Enron Corp. Risk Assessment & Control - PowerPoint Presentation

1. Enron Corp. Risk Assessment & ControlPresented by:Ted MurphyVice President

2. Gas Pipeline GroupPortland General ElectricEnron Capital & TradeNorth AmericaEuropeEnron InternationalEnron Energy ServicesEnron CommunicationsAzurixEnron Oil & Gas CompanyEnron Corp. - Business UnitsWholesale Energy Operations and ServicesRetail Energy ServicesTransportation& DistributionExploration & ProductionNew Businesses

3. Key Elements of Enron’s Wholesale BusinessWorldwide Marketing and Sales of Energy CommoditiesPrice Risk Management ProductsDevelopment, Construction and Operation of Energy Assets WorldwideOrigination and Management of Large Energy Investment and Finance PortfolioCommoditySales and ServicesEnergy Assets & Investments

4. President & COO EnronJeffrey K. SkillingChief Risk OfficerRichard B. BuyRisk Assessment & Control Group (“RAC”)126ProfessionalsMarket RiskManagementControlsUnderwritingRiskAnalytics(RAROC)ResourceEvaluationCreditRiskManagementResearchJohn S. HopleyTed MurphyMark A. RuaneMonte L. GleasonWilliam S. BradfordVince KaminskiEnron Board ofDirectors

5. Evaluating RiskProtect Shareholder ValueOptimal Capital AllocationsPerformance MeasurementIdentify, Monitor, Analyze RisksCapture and UnderstandRisksRiskControls InfrastructureBoard of DirectorsSenior Management

6. Transaction UniverseProductsProject FinancePre-Paid Forward ContractsSubordinated DebtWarrantsCorporate EquityGasPowerOilLiquidsCoalMetalsDomestic and International MarketsPaperSteelTelecomPipelinesOilfield ServicesUnderwriting

7. BUSINESSUNITRISK ASSESSMENT & CONTROL(RAC)ORIGINATINGENTITYCapital Expenditure Request(>$500,000)Transaction Approval ProcessCONFORMINGPORTFOLIO REVIEWDEAL$MMAPPROVINGUNITBUSINESS UNITCEO / COO BOARD OF DIRECTORS$5 million$75 million$75+ millionEnron Board of Directors Actively Reviews Capital TransactionsNON-CONFORMINGTRANSACTIONSCEO / COO BOARD OF DIRECTORS$25 million $25+ millionTRANSACTIONREVIEWRISK ANALYTICSPRICING

8. Transaction ReviewEngineering &ResearchCreditTaxMarketLegalAccountingInsuranceUnderwritingRiskAnalyticsOriginationPortfolio ofInvestmentsSyndicateHoldTRANSACTIONREVIEWRISK ANALYTICSPRICING

9. Risk Analytics ProcessDeterministicTransactionModelProbabilistic Transaction ModelTransactionApprovalOngoingEvaluationReview Models and MethodologiesAnalyze Risk and AssumptionsApply Distribution to Capture Risk Simulate Possible OutcomesMultiple Sign-Offs RequiredRequires Completion of Risk AnalyticsQuarterly Review of TransactionPerformanceSenior Management ReportingTRANSACTIONREVIEWRISK ANALYTICSPRICING

10. Risk Assessment ProcessMarketPricingRisk / ReturnProfile of TransactionFundamental Analysis

11. Example Transaction Approval DocumentSUMMARY (note – each instrument must be shown – options must be shown separately)($000)Capital Commitment:$140,000Weighted Average Life (yrs.):19.00Bid Bond Amount:$10,000Return Components:PV @Capital PriceCumulative IRRCapital Price ComponentsCash Outflows148,737N/ARisk free rate (%):5.50Fees00.00%Equity/Credit premium (%):5.00Intermed. Cash Flows140,01411.95%Country Premium (%):3.50Terminal Value54,98318.50%Other (%):3.00Total NPV66,16918.50%RAC CAPITAL PRICE:17.00%HEDGABLE OR MARKET RISKSForeign ExchangeRiskInclude curves used, description of hedges in place, functional currency of thetransaction..Interest Rate RiskInclude interest rate basis of outstanding or projected debt. Describe hedges inplace at transaction level. Does not include issues related to Enron’s funding ofthe transaction. Note that all transactions carry interest rate exposure throughthe discount rate. Equity RiskInclude for all non-structured credit transactions. Include discussion ofadjustments to value made for lack of liquidity. Note that equity market risk isreflected as a component both of the exit multiple and the discount rate. Marketcomparables are required for all private merchant transactions. List comps andthe associated multiples used if applicable.Credit RiskInclude for all structured credits. Describe rating (implied or otherwise) for thecounterparty. Include discussion of how credit risk is modeled. Note that creditrisk is reflected as a component of the discount rate.Inflation RiskDiscuss impact of inflation on cash flowsCommodity RiskInclude commodity volumes, base curves, source of curves, relative marketliquidity, hedges in place at transaction level. Include attachments if necessary. APPROVALS:NameSignatureDateRAC ManagementJohn HopleyEnron Capital ManagementAndy Fastow/Jeff McMahonBusiness Unit OriginatorBusiness Unit LegalBusiness Unit MgmtPortfolio ManagerJere Overdyke/Cliff SheddENE ManagementJeffrey SkillingJoe SuttonSheila TweedJ. Paul Oxer1-21-991-21-991-21-991-21-991-21-991-21-991-21-99DEAL DESCRIPTIONStrategic Interest is a water and sewage company in a South American Country (SAC).Acquire an interest from the SAC government of between 39.8% and 50% of the StrategicInterest, and through a Shareholders’ Agreement be granted control over all but a limited numberof corporate matters. It serves a population of 2.0 million and has approximately 400,000 water customers and 300,000 wastewater customers. All customers are metered with a collection rate atapproximately 95%. Average water losses of 40% can be reduced to 30% in five years. Azurix requests approval to acquire the Strategic Interest for cash consideration of up to $150 million.TRANSACTION SOURCES AND USES OF FUNDS ($ Thousands)SourcesUsesEnron Equity$140,000Acquisition$140,000Total$140,000$140,000DEAL NAME:EXAMPLE TRANSACTIONDate DASH Completed:12/18/98Counterparty:RAC Analyst:Business Unit:AzurixInvestment Type:Business Unit Originator:J. Paul OxerCapital Funding Source(s):Balance SheetpPublic xPrivatepMerchant xStrategicExpected Closing Date:Feb. 27, 1999 —April 15, 1999Expected Funding Date:Feb. 27, 1999 –April 15, 1999xConforming pNonconformingBoard Approval: X Pending p Received p p N/A

12. Underwriting SummaryAssurance that returns are evaluated relative to the risks assumed Provide independent quantitative and qualitative feedback to senior management.Mitigate risks in transactions where appropriate.Coordinate other internal resources (tax, legal, accounting, insurance, trading, etc.) for transaction evaluation and capital allocation.Participate in negotiations with origination Assist in syndication efforts

13. Credit Risk ManagementGasPowerOilLiquidsChemicalsCoalWeatherPaperEquitiesInterest RateCurrencyForwardsSwapsOptionsSwaptionsExoticsOver $4 billion in price risk management assetsOver $1 billion in A/R exposureOver 80% of exposure to investment grade counterparties8,000 counterparties, 2,500 activePhysical and FinancialProductsDomestic and International MarketsTransaction Universe

14. Credit Risk Measurement and Management Recommendations from the Publication Derivatives: Practices and PrinciplesGROUP OF THIRTYCredit Risk Management PrinciplesCredit EnhancementMaster AgreementsIndependent Credit Risk ManagementAggregating ExposureMeasuring ExposureThe Group of Thirty is a private, independent, body established in 1978 to provide analysis and recommendations for the financial markets1012111314

15. CreditScoring:E-RatingCreditEnhancementContractTermsCreditReserveInformationSystemsCounterpartyCreditExposureCredit Risk Management DriversCounterpartyCreditEvaluationManagement Tools

16. Establish Internal “Enron Rating” for All CounterpartiesCounterparty Credit Evaluation Assess Counterparty’s Ability and Willingness to Honor ObligationsQuantitative AnalysisQualitative AnalysisFinancial strengthKey financial ratiosOperating performanceLiquidityDebt serviceLeverageIndustry sectorRank within industryManagementTrading activities and controlsSovereign risk

17. Credit ReserveCredit priced at transaction level via Monte Carlo simulationFactors in simulation model International Counterparty Credit Rating Probability of default derived from corporate bond spreads Tenor of deal Price Volatility Deal Pricing vs. Current Price Curve Interest Rates Credit EnhancementsReserve held against MTM earnings reflects market price of credit on transactionCredit reserve valued on portfolio basis monthly to confirm adequacy

18. Credit Risk Management SummaryManage global credit exposureMonitor and limit concentration risksCounterpartyCredit RatingClassINVESTMENT PORTFOLIOTRADE CREDIT PORTFOLIOGeographicRegionIndustry Class

19. Responsibilities of Risk Management ControlsAdministration / Guardianship of the Enron Corp. Risk Management PolicyCommodity Portfolio Risk AnalysisLimits are reviewed daily by Risk Management ControlsLimits are reviewed and ratified by the Enron Board of Directors

20. Value-at-Risk (V@R) has become the standard measure of risk across portfolios and businesses Dollar loss that may be experienced in the value of a portfolio over a defined time period with a given confidence interval due to changes in market risk factorsEnron Corp.’s V@R methodology uses a 95% confidence interval and a one-day time horizonOther MeasuresStress testingScenario analysisValue-at-Risk0.00.20.30.40.5Return05%0.1

21. Backtesting ENRON V@R - 1/1/98 to 2/26/99P&LValue at RiskV@R LimitSummer 1998 Power Price SpikeHurricane Mitch

22. Risk Controls IntegrationChecks and BalancesRisk Control personnel on the trading floorMulti-disciplined assessment teamExpertise of staffSenior Management Review

23. Market Positions & RiskPORTFOLIOSNA GasNA PowerEmerging BusinessesGlobal LiquidsEuropean TradingTreasuryLimitsRisk & Performance AnalysisRisk Management Controls - Major Portfolios

24. ECT North America - Natural Gas Risk Book HierarchyEnron defines the portfolio risk hierarchy tomanage individual, portfolio, and enterprise risk

25. RISK ADMINISTRATIONTRADERSRISK MANAGEMENT CONTROLSGRMSDeal CaptureData IntegrityRisk AnalysisGlobal System Integration - Risk Management ControlsThe Global Risk Monitoring System (GRMS) is a tool for evaluating and analyzing the risks associated with Enron’s trading positions globally.

26. Pricing and Valuation ModelsRiskAssessmentToolsData Acquisition andAnalysisWeatherInformationAcquisitionandAssessmentResearch Group Main FunctionsCentralized development of accurate and consistent quantitative models across Enron

27. 7 Ph.D.s In Physics 1 Ph.D in Computer Science2 Ph. D. In Economics1 Ph.D. In Operations/Research 11 Ph.D. Earth Sciences/ J.D. 1 Ph.D. Mathematics1 Ph.D. In Material Science1 Ph.D.s In Engineering1 Ph.D. Electrical Engineering1 Ph.D. Earth Science1 MBA/ M.S. Physics1 M.S. Mathematics1 M.S. Economics1 M.S. Business2 MBAs2 Student Candidates for MBAStrong Educational Background

28. Staying on the Cutting Edge of TechnologyMonitoring Important Developments:Financial EconomicsApplied MathematicsOther Fields of Interest to Enron

29. ConclusionEnron has invested in the people, tools, and systems necessary for effective risk management.Enron highly values an independent group focused on controls.Integration of multiple disciplines in Risk Management Controls Group enhances overall effort.The Board of Directors’ involvement indicative of Enron’s focus and commitment to monitor risk.Commitment includes applying sophisticated concepts (relative to financial securities industry) that are appropriate for Enron’s unique markets and risks.