Looking Forward – Regulatory Challenges in the Energy Industry

Pipeline in the Alaskan wilderness

Deloitte’s report, titled “Navigating the Year Ahead – Energy and Resources Regulatory Outlook 2017,” steers readers through the murky water of regulation. The report focuses on changes and trends facing businesses in the energy sector, which is no stranger to government regulation. But the financial rules they face are constantly evolving, and companies that stray from these rules can find themselves facing fines, penalties, and a loss of consumer confidence. So it is important that companies are up to date on the most recent regulatory developments, and determine what they must do to fulfill them. While this can be a difficult prospect at any time, 2017 has been seen as a particularly troublesome year due to the impact of the 2016 U.S. Presidential election. The change in the White House has the potential to pave the way for a number of sweeping regulatory changes, but particularly as they apply to the energy sector.

Commodities Regulation Conundrums

The report illustrates possible changes to the commodity derivatives market, highlighting “de minimis” thresholds and position limits as areas of focus. The de minimis threshold is a demarcation line created by the Dodd-Frank Act to reduce swap trading that was seen as risky. Under the rules initially created, an entity whose portfolio exceeded $8 billion in swap trades would have to register as a swap dealer with the threshold decreasing to $3 billion in December 2018 (having been pushed back a year from December 2017). The change in threshold, along with the delay in decreasing it, has resulted in confusion for trading entities involved. These companies must either reduce their swap portfolio to under $3 billion and risk losing out on months of trading should the threshold remain at $8 billion, or hold at $8 billion and be forced to undergo the arduous and costly process of registering as a swap dealer.

Another change to the commodities market deals with speculative position limits. Although most indices created their own position limits, since the 1920s the federal government had established limits on certain commodities in an attempt to regulate speculation. These commodities include agricultural contracts, energy contracts, and metal contracts. Deloitte is quick to point out that “the debate on speculative position limits began almost a century ago,” showing that the matter is still far from settled and indicating to firms that they have the ability to make their voices heard on the subject.

The report also suggests that companies engage in price reporting themselves rather than let third-party price index developers set a commodity price. While this is strictly voluntary, Deloitte points out the benefits gained by both individual entities and markets as a whole thanks to increased transparency. The more companies that report their data leads to a more accurate view of the trade market and allows regulators, lenders, and investors a clearer picture.

A Look at Market Trends Coming Down the Pipeline

Many businesses in 2017 warned that they were having difficulty finding workers with the proper technical skills required of their jobs.  No industry has been hit harder than the energy sector and in particular pipeline integrity. The greater regulatory burdens mean that companies need employees with the skills to navigate these regulations and instill order. The report advises businesses to assess their current position while locating the proper talent to manage the increased regulations.

Cybersecurity is also listed as a new and growing area that companies need to address. While no federal regulations are currently in place, efforts by state agencies mark an increased focus on the cybersecurity of utilities. Along with greater oversight, an added emphasis on surveillance is stressed by Deloitte’s report. Not only must records be kept to monitor trading activities but any communications that may arise over trade practices. Failure to follow these rules will result in increased scrutiny as well as hefty fines. The report even stresses that “inadequate capabilities can be worse than nothing” since they may misdirect stakeholders and regulators and have the propensity to evolve into larger problems.

Changes to hedging strategies are also on the horizon for utility companies. Traditionally they reduced price volatility by “locking in” prices, leading to “good years” and “bad years” for utilities; the good and bad was reflected in consumers energy bills. But with a wider range of energy options available, consumers may choose to abandon companies that refuse to adapt. The answer lies in formulating risk-based hedging strategies tied to the market rather than opting for the “locked in” prices. As always, such a strategy requires firms to be aware of the current regulations and ensure proper oversight mechanisms are in place to mitigate as much risk as possible.

A Brighter Future?

The biggest takeaway is how much uncertainty is hanging over the regulatory world. The 2016 election was a huge stone dropped in the regulatory pool, and the ripples will be felt for a long time. The makeup of the CFTC and FERC, the primary bodies overseeing energy regulation enforcement, is set to be changed as new members are appointed by the president. The scope of government regulation of the private sector is even up for debate. Energy entities especially should prepare for an ever-increasing amount of regulation as agencies have access to more data and continue to share it across organizations. Companies need to keep their ear to the ground and ensure that they are in compliance with the regulatory rules, and if not to begin the process as soon as possible. As scrutiny increases, stakeholders are demanding that companies take steps to eliminate risk both physical and financial. By keeping up with compliance activities companies mitigate the financial and reputational damages that non-compliance brings.

 

To download the full report, click here:

https://www2.deloitte.com/content/dam/Deloitte/us/Documents/regulatory/us-energy-regulatory-outlook-2017.pdf

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