It is an accentuated aim for Risk Management to deal with all of the external challenges in order to support the stable and sustainable financial position of MOL. It is a necessity to have an effective and comprehensive risk management as a prerequisite tool of good corporate governance. MOL Group can state that it has developed risk management function as an integral part of its corporate governance structure. This was repeatedly confirmed by SAM Research AG in its 2011 benchmarking report for Dow Jones Sustainability Index that ranked MOL’s risk management as one of the best in class with 94% performance, 30 percentage points above the sector’s average. This underlines MOL’s well-defined responsibility for risk and crisis management, our extensive risk definitions, the applications of risk mapping, quantification, stress testing and sensitivity analysis for all financial and non-financial risks and our well-defined risk response strategy.
MULTI-PILLAR SYSTEM FOR MANAGING A BROAD VARIETY OF RISKS
Incorporation of the broadest variety of risks into one long-term, comprehensive and dynamic system is arranged by Enterprise Risk Management (ERM) on group level for all division. ERM integrates financial and operational risks along with a wide range of strategic and compliance risks and also takes into account the potential reputation effects of events. Following identification, different classes of risks are quantified using a unified methodology. The time horizon of the model emphasises long term view (according to strategic horizons): up to 10 years and even beyond, when analysing the variability of net present values. The ERM process identifies the most significant risks to the performance of the company (both on divisional and on group levels) and calls for a decision to be made regarding which risks should be retained and which should be mitigated and how. The main risk drivers of the Group are the following:
- Commodity price risk: MOL is exposed to commodity price risk on both the purchasing side and the sales side. The main commodity risks stem from long crude oil position to the extent of its group level production, long refinery margin position to the extent of the refined product volumes and long petrochemical margin position. Investors buying oil companies’ share are generally willing to take the risk of oil business so commodity price risk should not be fully eliminated from the cash flow. However, commodity hedge deals might need to be considered to eliminate risks other than ‘business as usual’ risks or general market price volatility.
- Foreign Exchange (FX) risk: Business operation is economically driven mainly by USD. The overall operating cash flow exposure of the Group is net long USD, EUR, RON, and net short HUF, HRK, RUB from economic point of view. According to MOL’s current FX risk management policy the long FX exposures of the operating cash flow are decreased by the short financing cash flow exposures.
- Regulatory risk: Due to the economic crisis the risk of potential government actions increased as well as potential impact of such decisions.
- Country risk: The internationally extending portfolio requires the proper management of country risk exposures. Country exposures are monitored on a regular basis in order to enhance the diversification effect in the investment portfolio.
- Drilling risks: The uncertainty related to drilling success is a typical business risk in the exploration activity.
- Equipment breakdown: Due to the high asset concentration in Downstream business it is a significant risk driver. The potential negative effects are mitigated by the insurance management program.
- Market demand uncertainties: External factors like drop in market demand can affect MOL’s results negatively.o Ho
- Reputation risk: Reputation of energy industry players has been in the focus of media for the past years due to extreme negative events (e.g. BP oil spill, Fukushima nuclear accident). MOL as a major market player in the region operates under special attention from stakeholders.
Generally, the risks are aggregated, measured and mitigated at group level in order to take into consideration the portfolio effects and to optimize the Group’s financial performance. Some of the risks are managed centrally, while some are dealt with the divisions, overseen by nominated risk owners. Risk Management regularly controls the realization of these risk mitigation actions – in a form of quarterly required reports from the risk owners.
Main risk management tools
To ensure the profitability and the financial stability of the Group Financial Risk Management (FRM) as part of the ERM is in place in order to handle short-term, market related risks. Commodity price, FX and interest rate risks are measured by using a complex model based on Monte Carlo simulation (which takes into account portfolio effects as well) and are managed – if necessary - with risk mitigation tools (such as swaps, forwards and options). This function concentrates on a 12-month time horizon. Reports on compliance with limits linked to strategic and financial objectives of the Group are compiled for the senior management on a monthly basis whereby mitigation action plans are proposed by Risk Management on an ad-hoc basis when required.
Transferring of excess operational risks is done by Insurance Management (IM). It means purchase of insurance, which is an important risk mitigation tool used to cover the most relevant operational and liability exposures. The major insurance types are: Property Damage, Business Interruption, Liability and Control of Well Insurance. Due to the peculiarity of the insurance business major tasks of this function are set around a yearly cycle (i.e. annual renewal of most insurance programs). Since insurance is managed through a joint program for the whole Group (including MOL, INA, Slovnaft, TVK, IES and Slovnaft Petrochemicals), MOL Group is able to exploit considerable synergy effects.
Business Continuity Management (BCM) is the process of preparing for unexpected disruptions that have low probability for occurrence but high impact. Crisis Management (CM) processes, Incident Management, Disaster Recovery, Business Continuity Plans (BCP) and other risk control programs (like regular engineering reviews) are crucial in such a business like MOL Group’s where operational risk exposure is significant as a result of the chemical and physical processes underlying most of the operations. The quality of both BCP and CM is often measured in financial terms when dealing with insurance agencies during annual renewals, and consequently may result in decreasing insurance premiums. The Business Continuity Management covers the whole operation of the company, and ensures the proper management of crisis events with multi-divisional cooperation.
Valuable synergies can be exploited when risk is approached in a comprehensive way
The existence of an integrated risk management function enables MOL to exploit the synergies between the above detailed pillars of risk management. The methodology and input sources of modeling financial risks are applied in ERM as well. Similarly, the accumulated information on operational risks gained through managing insurances is also an important factor in the ERM development. The results of ERM on operational risks (i.e. the impact hierarchy of operational risks) can give a better direction to insurance management by highlighting which are those areas that shall be covered by insurance as a must and which are those where further analysis is required to make decisions on how to manage the related risks. Both ERM and insurance management produce inputs to BCM as a priority list of key areas to focus on. BCM and IM have anyway strong relationship as they both deal with operational risk management. For example an effective BCM can reduce the exposure of MOL Group for business interruption risk and hence reduces the extent of insurance coverage to be bought. Risk awareness culture across the whole organization had already been enhanced as well, especially via the group-wide involvement of the Group’s divisions and units during ERM and BCM processes.
Decision making support of capital allocation
The role of ERM is not just to provide information on which the most imperative risks are that MOL Group faces with, but to enable top management and the Board of Directors to make more educated decisions on investments, taking into consideration the risk profile of each project as well. In order to serve this purpose Group Risk Management is involved in the evaluation of each major project and potential acquisitions and divestitures through the utilization of its ERM capabilities to provide opinion on capital allocation and financing headroom. Potential effects on the risk profile of the Group are analysed whether the acquisition/divestment ensures the attainability of the target risk-return profile while keeping the riskiness of the Group in line with its risk-appetite.