HFS371 Risk Assessment and Managemen

Discussing Risks And Derivatives From Consulting Report Of Gemoil’s Case Study:

The present study is conducted from the end of professional risk managers who are working under iManageRisk, Singapore. Mr. Robert Lee, Gemoil’s treasurer has approached their team for investigating their financial risk management. Gemoil Pte Ltd deals with petrochemical equipment and its trade. They have plans of increasing their size, valuation and cash flow expansion of operations of oil trading for upcoming years. In the following analysis, risks to be faced by the company are investigated for the team.

Understanding Financial Risks And Different Operational Risks:

Financial Risk:

Firstly, there is price risk. The oil supply is on rise from previous years. Huge increase to produce oil and decreasing oil prices took place. Thus, as they buy oil at greater cost and stores that for some time, the costs might drop, leading to decrease in revenues. Hence, there is price risk for them. After that, there is foreign exchange risk (Samimi 2020.). Though their currency to trade is in USD that never grant resistance for risk of foreign exchange. As the value of SGD, for example, drop against USD that might impact them for forking out more SGD for purchasing oil for trading with others. Thus, this risk poses threat towards their revenues. Then, there is basis risk. Gemoil can be facing the basis risk as they spot oil costs hedged at specific cost (Lu et al. 2019). However, future cost contract never move as per the underpinning asset. Quantity of risks relies on amount of future contracts involved.

Operational Risk:

Firstly, there is delivery and logistic failures. That can poses significant threat for Gemoil. Since they are trading oil globally, their oil delivery take place through sea. It is seen that transportation via sea can come across natural accidents and disasters. Here, for instance, tankers to transport oil follow particular path for delivery. This is prone to oil spillage and piracy. Thus those threats must impact transportation of Gemoil for the oil of their client (Lee, Lee and Ning 2017). Secondly, there is staff involvement. Human error that is because of oil trading impacts profits and revenues drastically. Human beings are important to trade oil since they depends on maritime for delivering oil to clients. Here, for instance, terminal employees might access the quantity oil wrongly. This affects quantity of oil intended to be transferred to client (Meidell and Kaarbøe 2017). Thus, mistake of human beings might result them to lose out their profits and revenues.

Explaining The Use Of Derivatives:

Derivatives are used for transferring risk from one party to other. Nevertheless, that never places immunity to the risk of use. Though usage of derivative is suggested for Gemoil, they are still cognizant to involved risks.  There are certain drawbacks of derivatives for Gemoil. Firstly, there is high leverage. Their derivate might carry greater risk levels since that is traded on leverage. Though that permits traders to consider over-magnified betting, that can potentially magnify losses of trades in many ways. After that, there is liquidity risk since derivatives are primarily OTC or over-the-counter investors to get exposed to risks of liquidity. This leads in spreads of huge bid-aspects or complicated unwinding areas under the squeeze of liquidity (Yang, Haugen and Paltrinieri 2018). Apart from that, there are counter-party risks. The pertinent risks of this are unlike equities. Here, a counter-party is needed for executing the transaction of derivative. It exposes the derivative’s holder towards risks of counterparts that are never being able to honour their obligations. For example, these threats are exemplified in the event of “London Whale” of J.P. Morgan that was one of greatest loss bank trading. Nonetheless, it cannot be denied that derivatives can be used by them for determining cost of underpinning asset. Sport prices of future is able to serve approximation of commodity cost (Annamalah et al. 2018). Besides, through using derivative contracts, Gemoil can replicate payoff of assets.

From the above analysis it can be derived that concerns of Mr Robert regarding experiences and derivatives have occurred to various organizations. Here, the major issue is never use of derivative. This is operational error where they never reported risk as per superiors. It is strongly recommended that they must be using future contracts for hedging cost of risk in trading market. Thus, they reiterate advantages to adopt usage of derivatives provided that it mitigates exposure of risks, currency fluctuations and interest.

References:

Annamalah, S., Raman, M., Marthandan, G. and Logeswaran, A.K., 2018. Implementation of enterprise risk management (ERM) framework in enhancing business performances in oil and gas sector. Economies, 6(1), p.4.

Lee, C.C., Lee, C.C. and Ning, S.L., 2017. Dynamic relationship of oil price shocks and country risks. Energy Economics, 66, pp.571-581.

Lu, H., Huang, K., Azimi, M. and Guo, L., 2019. Blockchain technology in the oil and gas industry: A review of applications, opportunities, challenges, and risks. Ieee Access, 7, pp.41426-41444.

Meidell, A. and Kaarbøe, K., 2017. How the enterprise risk management function influences decision-making in the organization–A field study of a large, global oil and gas company. The British Accounting Review, 49(1), pp.39-55.

Samimi, A., 2020. Risk Management in Oil and Gas Refineries. Progress in Chemical and Biochemical Research, 3(2), pp.140-146.

Yang, X., Haugen, S. and Paltrinieri, N., 2018. Clarifying the concept of operational risk assessment in the oil and gas industry. Safety science, 108, pp.259-268.

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