Volume 4— Credit Risk Management © Copyright 2002, CCRO. All rights reserved. 13 IV MEASUREMENT In this section, we describe a framework that credit managers can use to think about various credit risk metrics being discussed in the industry today, including potential exposure, loss distributions, and Credit Value at Risk (CVaR). The specific implementation and modeling of the components will not be prescribed here, but left to the discretion of individual companies, given that companies may have different analytical capabilities and that techniques for modeling energy credit risk are still evolving. Best practice includes the routine application of potential exposure and loss distribution analysis, both for the trading portfolio and for large structured transactions, to adequately communicate working capital needs and balance sheet commitments associated with trading, marketing, and hedging to the company’s senior leadership and board of directors. 1.0 Credit Exposure The starting point for measuring risk in the credit portfolio is identifying credit exposure. Two types of exposure need to be measured: current exposure, and potential exposure. Current exposure includes both billed and unbilled receivables for product that has already been delivered, as well as MTM exposure for products yet to be delivered. If the companies have netting agreements in place, receivables would be netted against payables, both billed and unbilled, for product that has already been delivered. In this context, “product” could mean either the actual physical commodity or a cash payment tied to some market measure of the underlying commodity’s value. Potential exposure measures the range of values that current exposure could take over a given time horizon as a result of price and/or volumetric uncertainty. The relationship between current and potential exposure is described graphically in Figure 1, which shows a frequency distribution of the credit exposure. Figure 1. Current Exposure and Potential Exposure Figure 1 illustrates a case where current exposure is positive. A positive exposure means that the entity is a net creditor, whereas a negative exposure means that the entity is a net debtor. F r e q u e n c y $ 0 .0 0 C u r r e n t E x p o s u r e P o te n tia l E x p o s u r e E x p o s u r e ( $ )