Value-at-Risk (VaR) Reporting

VaR reporting has become commonplace in the energy and financial services industries due to the high degree of uncertainty in the future value of financial derivative positions. Companies with exposure to the energy markets often enter into derivatives positions to hedge against adverse changes in portfolio value, however, these positions themselves need to be monitored regularly as market conditions change. In fact, many regulatory agencies and organizational risk policies require such VaR reporting on a frequent basis.

robust VaR process reports contract-level MtM, VaR, and one or more of the “Greeks” that indicate the sensitivity of contract value to movements in the underlying commodity price. In addition, it should also report MtM and VaR for the portfolio as a whole, accounting for diversification, or the “canceling of risk”, between distinct positions. This is particularly important when assessing a portfolio where contracts have been implemented as hedges against adverse market moves.

For example, summing the individual contract VaRs will almost always overstate the overall portfolio risk because it assumes the worst case scenario occurs simultaneously for every single contract. In practice, however, short and long positions will offset each other and one commodity’s price may rise at the same time as another commodity’s price declines. These dynamics lead to portfolio diversification that must be properly captured and reported to give an accurate picture of an organization’s VaR exposure.