Energy Risk Management Credit Rating Perspective

Energy Trading & Marketing Credit Rating Methodology Our Objective: Understand an energy companies’ risks and how well those risks are managed Both quantitative and qualitative analysis tools are used to evaluate risks Findings are incorporated into credit ratings 9/17/2018

Analysis Tools Three pronged approach Risk Management Practices Evaluation of a company’s ability to identify and monitor significant risks, limit losses and operate within well communicated risk tolerances Capital Adequacy Measures discrete risks of market, credit and operational risks Liquidity Measures exposure to collateral calls under stress scenarios 9/17/2018

Risk Management Practices Qualitative assessment of risk management practices Analysis will be tailored for specific business model For a company that has good financial flexibility and capital or takes few unusual or complex risks, risk management practices will be less important For a company that has weak financial flexibility and capital or takes unusually high or complex risks, risk management practices will be very important 9/17/2018

Risk Management Practices Framework Policies – Risk Culture and Structure II. Infrastructure – Process and Technology III. Methodology – Measurement and Reporting 9/17/2018

Policies Risk Tolerance Authorities Disclosure Business Strategy What is the business model? What risks are included in the business strategy? Risk Tolerance Is the risk tolerance consistent with the business strategy? Authorities Do authorities reflect a desired tolerance for risk? Disclosure Is the risk and its effect on cash flow disclosed externally and internally? 9/17/2018

Policies Evaluation In the policy dimension, Standard & Poor’s will look for: Corporate commitment to risk management Communication with board on risk positions and risk management programs Clearly defined and communicated risk management policies Corporate governance structure that supports risk management Independent risk management function Consistency between business strategy and risk Senior management’s involvement in the risk process Risk limits that reflect risk tolerance and capital deployed Compensation is tied to achievement of risk management objectives 9/17/2018

Infrastructure Operation Data People Technology Is sophisticated software and effective hardware in place? Operation What is the quality of the operational processes? Data What is the level of data integrity? People Are the appropriate people employed and are the proper incentive programs in place? 9/17/2018

Infrastructure Evaluation In the Infrastructure dimension, Standard & Poor’s will look for: Qualified risk management staff Adequate training and budget available to risk management staff Compensation linked to achievement of risk management objectives Proper infrastructure exists to support risk management Data quality – data is validated and timely Controls are in place with respect to data usage Technology used is consistent with risk tolerance and business strategy 9/17/2018

Methodology VaR, stress testing and other measures Model vetting Are the models and stress tests appropriate for the business Model vetting Are the models properly vetted? Valuation How are the positions valued? Performance Are the methodologies tied into performance? Management understanding Does senior management understand the model risks? Methodology questions will be tailored for business model 9/17/2018

Methodology Evaluation In the methodology dimension, Standard & Poor’s will look for: Identification of metrics used to quantify risks and manage limits Understand how metrics influence decision making Metrics are commensurate with business strategy Independent validation of models Models that are validated against actual market outcomes Risk factors that are evaluated periodically Assumptions that are reasonable Reports that are in place to support compliance with risk management policies Reports effectively control business activities and disclose risks on a timely basis Appropriate risk management documentation is in place 9/17/2018

Capital Adequacy Model Addresses the potential economic loss due to market, credit and operational risk of a trading operation Estimate the amount of risk capital and impute it as debt Current Model imputes debt = 6x trading VaR + 4x probability adjusted credit exposure 9/17/2018

Market For trading positions, Standard & Poor’s primarily relies on VaR calculation Use a 10 day holding period with 99% confidence interval Multiple is used depending on credit rating, e.g. 4x that number is necessary for a “BBB” rating 9/17/2018

Credit Credit risk is measured by taking the one year default probability times the unsecured credit line for each counterparty That number is multiplied by a factor depending on credit rating, e.g. 4x for investment grade 9/17/2018

Operational Operational risk should incorporate both financial and physical operational risk Currently using 50% of the market risk capital 9/17/2018

Liquidity Analysis Standard & Poor’s Objective: To measure the sufficiency of liquidity under stress scenarios Credit Event Downgrade to non-investment grade Market Event Stress test movement in commodity prices 9/17/2018

Liquidity Analysis Tools CELA measures a company’s exposure to a credit event MCELA measures a company’s exposure to a simultaneous credit event and market event 9/17/2018

Liquidity Analysis Tools Credit Event Liquidity Adequacy CELA = Primary liquidity . Neg MTM without price stress Market and Credit Event Liquidity Adequacy MCELA = Primary liquidity . Neg MTM with price stress Primary liquidity = unrestricted cash + committed credit lines 9/17/2018

Ratings Implications 9/17/2018

Investment Grade companies should maintain an MCELA ratio of 1.0x Ratings Implications Investment Grade companies should maintain an MCELA ratio of 1.0x 9/17/2018

Mitigating Factors Discretionary inventory Reserves Discretionary business Capital spending Debt maturity profile 9/17/2018

Director, Utilities, Energy and Project Finance Standard & Poor’s Arleen Spangler Director, Utilities, Energy and Project Finance Standard & Poor’s 55 Water Street New York, NY 10041 P 212-438-2098 F 212-438-2154 arleen_spangler@sandp.com 9/17/2018