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Volume risk

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Example

An electricity retailer cannot accurately predict the demand of all households for a given time which is why the producer cannot forecast the precise time that a power plant will provide more electricity that consumed, even if the plant always delivers the same output of energy.

Volume risk (or, quantity risk) refers to production- or sales volumes materially and adversely deviating from their expected quantities.[1] [2] The term will have context specific applicability.

As regards commodity risk, [3] a major concern is uncertainty re production - often referred to as "yield risk" - i.e. insufficient quantities of the respective commodity, being mined, extracted or otherwise produced. A participant here further faces uncertainty concerning demand, where large deviations from forecasted-volume may be caused, for example, by unseasonal weather impacting gas consumption. Other concerns include [4] plant-availability, collective customer outrage, and regulatory interventions. These changes in supply and demand often result in market volatility. [2] Producers here are relatedly subject to price risk,[5] although in a narrower sense than usually employed.

In the context of business risk, volume risk relates primarily to revenue, where the deviation from budget may be due to external or internal factors.[1] Internal factors, such as insufficient human capital and aging plant, may negate the business line's ability to execute the operational or business plan. External factors comprise primarily of [1] the competitive landscape. A PPP, or Public–private partnership, carries what is there referred to as "revenue risk".[6]

Risk management entails [2] formally modeling demand and responding dynamically (if not preemptively) to the market. Scenario planning may explicitly incorporate varying levels in demand. [7] For PPPs, a tax-supported MRG, "minimum revenue guarantee", may be provided by the (local) government. [8][9] Re production uncertainty, an approach often taken is [5] to diversify spatially; it may also be possible to allow for contingencies in plant availability.

Direct hedging, though, "becomes difficult" [10] when the quantity is uncertain, particularly where the underlying commodity is not storable. One approach is to hedge against fluctuations in total,[10] i.e., quantity times price. Various strategies have been developed, using, for example, weather derivatives [11] and electricity options. [10] At the same time, producers − and their customers − regularly hedge against price risk using [12] commodity-derivatives where available. Commodity traders will similarly have hedges in place for the resultant market- and volatility risk.

See also

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References

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  1. ^ a b c Volume Risk, openriskmanual.org
  2. ^ a b c Volume Risk, capital.com
  3. ^ Kandl, Peter; Studer, Gerold (January 2001). "Factoring in volume risk". Risk Magazine: 84f. Retrieved 23 October 2015.
  4. ^ Pellegrino, R.; Tauro, D. (March 27, 2018). "Supply Chain Finance: A supply chain-oriented perspective to mitigate commodity risk and pricing volatility (in press)". Journal of Purchasing and Supply Management. doi:10.1016/j.pursup.2018.03.004. S2CID 169679135.
  5. ^ a b Volume Risk and Price Risk, TAS Royalty Company
  6. ^ Revenue Risk, APM Group
  7. ^ Jay Ogilvy (2015). "Scenario Planning and Strategic Forecasting", forbes.com
  8. ^ International Monetary Fund (2019). "PPP Fiscal Risk Assessment Model"
  9. ^ Global Infrastructure Hub (2016). "Allocating Risks in Public-Private Partnership Contracts"
  10. ^ a b c Yumi Oum, Shmuel Oren, Shijie Deng (2006). "Hedging Quantity Risks with Standard Power Options in a Competitive Wholesale Electricity Market". Naval Research Logistics. Vol. 53.
  11. ^ Takuji Matsumoto, Yuji Yamada (2021). "Simultaneous hedging strategy for price and volume risks in electricity businesses using energy and weather derivatives". Energy Economics. Volume 95, March 2021
  12. ^ Bloomberg.com (2022). 5 things new commodities hedgers need to know