4/20/2020 Understanding Enterprise Risk Management for Utilities © Copyright 2007, CCRO. All rights reserved. 20 Other risks that may be disallowed include fraud risk, an intentional act that results in a material misstatement in the financial statements, information processing and technology risk, or using information technologies that could expose the organization’s ability to sustain the operation of critical processes. Finally, modeling or forecasting risk is the failure to properly measure or forecast results where data is not observable. Most regulators will deem the utility the best estimator of their forecasted loads, supply costs and other revenue requirement components, and may or may not allow cost recovery because they missed their forecast. 2.3.4. Business Risk Today, the dominant business risks for utilities are regulatory and environmental risks. Changing regulations complicate the organization’s capacity to efficiently conduct business and changing environmental legislation may require significant investments to keep assets operating. In today’s dynamic marketplace, it is difficult to know how the market rules will change as regulators and legislatures respond to a changing business environment and occasionally, market crises. With uncertain futures, utilities find it hard to know when and how much to invest, and lenders are leery of loaning to these entities without knowing the revenue streams guaranteed by regulation will come to fruition. In the 1980’s and 90’s, many utilities faced stranded costs as legislators moved the gas market and numerous power markets to deregulation. Now many of these legislators are reviewing the merits of re-regulation, or changing back to the rules of the regulated markets. Rating agencies are eyeing these changes with caution and some utilities are facing credit downgrades. This situation highlights the need for utilities to manage regulatory risk effectively as a holistic approach to risk management. Regulatory risk magnifies two additional business risks for utilities capital availability and reputational risk. First, the risk of the lack of capital availability or sufficient access to capital threatens the organization’s ability to execute its strategies and meet its mandated service requirements. As utilities become less vertically integrated, they become more vulnerable to market fluctuations and changing market rules. As a result, credit ratings can suffer, which will make capital more expensive. These risks can then limit the ability of a utility to maintain and improve their infrastructure. Second, risk to image or reputation could lead utilities to lose customers, investors, or suffer adverse regulatory or legislative decisions that could further cripple their ability to perform their responsibilities and meet customers, shareholder and stakeholder expectations. Another business risk that has become a more significant issue for utilities in the last ten years is environmental risk. With concern over global warming and excessive emissions, both national and regional legislation are increasing costs for utilities, some of which may not be recoverable. For utility generators, this legislation is requiring extensive capital expenditures to retrofit existing power plants to lower emissions, or forcing them to pay the cost of emissions ‘credits’ to offset the physical discharge. Uncertainty about potential future legislation adds another layer of complexity to this issue. Additionally, some legislators are now requiring investment in renewable energy, which can be much more costly than conventional generation and can create operations problems. These requirements are for the longer term, forcing utilities that serve load, to either enter into long term (more than ten year) renewable contracts, or to invest in the