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The current natural gas price regime allows the producing a marvelous opportunity. Rather than focusing on Value at Risk (VaR) or Earnings at Risk (EaR), Volatility Managers suggests that producers look at two very different parameters – Cash Flow at Risk (CFaR) and Investment at Risk (IaR). For while the first two parameters have great applications and implications for trading activity, the later two have much more applicability to hedging activity. CfaR is a concept that has been discussed recently – what is it? It is the measurement of the impact on corporate cash flow – and thereby working capital – from differing price paths in a commodity going forward. For example, if a producer has hedged its production with a NYMEX contract and an OTC basis swap the producer now has three sources of cash flow impact from the its production – any movement in the margin on the NYMEX contract; any changes in the credit collateral on the OTC transaction; and the cash flow from the actual sale of the production. What does this mean to the producer? First, the NYMEX contract has initial margin requirements. This means that at the time the contract is traded the producer has a cash call equal to the initial margin. Since the producer is likely to be hedging by selling a contract, we will assume the transaction is a sale. If the market price goes down, the producer’s margin requirement decreases – if the market price declines steeply enough the margin account will actually become cash positive for the producer. Similarly, if the market price goes up the NYMEX will call for “variation margin”. This is a cash call that is calculated from the potential loss on the contract (the current market price minus the original sales price). The variation margin is designed to assure a continuous positive margin account balance for each traded contract. But note the only market price movement that is of concern is the month (or months) for which the producer sold the contract. Therefore if the producer sells a forward month and the forward months (next winter for example) go up while the near months stay flat, the margin call may not be offset by increasing current month sales prices. This calculation is very cut and dried. The NYMEX published its margin requirements and shows how margin requirements are calculated. For an OTC transaction, the ISDA, GISB or other master agreement and its credit provisions apply. It is critical for CfaR analysis for a producer (or consumer) to know what the collateral requirements are in the contract, how frequently the collateral requirements can be adjusted, what the methodology for calculating a collateral call is and what rights the producer may have to contest a collateral call. Many CfaR calculations work from “assumed” calculation, settlement and payment dates. The only way to truly have a complete knowledge of potential cash flow needs is to have these dates for every hedging and sales transaction in the corporate information database. In that manner when pricing stress tests are run the system can be used to calculate all the cash flow implications for the company. This also will allow the company to determine the positive or negative float implications of the differing payment dates between NYMEX contract, OTC transactions and the underlying physical sale. This “float” cost – or gain – should be included in the company’s cost of doing business and reflected in required sales margins. IaR is a very useful tool for asset investors – either producers or power generation owners. It calculated by taking the actual hedged cash flow from the asset minus the operating costs to determine the total excess cash throw from these transactions. This cash throw is, in essence, return of capital for the asset investment that is guaranteed to be recovered from hedged sales. This also gives significant hedging strategy input when total investment return can be guaranteed with less than total hedging. In the current pricing environment, it may be possible for producers to show zero IaR with significant upside from unhedged volumes. In this manner, a producer could assure its investors or lenders as to the security of their investments without having to discuss actual transactions and positions. In addition, the CfaR calculation can then illustrate the working capital needs that may arise to keep this zero IaR value. Especially for lenders and credit rating agencies, the CfaR and IaR should provide a significant basis for proving corporate stability, viability and strength. Internal discussions with hedging staff and IT resources to adapt existing systems to this strategy should be a priority.