Credit Risk in Energy Trading

Diana Higgins

“There is no such uncertainty as a sure thing.”
Robert Burns

After reading this chapter, one should be able to understand the concepts required to analyse portfolios in the context of compressions, and also to participate in compressions. The concepts presented here provide the knowledge base required to understand and analyse portfolios in Chapter 5 and to run a compression cycle in Chapter 6.

The first section should help readers with no credit risk background in energy trading. It explains why credit risk matters in the wholesale energy market, and tours the five areas of credit risk applicable to energy trading business. However, professionals that are already practicing credit risk will also benefit from reading the chapter as it focuses on those aspects of particular relevance for compressions. The description of how risk takes different forms in the financial risk framework is particularly relevant for compression tasks. Executing compressions may transfer risk across market, credit, operational, regulatory and liquidity risk, and may mitigate one risk but not another.

The main reason why portfolio compressions were used before regulations made them more relevant