structure. Operational risk Operational risk with reference to the LNG trading company may occur as a result of the execution of the company’s plans. These results are mainly from some internal failed processed, physical and environmental risks as well as fraud and people failure (Hutto, 200). Some issues are key contributor like Physical evidence, which refers to facility design, employee dress and other tangible elements. It comprises the environment that the service is provided. All tangible goods that contribute to the communication and performance of the service are what comprise physical evidence. Marketers are usually involved in strengthening cues, which the customers search for when judging the service quality. Employees of service organizations Other key essentials for service marketing include the service, service encounters and service recovery. The service as an element of service marketing mix is an intangible element. It involves an increased perceived risk in decision-making process. The quality of the service is dependent on the people, physical evidence and processes. The perception of the service is also affected by the brand name. Marketers of services and products often provide service trials wherever possible. Services encounters acknowledge that any terrible ending often dominate the recollection of the experience of a person. In most cases, customers do not notice how long it takes the service to be delivered when they are engaged mentally and hence service marketers often take advantage of this to engage their customers mentally. Furthermore, more often than not customers desperately want to make sense out of unexpected events. The service encounters should therefore be studied from the customer’s point of view. Marketers should finish strongly, ensure they get the bad experience out of the way early, segment the pleasure, combine the pain and build commitment via choice and offer people rituals and stick to them. On the other hand, service recovery ensures that angry customers are assuaged through well-intentioned, apt, and prompt recovery. This requires that all stakeholders at the firm have the motivation, skill and authority to make service recovery to be the main component of service operation. In order to attain high service standards the service delivery system need to be production oriented. Counter-party and credit risk This is perhaps in every form of business the most important risk, which is variable in the determination of if and the speed at which the financial disturbances will become the chocks of the finance with the potential of systemic traits. The credit risk can also be referred to as the investor’s risks of the loss, which arises from the borrowers who do not make the payment like they had promised. This is what is mainly referred to as default of the loans or debts. Hence, the counterparty and credit risk (Culp, 67). The investor losses include the interest and the lost principal, the increased costs of collection and decreased cash flow. Most of this risk occurs in the company due to the consumers not making the payment whenever the trade invoice is due and in case the company is granted by the government bankruptcy. Country risk This is one kind of credit risk, which occurs as a result of a sovereign country or state freezing the payments of the foreign currency payments. It also occurs when the defaults are of its obligation. This is also a risk due to investing in a particular country. The company has automatically taken a big risk to invest in the country depending on the likely business environmental changes to occur in the country (Van et el, 100). This also contributes mainly on to the operational risk due to civil wars in the country, potential or political events and mass riots among others. In this particular company depending on the country, the most likely risk in this category includes the political and economic risk. Currency risk Currency risk is also referred to as the exchange rate risk, which represents a financial risk as a result of potential change in the exchange rates within the different use currencies in the count ry. The investors may face the risk once the operations or assets are across the country national boarder or in case there is a loan, which is taken in the foreign currency. Some times the company is forced to take loans in a foreign currency because some of the banks in the country only agree to give loans in the USD currency, which at times losses or gains value against the countries currency. Main sources scale and timing of risk A business dealing with Liquefied natural gas is exposed to risks as well as barriers that can be a threat to investment. The main treatment of risk according to Crockford (18), include good or proper projection of risk occurrence as well as the use of the right scales of measuring the extent of risk to be able to prioritize the management of that particular risk. Some of the ways the company uses includes avoidance of the risk or elimination, reduction of risks, sharing and retention or acceptance and budgeting the right way. Technological risk Technological risk includes risks, which results as a result of failure in technology, or expenses that may be incurred the changes the company may need to implement in a company. The world is very dynamic especially in terms of technological innovation. This brings about the aspect of competition of which a company cannot create a platform to stand against the wave of competition may be wiped out. Amazon.com is a company experiencing changes in technology and especially the Amazon Kindle (Borodzicz, 122). According to the Australia theory, the following are the five environmental factors, which influence competition due to technological changes: public decisions on policies, consumer behaviours, competitor and supplier’s actions, the societal resources from where the firm draws and institutions in the society. There has been a drastic organizational growth in terms of market share. Through this kind of technology many people have has an opportunity to access reading materials easily hence their preference meaning it is widely preferred. It has also enabled the company to reach very quickly to the return on the potential of investment. This is because many people have embraced the new technology and so the sales are great hence profitability. It has also led to some changes in terms of global reach. This whereby, the new technology had led the company to open its doors for employees all over the world trained to use the technology because it has been involved in opening of new branches in many parts of the world. Due to competition, the company is continuously coming up with innovations as far as the new technology is concerned to ensure that it has a great ability to reach out globally. It is the aspect of competition that motivates different firms to be involved in innovation so as to increase the productivity according to the neoclassical theory (Borodzicz, 211). The use of all possible knowledge of production in the area of competition, by doing that the firm is able to maximize its profit irrespective its market structure. The issue of competitiveness is defined depending on extent the company has gained power over the market. References Borodzicz, Edward. Risk, Crisis and Security Management. New York: Wiley, 2005. Crockford, Neil. An Introduction to Risk Management (2nd ed.). Canada: Woodhead-Faulkner, 2006. Culp, Christopher . The Risk Management Process. New York: Wiley Finance, 2001. Dorfman, Mark S. Introduction to Risk Management and Insurance (6th ed.). Canada: Prentice Hall, 2007. Hopkin, Paul . Fundamentals of Risk Management. London: Kogan-Page. 2010. Hutto, John. Risk Management in Law Enforcement, Applied Research Project. Texas: Texas State University, 2009. Michel, Crouhy, Dan.Galai & Robery, Fark. Risk management. London: McGraw-Hill., 2000. Moteff, John. Risk Management and Critical Infrastructure Protection: Assessing, Integrating, and Managing Threats, Vulnerabilities and Consequences (Report). Washington DC: Congressional Research Service, 2005. Satyajit, Das. Risk management1. New York: John Wiley & Sons, 2006. Van Deventer, Donald R., Kenji Imai and Mark Mesler . Advanced Financial Risk Management: Tools and Techniques for Integrated Credit Risk and Interest Rate Risk Management. New York: John Wiley, 2004. Read More