Analytical challenge – recognising the separate components in Risk, and their influence


The Level of Risk in the NEM is increasing.  That’s what we highlighted under Theme 2 in Part 3 of our Generator Report Card 2018:

2018GeneratorReportCard-Part2-Theme2-Header

Not only is the level of risk been increasing – we have also seen the volume of chatter about risk also increasing (one particular bout in the mainstream media prompted this article on 9th August 2019)….

(A)  Confusion about Components

… however as that volume of chatter increases, it also highlights that there’s some considerable confusion amongst the broader group of energy sector stakeholders about two distinctly different components of risk – probability, and consequence.

Back on Friday 23rd August, guest author Allan O’Neil used a simple gambling analogy to help explain the confusing mass of acronyms and technical concepts that plague important documents like the Electricity Statement of Opportunities.  Let’s continue with a “rolling the dice” gambling analogy to explain the difference between the different components:

Probability
… of something happening
Consequence
… of something happening if it does
If we’re rolling the dice in the casino, then the probability of the dice turning up with a SIX is 16.7%

(a)  in layperson terms, that’s the “chance” of something occurring;

(b)  which is just calculated as 1/6 (i.e. 1 state we want, out of 6 possible (and equally likely) states in total).

Let’s say that our dice does indeed turn up on a SIX and our payout was a tidy $60 from the small $10 bet we placed at this Casino at the simplistic* odds they gave us.

*  this casino operator’s probably not going to be in business very long.

That’s a handy, though not enormous consequence.  On the flip-side, the worst we could do would be lose our $10 wagered.

Some of us would probably be willing to take this bet – because:
1)  firstly, the downside consequence (i.e. loss of $10) is low; but
2)  also because the probability of success was sufficiently high (with respect to the expected payout) to justify the risk

In this sense, our level of risk (i.e. combining consequence and probability) was acceptable, we were happy to take a seat at the table …

… now let’s say that there was an altercation inside of this casino and we were dragged out onto a street resembling the Wild West, and our dice was swapped with a six shooter with one loaded chamber.

We’re now being asked to play Russian Roulette – where the odds (i.e. the probability) remain the same….

It should be pretty obvious that the consequences of “our number coming up” are so much more dire in this scenario – not because the odds have changed, but because the consequences have significantly escalated.

In this example, then, we should be able to clearly see how our level of risk has significantly increased not because the probability has changed, but because the consequence has become so much more significant.

 

Let’s leave the Wild West now and journey back into the NEM (though some might say there are similarities, I know), because we’re faced with increased risk in a number of different ways here.  Hopefully we can now understand, a little better, what this actually means.

(B)  Let’s look at summer 2019-20 fast approaching

With this background in mind, let’s move onto the second part of this two-part article and look at what’s looming for summer 2019-20

About the Author

Paul McArdle
One of three founders of Global-Roam back in 2000, Paul has been CEO of the company since that time. As an author on WattClarity, Paul's focus has been to help make the electricity market more understandable.

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