Commodity & Energy Risk Management

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Commodity & Energy Risk Management Introduction

Organisations exposed to energy, metal, and agricultural commodity raw materials are increasingly challenged by competitive economies, volatile markets, and onerous regulatory and accounting obligations. While many businesses are prepared to take action, rapid change requires additional emphasis on risk strategy, analytics, reporting, systems, and governance.

As global commodity markets experience sustained volatility, organisations have aggressively sought methods to identify and respond to market risks, credit risks, and operational risks.

At the same time, organisations are developing strategies and innovative solutions to integrate disparate systems, increase automation, improve reporting, enhance analytical capabilities, and reduce costs.

Whether your most pressing issue involves hedging strategies; governance; supply chain issues; data management; or accounting, tax, and regulatory issues, KPMG is ready to help you cut through the complexity.

2 | Commodity and Energy Risk Management Service Offering Overview

KPMG’s Commodity and Energy Risk Management (CERM) service is designed to help corporate and public sector CFOs, treasurers, controllers, risk managers, commercial and business development managers, and tax directors achieve tactical and strategic goals.

The CERM service applies to companies of all sizes and complexities. In particular, organisations with significant commodity market and credit risk, operational and modelling challenges, and integration or cost-reduction initiatives will find the CERM service a good fit.

Each service represented below is based on KPMG’s CERM methodology and industry accepted practices. KPMG recognises that each company is unique, and as such, each service is tailored to address distinct client size, complexity, development stage, and business objectives.

While each service may be delivered as a stand-alone initiative, combined activities accelerate organisations towards improved risk integration and coordination.

Hedging & Risk Strategy Model Forensics & Development, Investigations Validation & Remediation

TRATEG S Y Operations Internal Audit

N O Commodity & I

Risk Reporting C A Energy Risk O

& Management T

N Management Tax

Information C

Systems E T

P M I

Credit & Accounting Collections

Governance, Regulatory Roles & Policies

Commodity and Energy Risk Management | 3

Hedging & Risk Strategy

KPMG Service Activities

Hedging & Risk Identification • Identify and measure commodity exposures across business Forensics Risk Model Strategy Development, & Validation & and Measurement lines and/or commodities based on defined qualitative and Investigations Remediation quantitative metrics AT TR EGY • Identify, aggregate, and summarise existing commodity Internal S Operations Audit contracts, explicit and implied financial risks (e.g. optionality), N credit exposures, and operational exposures O Commodity & I

Risk Reporting C

A Energy Risk O • Identify and model commodity financial exposures using

& Management T

N Management Tax

Information C industry applied ”at-risk” indicators (e.g. Value-at-Risk (Var),

Systems P

P Conditional Value-at-Risk (CVaR), Cash-flow-at-Risk (CFaR)) M I

Credit & Accounting • Define risk measurement data and systems requirements Collections • Measure the impact of stressed market prices on realised and Governance, Roles & unrealised profit and loss Regulatory Policies

Risk Strategy and • Assist to define management’s financial and operational risk

Tolerance tolerance(s) based on internal metrics, peer practices, and external expectations and hedge objectives Organisations today are • Identify and evaluate methods to protect against commodity increasingly exposed to volatile price risks including the following risk mitigation strategies: commodities and increasing –– Derivative based hedging (exchange traded; Over-the- stakeholder demands for earnings counter (OTC) bilateral, cleared) stability and growth. Effective –– Physical procurement/sales management commodity risk management • Assist to define key hedge strategy components, including: requires an understanding of –– Hedge instruments, volumes, timing, frequency, duration, the underlying risk, alternative entry and exit points hedge strategies, instruments and • Perform peer and competitor benchmark analysis to assess marketplaces, as well as the use client positioning against industry participants of effective and comprehensive valuation and risk reporting tools. Risk Aggregation • Define internal and external commodity risk reporting and Reporting requirements KPMG can assist to address the • Define and develop integrated risk reports risk management requirements • Identify and develop alternative risk reporting formats and needed to successfully address templates/dashboards commodity risk exposures. • Identify data and infrastructure requirements supporting the Specifically, KPMG assists clients preferred risk monitoring and reporting framework to identify, measure, control, and report risks associated with Governance and • Design and document policies and procedures governing physical and financial energy, Compliance commodity risk management metals, and agricultural markets. • Design and document a governance framework consistent with regulatory standards and industry practices

4 | Commodity and Energy Risk Management Model Development, Validation, & Remediation

KPMG Service Activities

Hedging & Model • Assist model design and development for risk measurement Forensics Risk Strategy Model Development, Development (e.g., value-at-risk, cash flow-at-risk, earnings-at-risk, credit & Validation & value-at-risk) Investigations Remediation AT • Assist mark to market and capital allocation model design and TR EGY Internal S Operations development – valuation models for commodity and energy Audit products, instruments, and contracts N O I Commodity &

Risk Reporting C

A Energy Risk O

& Management T

N Management Tax

Model Risk and • Identify inventory and rank key financial, risk, and decision Information C

Systems P

Control support models P M I

• Review and improve model policy documentation (purpose, Credit & Accounting applicability, development, ownership, access, and oversight) Collections Governance, • Assess key risk sources associated with each model Roles & Regulatory Policies

Model • Assess model calibration standards Functionality • Assess model limitations (i.e., restrictions and conditions)

Model Integrity and • Review, validate, and design model parameters including: Models have become an Validation –– Model input (e.g., forward price curves, volatility increasingly important tool assumptions, correlation matrices) in evaluating, analysing, –– Model processing and analytics (e.g., model algorithms) and reporting key business information. Whether intended –– Model output (e.g., variance results) for risk management, financial –– Model governance (e.g., risk policy, limits) accounting, or business –– Model controls (e.g., model management) decision making, the increased –– Model reporting use and complexity of these • Review assumption applicability and robustness models have led to increased • Identify and design data linkages and controls model risk. Management has a vested interest to confirm the Model Comparison • Compare and assess alternative models (e.g., third-party vs. assumptions, theories and data internally developed models) used by models, as well as the • Compare and assess alternative data sources processing, output and reporting. Leading companies seek external Model Testing • Estimate implementation risk through value testing (extreme assistance to address these values, limiting cases, code review) concerns for both existing and • Observe errors attributable to all error sources (back testing) contemplated models.

Commodity and Energy Risk Management | 5 Operations

KPMG Service Activities

Hedging & Supply Chain • Assist clients to assess their operations and supply chain Forensics Risk Strategy Model Development, & Validation & and Operations performance, as well as to develop improvement strategies, Investigations Remediation Strategy transition plans and the supporting financial business case for change AT TR EGY Internal S Operations Audit • Assist clients to improve working capital management and N reduce their level of inventory investment while improving O Commodity & I

Risk Reporting C customer service

A Energy Risk O

& Management T

N Management Tax

Information C • Assess strategic benefits of outsourcing elements of supply

Systems P

E T

L P chain operations, such as service centre, logistics, and contract M

I manufacturing Credit & Accounting Collections • Benchmark operations to industry and leading practices Governance, Roles & Regulatory Policies Sourcing and • Assist management to define procurement strategies Procurement considering risk, security, and supply diversification Enhancements • Identify and evaluate opportunities to consolidate vendors, suppliers, and contracts in an effort to help minimise costs and improve performance Organisations are challenged to • Assist clients to improve performance and effectiveness of evaluate alternative strategies for direct and indirect sourcing and procurement processes operational improvements due to • Assess strategic supply acquisition to help minimise logistics a variety of economic pressures. cost and increase operational flexibility and price awareness

KPMG can offer assistance with Inventory • Assist to evaluate client effectiveness and efficiency in many supply chain related issues Management managing inventory input and output and help your management team • Assist to develop strategies to reduce inventory investment to reduce cost, add value and and improve cash flow minimise risk. • Provide recommendations for performance measurements/ metrics at the business unit, function and individual levels • Provide visibility and linkage between operational inventory performance and financial statement profit/loss results

Tax-Efficient • Assist clients to evaluate and align distribution networks and Supply Chain manufacturing footprint taking into account impact of higher Management energy costs, customs, and financial considerations • Assist to align global and regional business strategies across operations taking into account tax, duties, customs, risk exposure, and financial considerations

6 | Commodity and Energy Risk Management Operations

KPMG Service Activities

Operations Risk • Define operational risk strategies supporting critical processes and Control and systems to be consistent with corporate objectives and risk tolerances • Establish operational risk indicators to measure and evaluate operational performance (e.g. employee, process, systems, and operational capital efficiency indicators) • Quantify operating risks to better understand and mitigate operations exposure • Track benefits and/or consistency of new or existing procurement/supply chain operations • Benchmark procurement practices and processes to industry practices – review and identify improvement areas within: ––  Internal process efficiencies ––  Forecasting and reporting cycles • Evaluate existing policies and guidelines and enhance to meet high sourcing and procurement objectives • Recommend metric, score cards and operating reports to track performance and compliance

Commodity and Energy Risk Management | 7 Tax

KPMG Service Activities

Hedging & Forensics Risk Strategy Model Tax Planning and • Analyse the tax implications of commodity and derivatives Development, & strategies Validation & Analysis Investigations Remediation • Review international transactions for opportunities to reduce tax AT TR EGY liabilities Internal S Operations Audit • Assess existing or proposed cash management and funding N O Commodity & I strategies for negative tax implications and recommend

Risk Reporting C

A Energy Risk O

& Management T improvements, as applicable

N Management Ta x

E Information C

Systems P • Review proposed transaction for anticipated tax risks, treatment

E T

M I and financial impact (GAAP/IFRS) Credit & Accounting Collections Ta x • Identify local and international tax guidance, rulings or Governance, treatment Roles & Implementation Regulatory Policies • Identify programmes, policies, or tools to implement management defined tax strategies

Ruling and • Submit tax position and analysis on behalf of the company to Opinion Support solicit a local ruling Tax requirements associated • Provide a tax opinion based on KPMG’s analysis with commodity activities are complex, unique to specific Tax Analysis and • Research and report global tax law updates and significant national jurisdictions, and Research rulings that affect commodity businesses susceptible to change. Without • Analyse potential tax impact and remediation strategies sufficient up-front consideration considering new or evolving tax legislation for and deep knowledge of Tax Incentives • Review the business plan and activities and advise the relevant tax considerations, incentive(s) best suited for the company to consider. a routine or seemingly Advisory advantageous transaction can • Propose refinement of the company’s business plan to enhance the likelihood of a successful incentive application. create significant financial risk and compliance costs. • Assist the company in incentive application and negotiation strategy formulation. • Assist the company to put in place appropriate internal controls Given the significant exposure and procedures to monitor the progress in implementing their and the onerous operational proposed business plan and complying with the terms and requirements associated with conditions of the incentive award(s). issue or transactional analysis, leading organisations are turning to external support with deep geographic resources and specialisation.

8 | Commodity and Energy Risk Management Accounting

KPMG Service Activities

Hedging & Accounting • Assist management to develop processes for the application of Forensics Risk Strategy Model new or revised accounting pronouncements Development, Implementation & Validation & Investigations • Assist management to perform an impact analysis and evaluate Remediation alternative implementation activities, as applicable AT TR EGY Internal S Operations • Assist management to identify business and functional Audit requirements, perform current state gap analysis, and prioritise N O Commodity & I

implementation recommendations T

Risk Reporting C

A Energy Risk O

& Management T

N Management Tax

E Information C

• Review and summarise existing derivative positions Systems P

Hedge E T

L P M

Accounting and • Categorise derivatives as explicit or embedded options in I accordance with SFAS 133 and IAS39 guidance Credit & Accounting Technology Collections Support • Identify alternative methods applied by industry participants to Governance, Roles & calculate and evaluate hedge effectiveness (e.g. dollar offset, Regulatory regression, etc.) Policies • Establish models and related assumptions to calculate hedge effectiveness • Establish models to calculate proxy transactions as appropriate • Support derivative accounting system selection and business Commodity businesses are and functional requirements definition typically familiar with and active • Identify and design documentation templates commensurate with SFAS133 standards users of derivative and complex financial products. While • Identify and design templates and user guidance supporting required analysis derivatives serve a major and • Analyse and implement organisation requirements for hedge increasing role in commodity accounting (processes, organisation, IT, market data) risk management practices, • Prepare and review IAS 39 hedge accounting documentation new and evolving regulations • Support derivative accounting system selection and business require strict adherence to local and functional requirements definition and international accounting standards. Considering these Domestic GAAP • Provide technical support to companies with specialised risks and growing external financial reporting requirements and International scrutiny, leading companies Accounting • Present the latest domestic GAAP and IFRS/international accounting developments and standards to company seek assistance with accounting (IFRS) management and audit committees research and guidance, local and • Develop and present industry-specific research and analysis of international accounting support, accounting and reporting practices and trends or accounting documentation and governance. SFAS 157 • Review fair value measurement methodology and application

Documentation • Identify and recommend documentation requirements commensurate with domestic and international accounting guidance • Assist management to document commodity and derivative accounting procedures, assumptions, critical data, and user/ department accountabilities Commodity and Energy Risk Management | 9 Governance, Roles, & Policies

KPMG Service Activities

Hedging & Forensics Risk Strategy Model Infrastructure • Recommend infrastructure requirements supporting a Development, & Validation & and Governance wide-ranging commodity risk management framework Investigations Remediation • Assist to design and implement policies, organisational AT TR EGY Internal S Operations structure and roles and responsibilities within the Risk Audit Management operations N

O Commodity & I

Risk Reporting Energy Risk C • Recommend risk oversight committee structure and mandate, A O

& Management T

Management N

N Tax operational roles and responsibilities and controls supporting

E Information C

Systems P

T prudent risk management and Board/Audit Committee L P M

I oversight requirements Credit & Accounting Collections Industry • Survey industry participants to help determine metrics and Governance, Regulatory Roles & Benchmarking priorities around infrastructure, governance and compensation Policies structures • Survey industry participants to help determine industry practice with respect to resource levels (front-, middle-, back-office, operations), systems, committees and committee composition, Risk management operations transaction volumes and types, performance and cost metrics change as markets evolve and and roles and responsibilities business strategies adapt. As • Assess existing and emerging risks that may threaten business a result, policies, processes, Enterprise Risk Management objectives and design a road map associated with closing key systems and organisational gaps and associated benefits structures become outdated (ERM) or outgrown. Whether your • Assign and document risk governance organisational structure organisation is interested in and responsibilities maintaining consistency with • Assist management to establish risk appetite and tolerance internal policies or keeping pace levels with industry practice, KPMG • Prepare an ERM policy framework can provide tailored and wide- • Design a training and communication plan to help improve ranging support addressing many ERM awareness and accountability throughout the organisation aspects of your commodity risk • Assess risk management activities and identify potential management operations. improvements • Identify strategic and business risks that are both auditable and non-auditable and then implement a monitoring programme to monitor the risks • Measure key strategic risks through customised model development • Develop integrated dashboards and business intelligence

10 | Commodity and Energy Risk Management Regulatory

KPMG Service Activities

Hedging & Regulatory • Review regulatory and political climate, analyse regulatory Forensics Risk Strategy Model Development, Compliance and issues, and develop alternative policy positions and regulatory & Validation & Investigations Remediation Strategy case strategies AT TR EGY • Evaluate compliance with rules established by regulatory Internal S Operations bodies, assist in preparation of compliance documentation and Audit N

O reports I Commodity &

Risk Reporting C

A Energy Risk O

& Management T N

• Research alternative policy positions N Management Tax E Information C

Systems P

P M • Regulatory issues analysis I • General rate case support and testimony Credit & Accounting Collections –– Support in management of interrogatories and data Governance, Roles & responses Regulatory Policies –– Loan staff to support preparation of testimony and other filing requirements –– Investigation of special issues (prudence of new investments, economic analyses) –– Regulatory support of new energy procurement processes Laws and regulations are set up for institutions to protect • Rate design and testimony including customer segment consumers and investors. analysis, class cost of service and tariff design Government agencies examine • Catalogue and prioritise universe of relevant compliance organisations periodically to help requirements ensure they comply with the regulations. Failure to comply Cost Recovery/ • Evaluate fuel and power market supply planning, contracting, may result in fines and reputation Prudence purchase and disposition performance in light of regulatory requirements and relevant market conditions damages. Leading companies Readiness often enlist external assistance to • Review fuel and purchased power cost adjustment filings to address regulatory strategy and identify gaps/issues help manage compliance risk. • Benchmark fuel and power costs versus relevant market peers • Assess adequacy of fuel procurement documentation in light of KPMG can help organisations potential prudence challenges by regulators assess compliance, evaluate processes and controls and implement enhanced practices – helping to facilitate a positive relationship with regulators.

Commodity and Energy Risk Management | 11 Credit & Collections

KPMG Service Activities

Hedging & Forensics Risk Strategy Model Credit Risk • Identify and measure key credit exposure based on defined Development, qualitative and quantitative metrics, including: & Validation & Identification and Investigations Remediation Measurement –– Current AT TR EGY Internal S Operations –– Potential Audit N –– Concentration O Commodity & I

Risk Reporting C –– Settlement

A Energy Risk O

& Management T

N Management Tax

Information C • Identify methods to assess and quantify counterparty,

Systems P

P customer and vendor credit exposures M I

Credit & Accounting • Develop a methodology to evaluate and assign internal credit Collections ratings to unrated customers and counterparties Governance, • Assist management to develop credit downgrade triggers and Regulatory Roles & Policies the related impact to borrowing costs, collateral requirements, or market liquidity

Credit Risk • Design credit limit allocation and measurement guidelines to Strategy align with corporate risk tolerances In recent years, credit defaults • Develop credit “risk-based” pricing methodology and credit-related losses have • Identify and evaluate alternative credit risk mitigation methods increased, from the combined applied by industry practices (e.g. contract terms, collateral forces of rapid industry guidance, credit derivatives) evolution, sustained economic Credit Reporting • Review and develop KPIs (e.g. Risk-adjusted return on capital challenges, volatile foreign and Performance (RAROC)) exchange and commodity • Develop management reporting packages markets and increased • Assist to automate or select reporting tools competitive participation from traditionally passive Collections • Develop strategies and methodologies to help improve overall parties. Executives and risk collection performance managers recognise the need • Introduce technology methodologies to help minimise for improved credit risk strategy, collection expense measurement and reporting. • Evaluate outsourcing opportunities to potentially balance capacity or obtain capability KPMG can assist company leadership to develop or improve strategies and controls to help mitigate trading and marketing credit losses.

12 | Commodity and Energy Risk Management Risk Reporting & Management Information Systems

KPMG Service Activities

Hedging & Risk Reporting • Assess report output data vs. original business requirement Forensics Risk Strategy Model Development, & Validation & • Assess and define communication clarity, robustness and Investigations Remediation timeliness and risk report dissemination and understanding AT TR EGY • Identify or develop alternative risk reporting formats, templates Internal S Operations Audit and dashboards (”Business Intelligence“) N O Commodity & I

Risk Reporting C

A Energy Risk • Identify data and infrastructure requirements supporting the O

& Management T

N Management Tax

preferred risk monitoring and reporting framework Information C

Systems P

E T

L P

M • Assist to automate or select reporting tools I Credit & Accounting Collections Systems/ Assessment Governance, Roles & Applications • Assess the capability of the existing risk applications and tools Regulatory Policies to support functional business requirements and align with industry practices • Conduct detailed analysis of transaction flow from front-to back-office systems The right business information • Assess processes and controls within risk applications and reporting systems strategy can help organisations operate more efficiently, • Assess adequacy of the current system to support new or optimise costs, seize growth existing reporting requirements opportunities, manage risk and Evaluation, Selection, and Implementation deliver value to the bottom • Analyse compatibility and interface of existent IT system and line. This can be accomplished system architecture and planned system implementations through better alignment of • Identify minimum business and functional requirements, processes, tools and reporting establish vendor RFP and facilitate vendor demonstrations with enterprise business • Assist management to identify and select commodity risk objectives and strategies. management systems, analytics or modelling assumptions • Provide project management support during front-, middle-, and KPMG helps organisations back-office system implementation increase the effectiveness and value of their business information initiatives to improve performance and risk management. We bring a particular strength in helping clients enhance data management, reporting, and IT systems.

Commodity and Energy Risk Management | 13 Internal Audit

KPMG Service Activities

Hedging & Forensics Risk Strategy Model Internal Audit • Internal Audit Strategic Sourcing Development, & Validation & Strategic –– Recommend an internal audit programme to continuously Investigations Remediation Sourcing monitor commodity and derivative accounting activity and AT TR EGY consistency with internal policies Internal S Operations Audit –– Identify, review, and test auditable business and strategic N O Commodity & I risks

Risk Reporting C A Energy Risk O

& Management T

N –– Conduct in-depth, focused and specified reviews of a N Management Tax

E Information C

Systems P specific process or business area

E T

L P M

I –– Assess alignment with policy and controls framework Credit & Accounting Collections • Review contracts and receivables to help ensure companies Governance, Contract are invoicing/collecting customer revenue in accordance with Regulatory Roles & Compliance Policies contract terms • Review contracts and payments to help ensure companies are not being overcharged by or overpaying vendors

When organisations require internal audit assistance, KPMG is able to supplement or assume responsibility for an organisation’s internal audit function or select activities. We deploy dedicated internal audit professionals with appropriate subject matter and industry knowledge and operational experience to lead or assist corporate teams.

14 | Commodity and Energy Risk Management Forensics & Investigations

KPMG Service Activities

Hedging & Anti–Money • Identify and assess money laundering risks applicable to a Forensics Risk Strategy Model Development, Laundering particular institution, business line, product offering, customer & Validation & Investigations Remediation (AML) base or geography AT TR EGY Compliance • Assess, test and assist to develop automated transaction Internal S Operations monitoring systems Audit Services N O Commodity & I

• Assess compliance with the Bank Secrecy Act (BSA), the Risk Reporting C

A Energy Risk O

& Management T

AML provisions of the US PATRIOT Act and the sanctions N Management Tax

E Information C

Systems P

programmes administered by the Office of Foreign Assets T L P M

Control (OFAC) I Credit & Accounting • FCPA programme assessment, implementation, monitoring Collections and training Governance, Roles & Regulatory • Assist or validate regulatory compliance remediation efforts Policies

Financial • Assist to determine whether fraud, accounting irregularities or Reporting improprieties have affected financial reporting integrity and Securities • Make recommendations to address questionable accounting Many organisations encounter Investigations and disclosures and how similar issues may be avoided in the challenges to develop, future implement and maintain a risk- • Provide information to help determine whether restatement of based strategy that will protect financials or added disclosures are necessary against the risks associated with money laundering and Fraud Risk • Assess current state of fraud risk management against legal other financial crimes. Management and regulatory frameworks and industry practices • Design enhancements to controls and responsibilities to Whether assisting to help prevent, detect, and respond to incidents of fraud or proactively improve AML or misconduct Fraud Risk Management or reactively respond to a regulatory order, KPMG is able to provide services taking into account the unique circumstances of participants in global commodity markets.

Commodity and Energy Risk Management | 15 kpmg.com.sg

For further information regarding For further information regarding KPMG’s Commodity & Energy Risk KPMG’s Tax Services, please contact: Management Services, please contact:

Craig Davis Chiu Wu Hong Partner Partner Asia Pacific Head of Financial Risk Head of Mergers & Acquisitions Management Tax and Incentives KPMG in Singapore KPMG in Singapore T: +65 6411 8533 T: +65 6213 2569 E: [email protected] E: [email protected]

Oliver Hsieh Ho Kah Chuan Associate Director Director ASEAN Commodity & Energy Risk ASEAN Incentives Advisory Management KPMG in Singapore KPMG in Singapore T: +65 6213 7303 T: +65 6411 8037 E: [email protected] E: [email protected]

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Publication name: Commodity & Energy Risk Management