 In this lesson, we're going to talk about risk controls and energy commodity trading. Now, you've seen my notes out there on the lesson content page, as well as the, hopefully by now, I've read the case studies. But I'm going to walk you through the origins of risk control within the energy commodity business, and then some of the recommendations and risk measures themselves. In today's market environment, controls for financial trading have probably never been as important as they are today. The case studies illustrate the history of very huge losses by traders who really didn't know what they were doing, and there were no controls in place. And then Enron, when they collapsed back in 2001, it was the largest bankruptcy of its time. And of course, it resulted from their financial trading group and some false trades that basically were going on behind the scenes. But it's still occurring today, and unfortunately, there are still people out there making huge mistakes by making decisions and taking speculative positions. And there's no real oversight over these people to basically realize what's going on and try to stem those losses. As we've seen throughout the semester, especially in terms of your own little speculative trading and the FACTSIM simulator, there's extreme volatility these days in energy commodity prices. We've talked about the fact that we are in a global commodity. Crude trades definitely is a global commodity, and we'll presume we will be trading natural gas as a global commodity as well. And we know that the geopolitical climate is sort of an ever-changing landscape, and it has a direct impact on the perception of future energy prices. So this volatility, this constant rapid movement up and down, makes the oversight of financial derivatives in energy commodities even that much more important. We've also seen a situation with the credit crunch as the banks fell into problems back in 2008. Not as many banks are involved in supporting the financial derivative markets as they used to be. And then, of course, the standpoint of margin requirements. If you don't have sufficient credit, you're not going to be able to meet your margin requirements. And this will impact the cash flow of companies. Some companies either don't have or don't wish to put the cash out to cover margin. That's going to limit the number of positions that can be taken, as we all know in financial derivatives. And then, of course, weather. Weather can be extremely volatile, as we know. And weather is a key driving factor in terms of supply and demand for natural gas and for crude oil. And so we have events such as La Nina, El Nino. There are issues of global warming. And then we have unpredictable hurricane seasons, as we know that can be a huge factor in terms of the interruption of supply for both natural gas and crude oil in the Gulf of Mexico and the United States. Financial risk types. These types actually are several of them are what any particular company may face at any given point in time. Of course, market risk. What is going on in the market? Do you have a need for the commodity? And you're exposed to higher prices. Are you a seller of the commodity, and therefore exposed to lower prices? Operational risk. If there's an interruption in operations, you may not be able to perform under the financial derivative obligations that you've entered into. Liquidity, lack of counterparties. In other words, if you wish to go out and hedge a commodity for a certain period of time and a certain volume, are there enough counterparties out there these days to get that particular transaction done? Exchange interruptions. Although rare, exchange interruptions can occur. We've seen power outages. We have seen hacking. Back on 9-11, the New York Mercatile Exchange itself was shut down for several days. So it is a possible liquidity risk that's out there. And then, of course, the speed of the transactions. We have addressed electronic trading. There is trading going on 24 hours a day in essence. And you've got platforms like the Intercontinental Exchange, Ice Futures Europe, NIMEX, Globex, NIMEX is Clearport, and other international ones. So the fact that you can trade almost 24 hours a day but that you're trading electronically means that you can potentially lose more money faster than you could in the past. Other types of risks. These legal enters into this because you're going to enter into contracts. OK, the ISDA is the contract for financial derivative transactions. And that's the predominant contract there. It's a base contract. The NAISB is the North American Energy Standards Board. That's a bilateral or a buy-sell agreement for natural gas business. And then, of course, within contracts, we have force-majure language. Again, force-majures is sort of an out. If any of a very long list of events occurs, then one of the parties may not have to perform under the contract. These can be things that are weather-related, acts of God, interruption of, let's say, the pipeline movements, freezing of gas or gas lines, et cetera. There's just a host of them. And of course, any one of those, if it excuses the counterparty, that represents a risk for the other counterpart to that transaction. Credit, kind of like I mentioned, this goes along with the counterparty liquidity issue in the post-2008 economic collapse, where the banks found themselves in trouble. And the banks had entered the marketplace after Enron and others had exited. And they were providing the financial liquidity that was otherwise going to be lacking. Well, as the banks exited the business over the last several years, that does, in fact, influence and impact counterparty liquidity. There are a few partners out there with which you can get financial derivatives executed, which is going to impact hedging. And then counterparty solvency. You have companies that you may be trading with, or companies that you may be going through to execute hedge positions. You may find out that all of a sudden that company becomes insolvent. The question then becomes, what happens to your positions?