Right-way risk can create a false sense of security

Dealers typically find comfort in right-way correlations between their exposure to energy sector counterparties and the creditworthiness of such companies. While this reasoning is unquestionably correct, it may create a false sense of security, writes energy industry veteran Vincent Kaminski

Vincent Kaminski

The concept of right-way risk is one of the most important principles underlying credit risk management. At the highest level of abstraction, right-way risk describes a situation in which the credit exposure to a counterparty decreases as its probability of default goes up. For example, a producer of natural gas may manage its price risk by entering into a long-term swap with a dealer. Under the terms of the swap, the producer pays a floating gas price and receives a fixed price. If prices for