How can Power Nominals be applied to portfolio marking issues?

The adoption of FAS157 in November 2007 has presented many challenges to the financial community, including power trading. While the most visible controversies pertaining to FAS 157 have been on banking and credit, the lack of consistent and reliable mark to market information throughout the power markets has created difficulties there, as well.

CAVEAT: You must rely solely on the advice and counsel of your CPA and legal advisors for advice pertaining to Sarbanes-Oxely, FAS133 or FAS157 compliance. RisQuant Power Nominals should NEVER be used for compliance without the full knowledge and approval by by these professionals.

RisQuant Energy offers neither legal nor accounting advice and makes no representations as to whether Power Nominals can or should be used in any specific situation. We only suggest that Power Nominals be considered as a tool.

How can Power Nominals be used to address FAS157 problems? A recent position paper by the FASB staff indicates that Power Nominals, as a pricing service, would fit into the valuation hierarchy as Level 3. While the inputs are NYMEX fuel prices, the algorithm that establishes value is opaque. Nevertheless, Power Nominals can address FAS157 issues in power companies by providing an independent, external view of value. It is, therefore, preferable to using internally modeled values. Power Nominals also furthers the spirit and intent of FAS157 by providing independent, external views of volatility and correlation.  

FAS157 actually requires consideration of external sources of information for marking purposes when available. While the RisQuant Power Nominals service is not ideal under the valuation hierarchy, it is the only external information available on the forward curve in most of the areas we cover. According to the Federal Accounting Standards Board:

"... the reporting entity must not ignore information about market participant assumptions that is reasonably available without undue cost and effort."

How can Power Nominals be applied to hedge accounting? Power market hedgers face a “chicken and egg” dilemma. FAS133 requires that the hedger document the rationale for hedging before commencing a hedging program. However, the lack of a liquid market inhibits the hedger's ability to document. Then, that very lack of documentation inhibits hedge trading and stunts the market. However, Power Nominals modeled values can, in one step, provide both the values and the underlying analytic basis that enables both.  

Should Power Nominals be used alone? No. Your organisation should still examine spreads from liquid locations. However, matrix pricing is imprecise and not sufficient for compliance. Power Nominals can be used to supplement and sharpen matrix pricing, or the spreads can be used to buttress the use of Power Nominal prices for marking.