Summary
Mark-to-market (MtM) accounting while useful information for investors as a reference to future valuation and expected streams of cash flows, creates financial reports that are expected to provide in today's dollars all of the future value of the firms net worth. Given the numerous variables, including what discount rate to use in present valuation along with market price forecasts that exceed the tenor of liquid commodity futures, allows for mismanagement of the firms books. Its readily apparent that MtM has allowed many folks to be rewarded today for the all of the future cash profits, regardless of the time period. What is not considered in MtM is the present value of all the risk that the firm has undertaken. Stress testing scenarios that provide a 20% or more probability of occurrence should be used to net against the firms MtM valuation. To report the one side of the risk to return ration as an asset and basis of bonus is bad financial management.
Analysis
Utilities will need to unbundle trading operations from regulated business, including their balance sheet in order to properly determine its regulated capital mix. Additionally, the use of Mark to market (MtM) accounting does not provide a valid basis for a firms expected cash flows. MtM does not net market illiquidity nor denote the level of or lack of correlations of key variables thats contained in its risk profile.
