2012 Erp Practice Exam1

Energy Risk Professional (ERP® ) Examination Practice Exam 1

Energy Risk Professional Examination (ERP®) Practice Exam 1

TABLE OF CONTENTS

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

ERP Practice Exam 1 Candidate Answer Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3

ERP Practice Exam 1 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5

ERP Practice Exam 1 Answer Sheet/Answers Sheet/Answers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21

ERP Practice Exam 1 Explanations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23

© 2012 Global Association of Risk Professionals. All rights reserved. It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc.

i


INTRODUCTION

1. Plan a date date and and time time to take take the the practic practice e exam. exam. Set dates appropriately to give sufficient study/review

The ERP Exam is a practice-oriented examination. Its ques-

time for the practice exam prior to the actual exam.

tions are derived from a combination of theory, as set forth in the core readings, and “real-world” work experience.

2. Simulate the test environment environment as closely closely as possible.

Candidates are expected to understand energy risk man-

•

Take the practi practice ce exam exam in a quiet quiet place. place.

agement concepts and approaches and how they would

•

Have Have only only the prac practice tice exam, exam, candida candidate te answ answer er

apply to an energy risk manager’s day-to-day activities.

sheet, calculator, and writing instruments (pencils,

The ERP Examination is also a comprehensive examination, testing an energy risk professional on a number of risk

erasers) available. •

Minimiz Minimize e possible possible dist distrac raction tions s from from other other people, people,

management concepts and approaches. It is very rare that

cell phones, televisions, etc.; put away any study

an energy risk manager will be faced with an issue that can

material before beginning the practice exam.

immediately be slotted into just one category. In the real

•

Allocat Allocate e 2 minut minutes es per question question for the the practi practice ce

world, an energy risk manager must be able to identify any

exam and set an alarm to alert you when a total of

number of risk-related issues and be able to deal with them

120 minutes have passed (or 2-60 minute sessions

effectively.

with a break in between to simulate the actual exam

The ERP Practice Exam 1 has been developed to aid

conditions). Complete the entire exam but note the

candidates in their preparation for the ERP Examination in November 2011. This practice exam is based on a sample

questions answered after the 120-minute mark. •

Follow Follow the ERP calcul calculato atorr policy policy.. Candidat Candidates es are are only

of actual questions from the 2009 ERP Examination and

allowed to bring certain types of calculators into the

is suggestive of the questions that will be in the 2011 ERP

exam room. The only calculators authorized for use

Examination.

on the ERP Exam in 2011 are listed below, there will

The ERP Practice Exam 1 contains 60 multiple choice

be no exceptions to this policy. You will not be allowed

questions. Note that the 2011 ERP Examination will consist

into the exam room with a personal calculator other

of a morning and afternoon session, each containing 90

than the following: Texas Instruments BA II Plus

multiple choice questions. The practice exam is designed to

(including the BA II Plus Professional), Hewlett Packard

be shorter to allow candidates to calibrate their prepared-

12C (including the HP 12C Platinum and the Anniversary

ness for the exam without being overwhelming.

Edition), Hewlett Packard 10B II, Hewlett Packard 10B II+

The ERP Practice Exam 1 does not necessarily cover

and Hewlett Packard 20B.

all topics to be tested in the 2011 ERP Examination. For a complete list of topics and core readings, candidates should refer to the 2011 ERP Examination Study Guide.

3. After After complet completing ing the ERP ERP Practic Practice e Exam 1 •

Calculat Calculate e your your score score by by compari comparing ng your your answer answer

Core readings were selected in consultation with the Energy

sheet with the practice exam answer key. Only

Oversight Committee (EOC) to assist candidates in their

include questions completed within the first 200

review of the subjects covered by the exam. Questions for

minutes in your score.

the ERP Examination are derived from these core readings

•

Use the the practi practice ce exam exam Answ Answers ers and and Explanat Explanations ions to

in their entirety. As such, it is strongly suggested that candi-

better understand the correct and incorrect answers

dates review all core readings listed in the 2011 ERP Study

and to identify topics that require additional review.

Guide in-depth prior to sitting for the exam.

Consult referenced core readings to prepare for the exam.

Suggested Use of Practice Exams

•

Remember: Remember: pass/fa pass/fail il status status for the the actual actual exam exam is is

To maximize the effectiveness of the practice exams, candi-

based on the distribution of scores from all candi-

dates are encouraged to follow these recommendations:

dates, so use your scores only to gauge your own progress and level of preparedness.


1

Energy Risk ® Prof Profes essio sional nal(ER (ERP P) Examination Practice Exam 1 Answer Sheet


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3

Energy Risk ® Professional(ERP ) Examination Practice Exam 1 Questions


1.

An electric power generator is offering the following four separate bids: • •

50 MW at USD 20 per MW 100 MW at USD 25 per MW

• •


What would the market clearing price of electric power be if demand is 175 MW?

2.

a.

USD 40.00/MW

b. c.

USD 26.25/MW USD 32.72/MW

d.

USD 30.00/MW

Devon is interested in creating a synthetic commodity by combining a forward contract with a zero-coupon bond. What is the payoff required on the zero-coupon bond if the annual risk-free interest rate on a continuous basis is 2% and the price of the commodity forward contract at time 0 is F0,T = USD 150 (where T = 1 year)? a.

USD 147

b.

USD 150 USD 153 USD 156

c. d.

3.

4.

The Senior Management of Cristal Crude Refinery is planning to build a new refinery complex in Indonesia that includes a coker. Which of the following is true about the new refinery? a.

The refinery is a hydroskimming refinery.

b. c.

The refinery is classified as a simple refinery. The refinery is best suited for processing heavy crude oil.

d.

The refinery will produce nearly as much residual fuel as gasoline.

Which of the following statements regarding the transportation of petroleum products is correct? a.

Natural gas liquids like ethane, ethane-propane mixtures and LPGs are commonly transported by

b. c.

dedicated pipeline. Contamination is usually an issue when butane is transported via the same pipeline as gasoline and diesel. Ethane-propane mixtures are seldom transported via pipeline.

d.

Natural gasoline is typically transported through its own dedicated pipeline.


5


5.

6.

Which of the following best describes a royalty payment? a.

An amount equal to a percentage of the value of production paid by the holder to the State in cash or in kind.

b. c.

An amount paid by the contract holder to an independent agent for the right to exploit an asset. The money collected by the site inspector.

d.

A tax on production volume, independent of profits.

Which of the following energy forward contracts will have the greatest mark-to-market sensitivity to a singleday price spike created by an unplanned outage at a large generation plant during the delivery period? a. b. c.

d.

7.

5 x 16 contract for a week On-peak contract for delivery over the entire month Round-the-clock contract for delivery over a two-month period A 5 x 8, 2 x 2 4 calendar year contract

Heinz provides risk management support to a multinational energy trading desk. His primary responsibility is to inform the Chief Risk Officer about derivatives trades executed each day along with all trader risk limit exceptions. Which of the following risk control categories best describes Heinz’s primary responsibility?

c.

Risk Reporting Risk Review Risk Assessment

d.

Risk Control

a. b.

8.

Jim Johnson is studying issues associated with electricity options. Which of the following statements regarding electricity options is correct?

c.

Option models (i.e. Black-Scholes) can be modified to handle electricity as well as financials The use of convenience yield compensates for electricity price spikes Asian options are popular among electricity risk managers because of to their averaging feature

d.

The “no-arbitrage” argument can be applied to electricity in order to value derivatives

a. b.

9.

6

A power plant enters into a natural gas contract that has a take-or-pay value of 85% and a swing value of 20%. If the contract specifies delivery of 120 MWh of natural gas equivalent, what is the minimum amount of gas that must be purchased under the terms of the contract? a.

24 MWh

b. c.

96 MWh 102 MWh

d.

120 MWh



10.

Consider the delta profile for at-the-money European call forward options on NYMEX crude oil. What is the approximate delta value when the strike price is close to the forward price?

11.

12.

a.

0.00

b. c.

0.25 0.50

d.

1.00

Which of the following is NOT a method for managing credit-risk exposure within energy markets? a.

Clearing OTC energy derivatives

b. c.

Obtaining credit risk insurance Purchasing commodity forward contracts

d.

Securing a financial guarantee via an Irrevocable Standby Letter of Credit

Karachaganak, Kazakhstan is one of the largest gas condensate fields in the world, with proven reserves of 1.9 billion barrels of oil and 13 trillion cubic feet of gas. In 2004, the field produced about 220,000 barrels of oil and 1.3 billion cubic feet of gas per day. What is the producing gas-oil ratio? a. b. c.

d.

13.

4,300 5,909 6,842 7,523

LNG suppliers must assure the quality of the gas from their LNG terminals in order to fulfill which of the following specifications? a.

It is characteristic of the gas as it came from the reservoir.

b.

It meets the seller’s specifications. It is free of methane. It is consistent with the requirements of downstream gas customers.

c.

d.


7


14.

Two manufacturing plants — Factory Alpha and Factory Bravo — are told by the government they each need to reduce their greenhouse gas emissions. The target reductions and costs for each factory to meet this goal are shown in the table below. Alpha

Bravo

Required emissions reductions

10 tons

10 tons

Cost of emissions reductions

USD 120 per ton

USD 40 per ton

Total cost of reductions

USD 1,200

USD 400

Under an emissions trading scheme, Factory Alpha can pay Factory Bravo to reduce its emissions by an additional 10 tons, in effect, buying the needed emissions credit from Bravo. What will Bravo’s final emission reduction cost be if it charges Alpha USD 600 for the emissions credit? a. b. c.

d.

15.

USD 200 USD 600 USD 800 USD 1,000

A trader at XYZ Bank has been asked by a client who is a petroleum refiner client to quote the price on a 3-month crude oil forward contract. Given the following forward curve and discount factors for crude oil, calculate the price of the 3 month forward contract. Contract

Price

Discount Factor

Jan Contract Feb Contract

USD 79.10/bbl USD 85.60/bbl

0.95 0.92

Mar Contract

USD 83.90/bbl

0.88

a. b. c.

d.

16.

USD 75.91 USD 90.40

You have been asked by your supervisor to hedge a daily power option. Which is the most appropriate contract to use to hedge the daily option? a. b. c.

d.

8

USD 80.37 USD 82.81

Daily forward contract Daily futures contract OTC swap contract Balance-of-the-month contract



17.

Which of the following is NOT a disputable point in the performance of an energy commodity contract? a. b. c.

d.

18.

Poor commodity quality Default on a debt

Which of the following statements is/are true about the impact of a “Smart Grid”? I.

A smart grid is a more flexible control system that maximizes the utility of existing transmission assets and delays the need for creating new ones.

II.

A smart grid provides better control of the transmission system allowing peaker plants to run during periods of congestion

a.

I only

b.

II only Both I and II are correct Neither I or II are correct

c.

d.

19.

Credit ratings Missed deliveries or deadlines

Which of the statements below is/are an advantage of using Geometric Brownian motion (GBM) to model electricity prices? I.

GBM is an industry standard that can be easily applied for efficient computer simulation

II.

GBM is a stochastic process that captures the fat tails of price distributions

a.

I only II only

b. c.

d.

Both I and II are correct Neither I or II are correct


9


20.

Consider the following yields from a simple, complex, and very complex refinery. Each is processing the same

sour, heavy crude oil. Based on the output products listed, identify refineries X, Y, and Z by their complexity level. Product Type\Refinery

X

Y

Z

Gasoline Jet Fuel

60 15

50 15

30 15

Distillate Fuel

25

25

20

Residual Fuel Coke Refinery Fuel

— 5 15

— — 10

— — 8

Gain

(20)

(5)

(3)

a. b. c.

d.

21.

X = complex, Y = simple, Z = very complex X = very complex, Y = complex, Z = simple

Which facility type is usually considered the least desirable option for underground storage of natural gas because of expense and operational constraints? a. b. c.

d.

22.

X = simple, Y = complex, Z = very complex X = simple, Y = very complex, Z = complex

Depleted oil and gas fields Aquifers Salt caverns Storage tanks

Consider a power grid where the average heat rate for combined cycle gas turbine plants using natural gas is 8,500 Btu/kWh. The price of natural gas is USD 5.00/MMBtu, and the price of electricity is USD 30.00/MWh. What is the spark spread for this particular power grid?

c.

USD 0.0125/kWh USD 0.1250/kWh USD -0.0125/kWh

d.

USD -0.1250/kWh

a. b.

23.

Ann Kelly buys a long call at a strike of USD 50 and sells a long call at a strike of USD 75. She has purchased which of the following structures? a. b. c.

d.

10

Bull spread Bear spread Participating collar Participating cap



24.

Simone is interested in capturing large price swings in her energy portfolio and decides to use the delta-normal approach to compute portfolio VaR. The delta-normal approach will be least likely to capture large price changes in which of the following instruments?

b.

Futures Forwards

c.

Swaps

d.

Options

a.

25.

Which of the following statements regarding LNG project costs is correct? a.

The construction of liquefaction plant facilities typically represents the LNG chain’s most significant capital investment.

b.

LNG storage tank costs are independent of liquefaction plant location. The cost of a liquefaction plant is considered part of the upstream costs.

c.

d.

26.

27.

One unusual aspect of LNG upstream and downstream development is that future additions to achieve economies of scale are not planned due to the high cost of building LNG facilities.

A major hurricane has shut down drilling activity on hundreds of oil rigs across the Gulf of Mexico. The resulting supply disruption has caused the cash (spot) price of WTI crude to spike above the price of longer dated futures contracts. As a result the WTI contract is said to be trading in _____________. a.

backwardation

b. c.

contango short-term disequilibrium

d.

extreme volatility

High pressure in subsurface reservoirs can cause a significant volume of natural gas to be dissolved in underground crude oil reserves. Which of the following is the correct term for this build-up of gas? a.

Non-associated gas

b.

Crude oil gas

c.

Associated gas Free gas

d.

28.

Which of the following geographic regions is the largest importer of coal? a.

Asia

b. c.

Europe Former Soviet Union

d.

North America


11


29.

Environmental impacts must be considered when evaluating the operating efficiency of an electric generation facility. Using the information below calculate the economic impact of sulfur dioxide (SO2) in the cost of producing each MWh of electricity at Acme Power Generation. • •

Heat rate is 8 MMBtu/MWh SO2 price is USD 600 per ton (2,000 pounds/ton)

•

SO2 rate is 2.00 lbs per MMBtu

a.

USD 2.40 per MWh USD 8.25 per MWh

b. c.

d.

30.


Andreas purchased a monthly 100 MW on-peak power call option for a month that has 20 business days. The strike price is USD 75/MWh and the premium is USD 5/MWh. What would the gross settlement amount be if Andreas exercised the call option in a month when the average on-peak power price was USD 85/MWh? a. b. c.

d.

31.

32.

USD 160,000 USD 240,000 USD 320,000 USD 480,000

Which of the following is an example of basis risk? a.

The risk of a natural gas price spike during peak electricity demand for a gas fired power generation plant.

b. c.

The risk of failure to comply with FERC financial reporting regulations. The risk that a megawatt of electricity will cost USD 75 in Pennsylvania and USD 82.50 in New York.

d.

The risk of the inability of a power generation plant to meet demand in a given market.

Makati and Sons Heating Oil Company expects customer demand to average 2,200 gallons of heating oil during the upcoming heating season. The company sells oil to customers using fixed price contracts and has decided to store enough oil to meet average customer demand of 2,300 gallons. They have also purchased call options to protect against the risk of a much colder than expected winter. What risk is the company primarily seeking to hedge? a. b. c.

d.

12

Volume Risk Supply Risk Credit Risk Location Basis Risk



33.

On June 20, Caufield Refining estimates it will need to purchase 40,000 barrels of crude on October 12. Caufield decides to hedge price risk using a November NYMEX futures contract. The November futures price on June 20 is USD 67.00/bbl. On October 12, Caufield is ready to purchase its required crude oil and closes out the futures contract on that day; at this time the spot price is USD 70.10/bbl and the futures price is USD 68.50/bbl. In this scenario, what is the effective price paid per barrel? a.

USD 68.50

b.

USD 68.60 USD 70.10 USD 70.40

c.

d.

34.

An oil field estimated to have 50 Mbbl of oil is classified as "P90." What does this classification indicate? a. b. c.

d.

35.

b. c.

d.

Independent Integrated Speculative Wildcat

Which of the following is NOT considered a primary model for electricity trading arrangements?

c.

Integrated model Open access model Wheeling model

d.

Decentralized model

a. b.

37.

That the oil field is 90% depleted. That the oil field is determined to contain of 90% petroleum and 10% other material (e.g. natural gas).

Black Gold Co. is a firm specializing in the exploration, acquisition and drilling of new crude oil fields. Based on these activities, Black Gold would best be described as what type of oil operation? a.

36.

That there is a 90% probability the oil field will actually produce more than 50 Mbbl of oil. That there is a 90% probability the oil field contains 50 Mbbl of oil.

You have a portfolio of gas calls and puts that is gamma neutral. Which of the following trading strategies would you implement to make your portfolio delta neutral? a. b. c.

d.

Purchase a call option Purchase a forward contract Purchase either a call or a put option By definition a gamma neutral portfolio is also delta neutral so no action is necessary


13


38.

Steve Dolan is a power manager at Upstate Electric. He is negotiating a one-day contract to sell 100 MWh of electricity at USD 55/MWh for a 24-hour period and has been asked to calculate the Value-at-Risk (VaR) for the contract. If the daily volatility of electricity prices is 2%, what is the daily VaR on the contract assuming a 95% confidence interval? a.

USD 180

b.

USD 3,447

c.

USD 4,330 USD 5,412

d.

39.

40.

Which of the following pricing relationships include the elements of convenience yield? a.

Spot price

b. c.

Expected spot price Strike price

d.

Forward price

Wet gas refers to ______________. a. b. c.

d.

41.

14

Gas that has a high moisture content Gas that has a heating value greater than methane. Gas that has not been scrubbed of its sulfur impurities None of the above

Given the following information, how much power capacity (in MWs) would load serving entities in a capacity market be required to purchase to make the building of additional capacity economically viable? Expected end-user peak load:

100 MW

Average end-user load: Percentage reserve margin:

90 MW 10%

a.

10 MW

b. c.

110 MW 100 MW

d.

99 MW



42.

Which of the following statements is/are true regarding option valuation? I.

The intrinsic value of a call option is greatest when the value of the underlying is equal to the strike price of the option.

II.

The time value is the difference between the market quoted premium and the intrinsic value.

a.

I only

b.

II only Both I and II Neither I or II

c.

d.

43.

Which of the following tests can be used to demonstrate that model errors are unbiased and normally distributed? I. II.

QQ plot R-squared

III. Autocorrelation test a. b. c.

d.

44.

II and III I, II and III

Which of the following statements about the storage of natural gas is/are correct? I.

Gas is stored to provide base load storage to meet seasonal demands.

II.

Gas is stored to provide peak storage to smooth out the demand curve.

a.

I only II only

b. c.

d.

45.

I and II I and III

Both I and II Neither I or II

Countries have varying policies regarding hydropower, with some countries making it a national policy to rely on hydropower. From the options below, choose the one that correctly lists the four countries from highestto-lowest in terms of the ratio of hydropower-generated electricity to total national electricity generation: a.

Sweden, Norway, Brazil, Canada

b. c.

Canada, Norway, Brazil, Sweden Brazil, Canada, Sweden, Norway

d.

Norway, Brazil, Canada, Sweden


15


46.

Patel is managing a portfolio with 100 long puts on March peak forward power contracts. If the delta of the put contracts is -0.4, what position in March peak forward power contracts does Patel need to create for the combined portfolio to be delta neutral?

b.

Short 40 March Peak Forward contracts Long 40 March Peak Forward contracts

c.

Short 60 March Peak Forward contracts

d.

Long 60 March Peak Forward contracts

a.

47.

A producer holding a commodity is said to be _____ and could hedge by going _____ a forward contract. a. b. c.

d.

48.

Short, short Short, long

A natural gas-fired power plant uses 15,200 MMBtu of gas to generate 2,000 MWh of electricity. What is the heat rate for this power plant? a. b. c.

d.

49.

Long, long Long, short

0.131 MMBtu/MWh 7.6 MMBtu/MWh 30.4 MMBtu/MWh 7,600 MMBtu/MWh

A 3-month natural gas option with a strike of USD 6.00 on an August contract is trading at a Black-implied volatility of 45%. Another call option with the same contract specifications, with a strike of USD 6.50, is trading at a Black-implied volatility of 50%, producing a volatility smile. Which of the following conclusions can be made given the market information above? a.

The volatility smile tells us that the market is feeling good about the economy and prices are expected to go higher.

b.

The different volatilities for the two call options tell us that the lognormal Black model cannot capture

c.

the true underlying price behavior with a single volatility measure. A call option with the same contract specifications as the two options in the problem but with a strike of

d.

16

USD 7.00 must therefore be trading at a Black-implied volatility of 55%. The two options should have exactly the same volatility, and therefore this is a case of market arbitrage: the USD 6.00 option is under-priced relative to the USD 6.50 option.



50.

Consider global proven recoverable coal reserves. Which of the following correctly lists the countries in order of largest to smallest recoverable coal reserves?

51.

52.

a.

United States, China, Russia, Australia, India

b. c.

Russia, United States, India, China, Australia United States, Russia, China, India, Australia

d.

China, United States, Australia, Russia, India

Carsten needs to refine petroleum into high octane gasoline. Which process will he use? a.

Horizontal refining

b. c.

Catalytic cracking Distillation process

d.

Vertical hydrolytic emersi on

Which of the following processes refers to the refining of crude oil into separate fractions or cuts? a.

Distillation

b.

Treatment Blending Conversion

c.

d.

53.

A call swaption is exercised covering 6 months for 100,000 barrels of crude per month. The premium is USD 1.00 per barrel and the strike price is USD 65 per barrel. During the ensuing six months the average price is USD 70 per barrel. What is the net cash flow from the swaption? a. b. c.

d.

54.

USD 400,000 USD 500,000 USD 2,400,000 USD 3,000,000

A call option has a premium of USD 5 and a strike price of USD 28. What is the time value of the call option if the current price of the underlying is USD 31? a. b. c.

d.

USD 5 USD 3 USD 2 USD 0


17


55.

Eloise, ERP, is the risk manager for a large natural gas company. The company uses a VaR model with a 95% confidence level to measure risk exposure and compliance. If Eloise is concerned with the impact of extreme events, she should:

b.

Continue VaR testing at the 95% confidence level. Move the VaR confidence level up to 97%.

c.

Move the VaR confidence level down to 90%.

d.

Implement stress testing to assess the impact of extreme events.

a.

56.

57.

Which of the following “Greeks” measures the sensitivity of an option’s price to changes in the underlying instrument’s implied volatility? a.

Delta

b. c.

Gamma Theta

d.

Vega

Akiko, an ERP, is pricing a daily transportation deal between Henry Hub and Houston Ship Channel using the mean-reverting Ornstein-Uhlenbeck process to model gas prices. In order to calculate the at-the-money (ATM) implied volatilities for Henry Hub and Houston Ship Channel Akiko will need to do which of the following?

58.

a.

Calculate the correct volatilities since the implied volatilities from a Black-Scholes calculation are not the same volatilities used in the Ornstein-Uhlenbeck process.

b. c.

Scale the implied volatilities by 365250 since it is a daily deal. Roughly estimate implied volatilities. Nothing else needs to be done.

d.

Scale the implied volatilities by 250365 since it is a daily deal.

The Cost of Alternative Transportation method of establishing pipeline shippi ng rates involves comparison against the costs of alternative forms of product transportation such as ship, barge, rail, and truck. Assuming the cost of shipping 1,000 bbl of crude from Tucson, AZ to St. Louis, MO via truck is USD 25/bbl, and by rail is USD 21/bbl, what would be the appropriate charge for transporting 1,000 bbl of crude by pipeline? a. b. c.

d.

18

USD 23.00 — USD 25.00/bbl USD 19.50 — USD 21.00/bbl USD 24.50 — USD 25.50/bbl USD 21.00 — USD 22.50/bbl



59.

Hydroelectric projects are not being pursued in many developed nations despite the fact they are an emissions-free source of power. What is the primary reason most developed countries are not building hydroelectric plants? a. b.

National environmental regulations make the construction of new hydro projects extremely difficult Without a global cap-and-trade emissions scheme, it is less-expensive to build fossil fuel-powered generation plants

c.

d.

60.

Government incentives favor renewable projects like wi nd and solar over hydroelectric plants Most developed nations have already largely exploited their hydroelectric potential

Which of the following statements regarding oil sands production are true? I.

Extracting oil sands on a large scale has significant environmental impacts.

II. Mining and in-situ operations in oil sands use a significant amount of water. III. Large tailing ponds are created in the production of oil sands and their management is one of the main challenges for the industry. a. b. c.

d.

Statement I Statement III Statements I and III All are correct


19

Energy Risk ® Professional(ERP ) Examination Practice Exam 1 Answers


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21

Energy Risk ® Professional(ERP ) Examination Practice Exam 1 Explanations


1.

An electric power generator is offering the following four separate bids: • •


• •


What would the market clearing price of electric power be if demand is 175 MW? a.

USD 40.00/MW

b. c.

USD 26.25/MW USD 32.72/MW

d.

USD 30.00/MW

Correct answer: a Reading reference: Making Competition Work in Electricity , Hunt, Chapter 2, p. 170. Explanation: Answer a is correct. Use the price quoted for 250 MW: apply this amount (USD 40) to any demand level between 150 and 250 MW.

2.

Devon is interested in creating a synthetic commodity by combining a forward contract with a zero-coupon bond. What is the payoff required on the zero-coupon bond if the annual risk-free interest rate on a continuous basis is 2% and the price of the commodity forward contract at time 0 is F0,T = USD 150 (where T = 1 year)? a.

USD 147

b. c.

USD 150 USD 153

d.

USD 156

Correct answer: b Reading reference: Fundamentals of Derivatives Markets , McDonald, Chapter 6, p.171. Explanation: Answer b is correct because, in creating a synthetic, we enter into a commodity forward contract and purchase a zero coupon bond equaling e-rt* F0,T, this value is USD 147. The payoff is USD 150. The total payoff in formula form is: ST — F0,T + F0,T, or the payoff on the forward + the payoff of the zero bond. Answer a is incorrect because it is the investment, at time 0, in the zero bond.


23


3.

The Senior Management of Cristal Crude Refinery is planning to build a new refinery complex in Indonesia that includes a coker. Which of the following is true about the new refinery? a.

The refinery is a hydroskimming refinery.

b. c.

The refinery is classified as a simple refinery. The refinery is best suited for processing heavy crude oil.

d.

The refinery will produce nearly as much residual fuel as gasoline.

Correct answer: c Reading reference: Petroleum Refining in Nontechnical Language , 3rd Edition, Leffler: Chapter 20. Explanation: The presence of a coker defines this as a “very complex” refinery; very complex refineries usually make their best margins in processing heavy crude, which the coker allows them to break down into more desirable light petroleum products. Very complex refineries produce little or no residual fuel oil. By comparison, hydroskimming refineries are classified as “simple refineries” that do not include cokers and usually cannot profitably refine heavy crude. Since you know your refinery includes a coker, this means that answer b is correct.

4.

Which of the following statements regarding the transportation of petroleum products is correct?

c.

Natural gas liquids like ethane, ethane-propane mixtures and LPGs are commonly transported by dedicated pipeline. Contamination is usually an issue when butane is transported via the same pipeline as gasoline and diesel. Ethane-propane mixtures are seldom transported via pipeline.

d.

Natural gasoline is typically transported through its own dedicated pipeline.

a. b.

Correct answer: a Reading reference: Fundamentals of Natural Gas Processing , Kidnay and Parish, Chapter 12, p. 261. Explanation: Answer a is correct; LPGs are typically transported through their own product-specific pipelines.

24



5.

Which of the following best describes a royalty payment? a.

An amount equal to a percentage of the value of production paid by the holder to the State in cash or in kind.

b. c.

An amount paid by the contract holder to an independent agent for the right to exploit an asset. The money collected by the site inspector.

d.

A tax on production volume, independent of profits.

Correct answer: a Reading reference: Oil, Gas Exploration and Production , Institut Francais: Chapter 3, p. 198-200. Explanation: A royalty is an amount equal to a percentage of the value of production, paid by the holder to the State in cash or in kind. It is effectively a tax directly proportional to the value of production, that is, a tax on turnover, and independent of profits. The amount of the royalty depends not only on the percentage applying, but also on a number of other parameters which must be carefully specified.

6.

Which of the following energy forward contracts will have the greatest mark-to-market sensitivity to a singleday price spike created by an unplanned outage at a large generation plant during the delivery period? a. b. c.

d.

5 x 16 contract for a week On-peak contract for delivery over the entire month Round-the-clock contract for delivery over a two-month period A 5 x 8, 2 x 2 4 calendar year contract

Correct answer: a Reading reference: Energy Risk , Pilipovic: Chapter 7, p. 173-179. Explanation: A forward contract for delivery over a number of days is valued as a weighted average of the daily forward prices, be it the on-peak, off-peak, or round-the-clock prices given the contract specifications. Hence, a price spike expected to occur for just one of the days in the period will have the greatest impact on the shorter time period of delivery. That would make answer a the best answer above. Additionally, on-peak markets (5 x 16) tend to be more volatile than the round-the-clock markets (7 x 24), which further tend to be more volatile than the off-peak markets (5 x 8,2 x 24). Hence, in this regard, a is also the best answer.


25


7.

Heinz provides risk management support to a multinational energy trading desk. His primary responsibility is to inform the Chief Risk Officer about derivatives trades executed each day along with all trader risk limit exceptions. Which of the following risk control categories best describes Heinz’s primary responsibility?

b.

Risk Reporting Risk Review

c.

Risk Assessment

d.

Risk Control

a.

Correct answer: a Reading reference: Energy Markets: Price Risk Management and Trading, Tom James; Chapter 10, p. 183-84. Explanation: Reporting derivatives positions to upper management is a duty that falls under the reporting (communications) category of risk control; it is an important aspect of risk management because if upper management is not informed of derivative usage the effects on the company can be devastating. Daily reporting of derivative positions is not the same as an in-depth internal review of a company's finances or an audit, thus b is not the correct answer; nor do the reporting duties fall under the risk assessment or management control categories.

8.

Jim Johnson is studying issues associated with electricity options. Which of the following statements regarding electricity options is correct? a.

Option models (i.e. Black-Scholes) can be modified to handle electricity as well as financials

b. c.

The use of convenience yield compensates for electricity price spikes Asian options are popular among electricity risk managers because of to their averaging feature

d.

The “no-arbitrage” argument can be applied to electricity in order to value derivatives

Correct answer: c Reading reference: Fundamentals of Electricity Derivatives , Kaminski, Chapter 2, p.64. Explanation: Answer c is correct — according to the authors Asian options are gaining in popularity among electricity managers for this reason.

26



9.

A power plant enters into a natural gas contract that has a take-or-pay value of 85% and a swing value of 20%. If the contract specifies delivery of 120 MWh of natural gas equivalent, what is the minimum amount of gas that must be purchased under the terms of the contract?

b.

24 MWh 96 MWh

c.

102 MWh

d.

120 MWh

a.

Correct answer: c Reading reference: Managing Energy Risk: An Integrated View on Power and Other Energy Markets , Burger, Graeber, and Schindlmayer, Chapter 4, p. 166-177. Explanation: The take-or-pay percentage refers to the percentage of the contract that must be paid for whether the importer wants to take delivery of the gas or not. For this contract, the minimum that must be paid for is 85% x 120 MWh = 102 MWh.

10.

Consider the delta profile for at-the-money European call forward options on NYMEX crude oil. What is the approximate delta value when the strike price is close to the forward price?

c.

0.00 0.25 0.50

d.

1.00

a. b.

Correct answer: c Reading reference: Energy Derivatives: Pricing and Risk Management, Clewlow and Strickland; Chapter 9, p. 166. Explanation: Answer c is correct. For at-the-money options, where the strike price is close to the forward price the delta is approximately 0.5.

11.

Which of the following is NOT a method for managing credit-risk exposure within energy markets?

c.

Clearing OTC energy derivatives Obtaining credit risk insurance Purchasing commodity forward contracts

d.

Securing a financial guarantee via an Irrevocable Standby Letter of Credit

a. b.

Correct answer: c Reading reference: Energy Markets: Price Risk Management and Trading , James: Chapter 16, p. 319-21. Explanation: Methods for managing credit-risk exposure include: master netting; collateralization; financial guarantees; credit insurance; credit derivatives; assignment; and clearing OTC energy derivatives. The purchase of commodity futures is a hedging strategy.


27


12.

Karachaganak, Kazakhstan is one of the largest gas condensate fields in the world, with proven reserves of 1.9 billion barrels of oil and 13 trillion cubic feet of gas. In 2004, the field produced about 220,000 barrels of oil and 1.3 billion cubic feet of gas per day. What is the producing gas-oil ratio?

b.

4,300 5,909

c.

6,842

d.

7,523

a.

Correct answer: b Reading reference: Norman J. Hyne. Nontechnical Guide to Petroleum Geology, Exploration, Drilling, and Production, 2nd Edition (Tulsa, OK: PennWell, 2001): Chapter 1, p. 11.

Explanation: Answer B is correct. The definition of producing gas-oil ratio requires gas production (in cubic feet) to be divided by oil production (in barrels). Thus, GOR = (1,300,000,000 cf)/(220,000 bbl) = 5,909. Note that the gas-oil ratio of the proved reserves is computed as (13 Tcf)/(1.9 Bbbl) = 6,842 which denotes a field with oil (condensate) and gas production.

13.

LNG suppliers must assure the quality of the gas from their LNG terminals in order to fulfill which of the following specifications? a. b. c.

d.

It is characteristic of the gas as it came from the reservoir. It meets the seller’s specifications. It is free of methane. It is consistent with the requirements of downstream gas customers.

Correct answer: d Reading reference: LNG: A Nontechnical Guide , Tusiani and Shearer, Chapter 7, p. 180. Explanation: Answer d is correct. The quality of the gas that comes from an LNG import terminal must be consistent with the requirements of downstream gas customers or meet the specifications of the interconnected gas transmission lines, which vary by region and by country.

28



14.

Two manufacturing plants — Factory Alpha and Factory Bravo — are told by the government they each need to reduce their greenhouse gas emissions. The target reductions and costs for each factory to meet this goal are shown in the table below. Alpha

Bravo

Required emissions reductions

10 tons

10 tons

Cost of emissions reductions

USD 120 per ton

USD 40 per ton

Total cost of reductions

USD 1,200

USD 400

Under an emissions trading scheme, Factory Alpha can pay Factory Bravo to reduce its emissions by an additional 10 tons, in effect, buying the needed emissions credit from Bravo. What will Bravo’s final emission reduction cost be if it charges Alpha USD 600 for the emissions credit? a. b. c.

d.

USD 200 USD 600 USD 800 USD 1,000

Correct answer: a Reading reference: Energy and Emissions Markets: Collision or Convergence? , James and Fusaro; Chapter 3, p. 31-32. Explanation: By making the deal with Factory Alpha, Factory Bravo’s total cost of reductions will be USD 200 (answer A). Bravo will now have to reduce their emissions by 20 tons, at USD 40 per ton; this will cost Bravo USD 800. Bravo will receive a payment from Alpha of USD 600, making their final costs USD 200 (800 — 600 = 200).


29


15.

A trader at XYZ Bank has been asked by a client who is a petroleum refiner client to quote the price on a 3-month crude oil forward contract. Given the following forward curve and discount factors for crude oil, calculate the price of the 3 month forward contract. Contract Jan Contract

Price USD 79.10/bbl

Discount Factor 0.95

Feb Contract

USD 85.60/bbl

0.92

Mar Contract

USD 83.90/bbl

0.88

a.

USD 80.37

b. c.

USD 82.81 USD 75.91

d.

USD 90.40

Correct answer: b Reading reference: Markus Burger, Bernhard Graeber, and Gero Schindlmayr. Managing Energy Risk: Integrated View on Power and Other Energy Markets (West Sussex, England: John Wiley & Sons, 2007): Chapter 2, p. 50. Explanation: Answer b is correct, the equation is as follows:

Q1 Contract =

16.

79.1 * 0.95 + 85.6 * 0.92 + 83.9 * 0.88 0.95 + 0.92 + 0.88

227.729 = 82 2.75

You have been asked by your supervisor to hedge a daily power option. Which is the most appropriate contract to use to hedge the daily option? a.

Daily forward contract

b.

Daily futures contract OTC swap contract Balance-of-the-month contract

c.

d.

Correct answer: d Reading reference: Fundamentals of Electricity Derivatives , Kaminski: Chapter 2, p. 60, 70. Explanation: Most power markets, except perhaps the Nord Pool, do not have liquid markets for daily forward or futures contracts, so it is best to use a balance-of-the-month contract as a surrogate for daily forward/futures contracts to hedge daily options. The balance-of-the-month price is the price of power delivered every day from today until end of current month.

30



17.

Which of the following is NOT a disputable point in the performance of an energy commodity contract? a. b. c.

d.

Credit ratings Missed deliveries or deadlines Poor commodity quality Default on a debt

Correct answer: a Reading reference: Fundamentals of Electricity Derivatives , Kaminski; Chapter 12, p. 348-9. Explanation: Answer a is correct. Events and disputes that may come up with a physical contract include force majeure, the quality of the commodity being delivered, default on a debt, missed payments, or missed deliveries. Credit ratings are not created in a contract but rather via third parties.

18.

Which of the following statements is/are true about the impact of a “Smart Grid”? I.

A smart grid is a more flexible control system that maximizes the utility of existing transmission assets and delays the need for creating new ones.

II.

A smart grid provides better control of the transmission system allowing peaker plants to run during periods of congestion

a.

I only II only

b. c.

d.

Both I and II are correct Neither I or II are correct

Correct answer: a Reading references: US Department of Energy, “The Smart Grid: An Introduction”. Explanation: Answer a is correct: statement I is true because newer technology will allow better rerouting of excess power in constrained zones through underutilized transmission assets, while statement II is false because through better utilization of transmission lines during congestion, peaker plants within congested areas will not have to run just to meet the demand.


31


19.

Which of the statements below is/are an advantage of using Geometric Brownian motion (GBM) to model electricity prices? I.

GBM is an industry standard that can be easily applied for efficient computer simulation

II.

GBM is a stochastic process that captures the fat tails of price distributions

a.

I only

b.

II only Both I and II are correct Neither I or II are correct

c.

d.

Correct answer: a Reading reference: Energy and Power Risk Management: New Developments in Modeling, Pricing, and Hedging, Eydeland & Wolyniec: Chapter 4, p. 161-2. Explanation: Answer a is correct, Statement I is the only true statement as per the reading. Statement II is false, the principal weakness of GBM (cited on p. 162) is that it does not allow the modeling of fat tails of price distributions.

Consider the following yields from a simple, complex, and very complex refinery. Each is processing the same sour, heavy crude oil. Based on the output products listed, identify refineries X, Y, and Z by their complexity level. 20.

Product Type\Refinery

X

Y

Z

Gasoline Jet Fuel

60 15

50 15

30 15

Distillate Fuel Residual Fuel

25 —

25 —

20 —

Coke Refinery Fuel

5 15

— 10

— 8

Gain

(20)

(5)

(3)

a.

X = simple, Y = complex, Z = very complex

b.

X = simple, Y = very complex, Z = complex

c.

X = complex, Y = simple, Z = very complex X = very complex, Y = complex, Z = simple

d.

Correct answer: d Reading reference: Petroleum Refining in Nontechnical Language, 3rd Edition , Leffler: Chapter 20, p. 196. Explanation: d is correct. Refinery complexity refers to the capacity and type of processing units that comprise a refinery. Refinery complexity will increase when “complex” units with large capacity are added since they have greater ability to convert (heavy) crude input into gasoline. For a given grade of crude oil (in this case, medium sour, heavy), as the complexity of the refinery increases the gasoline yield increases and the residual fuel yield decreases (the residual fuel stream is being converted to gasoline).

32



21.

Which facility type is usually considered the least desirable option for underground storage of natural gas because of expense and operational constraints? a.

Depleted oil and gas fields

b. c.

Aquifers Salt caverns

d.

Storage tanks

Correct answer: b Reading reference: Fundamentals of Natural Gas Processing , Kidnay and Parrish: Chapter 12, p. 257. Explanation: B is correct. Aquifers are considered the least desirable underground storage facility for several reasons — the geology of the aquifer is usually not well understood, infrastructure (wells, pumps, compressors, etc.) is unavailable at the site, greater injection pressures mean higher operating cost, gas will need to be dehydrated, and more stringent environmental regulations will be in place.

22.

Consider a power grid where the average heat rate for combined cycle gas turbine plants using natural gas is 8,500 Btu/kWh. The price of natural gas is USD 5.00/MMBtu, and the price of electricity is USD 30.00/MWh. What is the spark spread for this particular power grid? a. b. c.

d.

USD 0.0125/kWh USD 0.1250/kWh USD -0.0125/kWh USD -0.1250/kWh

Correct answer: c Reading reference: Vincent Kaminski (ed). Managing Energy Price Risk , Chapter 3, p.120. Explanation: Answer c is correct, the calculation is as follows: Spark Spread = Output Price — Input Price Output Price = USD 30/MWh x 1MWh/1000kWh = USD 0.03/kWh Input Price= 8500 Btu/kWh x USD 5/1,000,000Btu = USD 0.0425/kWh Therefore, the Spark Spread = -0.0125


33


23.

Ann Kelly buys a long call at a strike of USD 50 and sells a long call at a strike of USD 75. She has purchased which of the following structures? a.

Bull spread

b. c.

Bear spread Participating collar

d.

Participating cap

Correct answer: a Reading reference: Managing Energy Price Risk , Kaminski, Chapter 2, p.60. Explanation: Answer a is correct since, a bull spread is comprised of buying a long call and selling the upside by selling a long call at a higher strike price (than the purchased long call).

24.

Simone is interested in capturing large price swings in her energy portfolio and decides to use the delta-normal approach to compute portfolio VaR. The delta-normal approach will be least likely to capture large price changes in which of the following instruments? a. b. c.

d.

Futures Forwards Swaps Options

Correct answer: d Reading reference: Energy Risk Management: A Non-technical Introduction to Energy Derivatives, Leppard; Chapter 4, p. 200-205. Explanation: d is correct. Since the delta-VaR method is a linear approximation, it works well only if a given portfolio is linear or close to linear. The term linear portfolio means that it consists of products that depend linearly on the risk factor changes. For example, a portfolio consisting of futures, forward and swaps is a linear portfolio. On the other hand, if there are many options in the portfolio it may be far from being linear. In fact, an energy portfolio is expected to be very nonlinear, especially if there are many asset-type deals (e.g. storage, generation, load service, and so on). In this case, linear approximation may be missing big changes in the portfolio values due to nonlinearity. Hence, delta-VaR method may yield inaccurate results for an energy portfolio consisting of options, since they are not linear instruments.

34



25.

Which of the following statements regarding LNG project costs is correct? a.

The construction of liquefaction plant facilities typically represents the LNG chain’s most significant capital investment.

b. c.

LNG storage tank costs are independent of liquefaction plant location. The cost of a liquefaction plant is considered part of the upstream costs.

d.

One unusual aspect of LNG upstream and downstream development is that future additions to achieve economies of scale are not planned due to the high cost of building LNG facilities.

Correct answer: a Reading reference: LNG: A Nontechnical Guide, Tusiani: Chapter 11, p. 301. Explanation: Answer a is correct; it is generally the most significant capital item. Answer b is incorrect, since storage tank costs are dependent on location, as well as, total production, distance from market and tank system design. The cost of a liquefaction plant are downstream, therefore, answer c is incorrect. Answer d is incorrect, since future additions are anticipated and undertaken if sufficient reserves are present.

26.

A major hurricane has shut down drilling activity on hundreds of oil rigs across the Gulf of Mexico. The resulting supply disruption has caused the cash (spot) price of WTI crude to spike above the price of longer dated futures contracts. As a result the WTI contract is said to be trading in _____________. a. b. c.

d.

backwardation contango short-term disequilibrium extreme volatility

Correct answer: a Reading reference: Risk Management in Commodity Markets , Geman: Chapter 2, p. 11. Explanation: Answer a is correct. A market in backwardation (inverted market) is characterized by cash (spot) prices that are higher than longer dated futures contracts. In contrast, a market in contango is characterized by an upward sloping forward price curve.


35


27.

High pressure in subsurface reservoirs can cause a significant volume of natural gas to be dissolved in underground crude oil reserves. Which of the following is the correct term for this build-up of gas? a.

Non-associated gas

b. c.

Crude oil gas Associated gas

d.

Free gas

Correct answer: c Reading reference: Nontechnical Guide to Petroleum Geology, Exploration, Drilling, and Production , Hyne: Chapter 1, p. 11. Explanation: b is correct. Because of high pressure in the subsurface reservoir, a considerable volume of natural gas can be dissolved in crude oil. The formation, dissolved or solution gas/oil ratiois the cubic feet of natural gas dissolved in one barrel of oil in that reservoir under subsurface conditions. The volume measurements are reported under surface conditions. In general, as the pressure of the reservoir increases with depth, the amount of natural gas that can be dissolved in crude oil increases. When crude oil is lifted up a well to the surface, the pressure is relieved, and the natural gas, called solution gas, bubbles out of the oil. The producing gas-oil ratio (GOR) of a well is the number of cubic feet of gas the well produces per barrel of oil. Non-associated natural gas is gas that is not in contact with oil in the subsurface. A non-associated gas well produces almost pure methane. Associated natural gas occurs in contact with crude oil in the subsurface. It occurs both as gas in the free gas cap above the oil and gas dissolved in the crude oil.

28.

Which of the following geographic regions is the largest importer of coal? a. b. c.

d.

Asia Europe Former Soviet Union North America

Correct answer: a Reading reference: Producing Liquid Fuels from Coal: Prospects and Policy I ssues, Bartis; Chapter 2, p. 6. Explanation: The chief importers of coal are Asian nations bordering the Pacific Ocean, including Japan, South Korea and China, making a the correct choice.

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29.

Environmental impacts must be considered when evaluating the operating efficiency of an electric generation facility. Using the information below calculate the economic impact of sulfur dioxide (SO2) in the cost of producing each MWh of electricity at Acme Power Generation. • •

Heat rate is 8 MMBtu/MWh SO2 price is USD 600 per ton (2,000 pounds/ton)

•

SO2 rate is 2.00 lbs per MMBtu

a.


b. c.

d.


Correct answer: d Reading reference: James and Fusaro, Energy and Emissions Markets , Chapter 3. Explanation: Answer d is correct: 8 * 2 *(1/2000) *USD 600 per ton = 4.80. a is incorrect: 8 *2*(1/4000) *USD 600 = USD 2.40 per MWH (use of 4,000 for lbs per ton), B is incorrect; just a guess, b is Incorrect: use of 1,000 lbs per ton.

30.

Andreas purchased a monthly 100 MW on-peak power call option for a month that has 20 business days. The strike price is USD 75/MWh and the premium is USD 5/MWh. What would the gross settlement amount be if Andreas exercised the call option in a month when the average on-peak power price was USD 85/MWh? a.

USD 160,000

b. c.

USD 240,000 USD 320,000

d.

USD 480,000

Correct answer: c Reading reference: Managing Energy Price Risk , Kaminski: Chapter 2, p. 46. Explanation: The correct answer is c: the payoff does not include the amount of premium (32,000 MWH x USD 85 - USD 75). Payout is max (St — k,0) x Q, wherein Q = quantity. a is incorrect, because it includes the premium cost of USD 160,000 (i.e. 32,000 MWH x USD 5). b is incorrect, because it assumes all-hours of 48,000 MWH and premium cost (48,000 MWH x USD 85 - USD 75-USD 5). d is incorrect, because it assume all-hours of 48,000 MWH (48,000 MWH x USD 85 -USD 75). Assumes candidates will know on-peak power call option means for 16 hours per day.


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31.

Which of the following is an example of basis risk? a. b. c.

d.

The risk of a natural gas price spike during peak electricity demand for a gas fired power generation plant. The risk of failure to comply with FERC financial reporting regulations. The risk that a megawatt of electricity will cost USD 75 in Pennsylvania and USD 82.50 in New York. The risk of the inability of a power generation plant to meet demand in a given market.

Correct answer: c Reading reference: Energy Risk , Pilipovic: Chapter 2, p. 32. Explanation: Answer c is correct. Decentralization introduces geographic “basis risk,” which is unique to energies. In financial markets,today’s dollar is worth a dollar anywhere in the country. In energy markets, price depends on location. A megawatt of electricity is priced according to delivery point; the same holds true for natural gas. Location is a fundamental driver of price. Pilipovic defines “basis risk” as the difference in prices between identical products but in two different markets.

32.

Makati and Sons Heating Oil Company expects customer demand to average 2,200 gallons of heating oil during the upcoming heating season. The company sells oil to customers using fixed price contracts and has decided to store enough oil to meet average customer demand of 2,300 gallons. They have also purchased call options to protect against the risk of a much colder than expected winter. What risk is the company primarily seeking to hedge? a.

Volume Risk

b. c.

Supply Risk Credit Risk

d.

Location Basis Risk

Correct answer: a Reading reference: Surviving Energy Prices, Beutel, Chapter 3, p. 29-30. Explanation: Answer a is correct, the heating oil company is concerned about a colder than expected winter, but does not want to be stuck with an excess of inventory. Call options allow the company to purchase additional inventory at a set price should temperatures drop below normal, the options can expire unused if the winter temperatures are at a normal level.

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33.

On June 20, Caufield Refining estimates it will need to purchase 40,000 barrels of crude on October 12. Caufield decides to hedge price risk using a November NYMEX futures contract. The November futures price on June 20 is USD 67.00/bbl. On October 12, Caufield is ready to purchase its required crude oil and closes out the futures contract on that day; at this time the spot price is USD 70.10/bbl and the futures price is USD 68.50/bbl. In this scenario, what is the effective price paid per barrel? a.

USD 68.50

b.

USD 68.60 USD 70.10 USD 70.40

c.

d.

Correct answer: b Reading reference: Energy Markets: Price Risk Management , James: Chapter 13, p. 263. Explanation: The effective price paid (in dollars per barrel) is the final spot price less the gain on the futures, or 70.10 — 1.50 = 68.60. This can also be calculated as the initial futures price plus the final basis, 67.00 + 1.60 = 68.60.

34.

An oil field estimated to have 50 Mbbl of oil is classified as "P90." What does this classification indicate? a. b. c.

d.

That That That That

there is a 90% probability the oil field will actually produce more than 50 Mbbl of oil. there is a 90% probability the oil field contains 50 Mbbl of oil. the oil field is 90% depleted. the oil field is determined to contain of 90% petroleum and 10% other material (e.g. natural gas).

Correct answer: a Reading reference: Oil, Gas Exploration, and Production , Institut Francais; Chapter 3, p. 91. Explanation: In 1997 the Society of Petroleum Engineers (SPE) and the World Petroleum Council formulated and adopted standards of reserve definitions. Px is defined as a number such that there is an x% likelihood that the true reserves exceed Px. For example, if the P10 of a field is 100 Mbbl, there is a 10% probability that the actual size of the field exceeds 100 Mbbl. Thus, in this case, P90 indicates a 90% probability the oil field will actually produce more than 50 Mbbl of oil. Other relevant classifications include P95, P50, P10 and P5.


39


35.

Black Gold Co. is a firm specializing in the exploration, acquisition and drilling of new crude oil fields. Based on these activities, Black Gold would best be described as what type of oil operation? a.

Independent

b. c.

Integrated Speculative

d.

Wildcat

Correct answer: a Reading reference: Fundamentals of Oil & Gas Accounting , Wright & Gallun; Chapter 1, p. 1. Explanation: Independent oil and gas companies are typically described as companies primarily involved in exploration and production (E&P) activities, as is Black Gold. Integrated oil and gas companies are usually involved in at least one downstream activity as well as E&P activities.

36.

Which of the following is NOT considered a primary model for electricity trading arrangements? a.

Integrated model

b.

Open access model Wheeling model Decentralized model

c.

d.

Correct answer: b Reading reference: Making Competition Work in Electricity , Hunt: Chapter 7, p. 127-9. Explanation: Answer b is correct, by definition it is not one of the models.

37.

You have a portfolio of gas calls and puts that is gamma neutral. Which of the following trading strategies would you implement to make your portfolio delta neutral? a.

Purchase a call option

b. c.

Purchase a forward contract Purchase either a call or a put option

d.

By definition a gamma neutral portfolio is also delta neutral so no action is necessary

Correct answer: b Reading reference: Clewlow and Strickland: Chapter 9.3, p. 170. Explanation: Answer b is correct. Call and put options have delta and gamma values. So the initial portfolio would be constructed with calls and puts such that the gamma of the portfolio was zero. There is no guarantee that the portfolio would also have zero Delta. Since forward contracts are linear, they only have delta and no gamma. Consequently to ensure that a gamma neutral portfolio was also delta neutral, you would buy or sell the right number of forward contracts to make it delta neutral.

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38.

Steve Dolan is a power manager at Upstate Electric. He is negotiating a one-day contract to sell 100 MWh of electricity at USD 55/MWh for a 24-hour period and has been asked to calculate the Value-at-Risk (VaR) for the contract. If the daily volatility of electricity prices is 2%, what is the daily VaR on the contract assuming a 95% confidence interval? a.

USD 180

b.

USD 3,447

c.

USD 4,330 USD 5,412

d.

Correct answer: c Reading reference: Price Risk Management in the Energy Industry: The Value at Risk Approach, Mauro, Section 6. Explanation: Answer c is correct: it is 100 x 55 x 24 x .02 x 1.64 = USD 4,330. Since the contract is for one day, no time adjustment is needed. Answer a does not include 24 hours in the calculation 100 x 55 x .02 x 1.64 = USD 180; b assumes a time adjustment of √ 365 and does not use 24 in the calculation 100 x 55 x .02 x 1.64 x √ 365 = USD 3,447; d assumes a 98% confidence interval using 2.05 in the calculation 100 x 55 x 24 x .02 x 2.05 = USD 5,412

39.

Which of the following pricing relationships include the elements of convenience yield? a. b. c.

d.

Spot price Expected spot price Strike price Forward price

Correct answer: d Reading reference: Managing Energy Risk: A Nontechnical Guide to Markets and Trading , Wengler; Chapter 6, p. 117. Explanation: The forward price includes the cost of risk, cost of carry, cost of money and other factors included within the concept of the convenience yield.


41


40.

Wet gas refers to ______________. a. b. c.

d.

Gas that has a high moisture content Gas that has a heating value greater than methane. Gas that has not been scrubbed of its sulfur impurities None of the above

Correct answer: b Reading reference: LNG: A Nontechnical Guide , Tusiani and Shearer, Chapter 3, p. 70. Explanation: Answer b is correct. Wet gas contains a higher composition of higher-chain hydrocarbons such as propane, butane, and condensates; it has a higher heating value relative to dry gas (methane).

41.

Given the following information, how much power capacity (in MWs) would load serving entities in a capacity market be required to purchase to make the building of additional capacity economically viable? Expected end-user peak load: Average end-user load:

100 MW 90 MW

Percentage reserve margin:

10%

c.

10 MW 110 MW 100 MW

d.

99 MW

a. b.

Correct answer: b Reading reference: Making Competition Work in Electricity , Hunt: Chapter 8, p. 166. Explanation: Answer b is correct. Under the capacity obligation system, load serving entities are required to purchase capacity tickets which require them to be able to cover a peak load, plus a reserve. The number of tickets is determined by the formula of peak load, multiplied by (1+x) or the reserve margin percentage. In the scenario above, this gives an answer of 110 MW.

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42.

Which of the following statements is/are true regarding option valuation? I.

The intrinsic value of a call option is greatest when the value of the underlying is equal to the strike price of the option.

II.

The time value is the difference between the market quoted premium and the intrinsic value.

a.

I only

b.

II only Both I and II Neither I or II

c.

d.

Correct answer: b Reading reference: Energy Modelling: Advances in the Management of Uncertainty , Kaminski (Hampton): Chapter 2, p. 52. Explanation: Answer b is correct: Statement I is false, all else equal, time value will be greatest when the underlying is trading at the strike price; Statement II is true, by definition the time value of an option is equal to the difference between the market quoted premium and the intrinsic value.

43.

Which of the following tests can be used to demonstrate that model errors are unbiased and normally distributed? I. II.

QQ plot R-squared

III. Autocorrelation test a. b. c.

d.

I and II I and III II and III I, II and III

Correct answer: b Reading reference: Energy Risk, Pilipovic ; Chapter 4, p. 81-84. Explanation: QQ plot and the autocorrelation test are used for testing that errors are normally distributed and that there is no bias from error to error. R-squared measure, on the other hand, measures how well the model fits the data. Hence, it tells us nothing about the distribution of the errors, but gives us general information about model performance. Hence, the correct answer is b.


43


44.

Which of the following statements about the storage of natural gas is/are correct? I. II.

Gas is stored to provide base load storage to meet seasonal demands. Gas is stored to provide peak storage to smooth out the demand curve.

a.

I only

b.

II only

c.

Both I and II Neither I or II

d.

Correct answer: c Reading reference: Fundamentals of Natural Gas Processing , Kidnay and Parish: Chapter 12, p. 254. Explanation: Answer b is correct; by definition both statements are factual.

45.

Countries have varying policies regarding hydropower, with some countries making it a national policy to rely on hydropower. From the options below, choose the one that correctly lists the four countries from highestto-lowest in terms of the ratio of hydropower-generated electricity to total national electricity generation: a. b. c.

d.

Sweden, Norway, Brazil, Canada Canada, Norway, Brazil, Sweden Brazil, Canada, Sweden, Norway Norway, Brazil, Canada, Sweden

Correct answer: d Reading reference: Energy for the 21st Century: A Comprehensive Guide to Conventional and Alternative Sources, Nersesian: Chapter 8, p. 299. Explanation:The correct ranking from highest to lowest is d: Norway, Brazil, Canada, and Sweden. In Norway reliance of hydropower is a national policy, nearly all the electricity in Norway is generated from hydroelectric plants.

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46.

Patel is managing a portfolio with 100 long puts on March peak forward power contracts. If the delta of the put contracts is -0.4, what position in March peak forward power contracts does Patel need to create for the combined portfolio to be delta neutral?

b.

Short 40 March Peak Forward contracts Long 40 March Peak Forward contracts

c.

Short 60 March Peak Forward contracts

d.

Long 60 March Peak Forward contracts

a.

Correct answer: b Reading reference: Energy Derivatives: Pricing and Risk Management , Clewlow and Strickland: Chapter 9.2, p. 164-7. Explanation: Answer b is correct. A Long Put is really a short position in the underlying, in this case March Peak Power. In order to make the delta of the complete portfolio neutral or equal to zero, the position in March Peak Forward power contracts needs to be long an enough to offset the -0.4*100 = -40 of the March Peak Forward. Consequently, one needs to be long 40 March Peak Forward power contracts.

47.

A producer holding a commodity is said to be _____ and could hedge by going _____ a forward contract. a. b. c.

d.

Long, long Long, short Short, short Short, long

Correct answer: b Reading reference: Managing Energy Risk, Burger, Chapter 2. Explanation: By definition, someone holding a commodity is said to be long and could hedge by going short a forward contract.

48.

A natural gas-fired power plant uses 15,200 MMBtu of gas to generate 2,000 MWh of electricity. What is the heat rate for this power plant?

c.

0.131 MMBtu/MWh 7.6 MMBtu/MWh 30.4 MMBtu/MWh

d.

7,600 MMBtu/MWh

a. b.

Correct answer: b Reading reference: Energy Trading & Investing, Edwards; Chapter 2.2, p. 109. Explanation: The heat rate is determined by dividing the quantity of fuel used by the quantity of power produced, in this example 15,200 MMBtu divided by 2,000 MWh = 7.6 MMBtu/MWh.


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49.

A 3-month natural gas option with a strike of USD 6.00 on an August contract is trading at a Black-implied volatility of 45%. Another call option with the same contract specifications, with a strike of USD 6.50, is trading at a Black-implied volatility of 50%, producing a volatility smile. Which of the following conclusions can be made given the market information above? a.

The volatility smile tells us that the market is feeling good about the economy and prices are expected to go higher.

c.

The different volatilities for the two call options tell us that the lognormal Black model cannot capture the true underlying price behavior with a single volatility measure. A call option with the same contract specifications as the two options in the problem but with a strike of

d.

USD 7.00 must therefore be trading at a Black-implied volatility of 55%. The two options should have exactly the same volatility, and therefore this is a case of market arbitrage:

b.

the USD 6.00 option is under-priced relative to the USD 6.50 option. Correct answer: b Reading reference: Energy Risk , Pilipovic: Chapter 8, p. 232. Explanation: Answer b is correct. Black-implied volatilities for options with the same contract specifications but different strikes are necessary to capture the true underlying price behavior and therefore traded option prices. Black option pricing model assumes log-normal price behavior for the underlying forward prices, which generally does not capture the full spectrum of behavior of energy prices given a single volatility measure. Therefore, the correct answer is b.

50.

Consider global proven recoverable coal reserves. Which of the following correctly lists the countries in order of largest to smallest recoverable coal reserves? a.

United States, China, Russia, Australia, India

b. c.

Russia, United States, India, China, Australia United States, Russia, China, India, Australia

d.

China, United States, Australia, Russia, India

Correct answer: c Reading reference: “Producing Liquid Fuels from Coal: Prospects and Policy Issues” Bartis, Chapter 2, p. 5. Explanation: Answer b is correct. As compared to oil and gas resources, coal reserves are often characterized as widely dispersed. On one hand this is an accurate characterization, because major portions of the global reserve base are spread among the continents. On the other hand, the eight nations listed in Table 1.1 hold 88 percent of reported prove recoverable reserves. Leading the list is the United States, with proven recoverable coal reserves of about 270 billion tons.

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51.

Carsten needs to refine petroleum into high octane gasoline. Which process will he use? a. b. c.

d.

Horizontal refining Catalytic cracking Distillation process Vertical hydrolytic emersi on

Correct answer: b Reading reference: Petroleum Refining: Technology and Economics, 5th Edition , Gary: Chapter 1,p. 4. Explanation: Answer b is correct in that it is the technique to create higher octane gasoline. Answers a and c relate to an early method of refining, one that does not produce higher octane gasoline. Answer d is incorrect because it is a made up term.

52.

Which of the following processes refers to the refining of crude oil into separate fractions or cuts? a. b. c.

d.

Distillation Treatment Blending Conversion

Correct answer: a Reading reference: Refining: Technology and Economics, 5th Edition , Gary et al, Chapter 1, p. 2. Explanation: Answer a is correct; refining begins with distillation by boiling crude, separating the resulting vapor and cooling it into separate fractions or cuts, creating a range of distilled petroleum products (gasoline, kerosene, naphtha, etc.) in the process.

53.

A call swaption is exercised covering 6 months for 100,000 barrels of crude per month. The premium is USD 1.00 per barrel and the strike price is USD 65 per barrel. During the ensuing six months the average price is USD 70 per barrel. What is the net cash flow from the swaption? a.

USD 400,000

b.

USD 500,000 USD 2,400,000 USD 3,000,000

c.

d.

Correct answer: c Reading reference: Managing Energy Price Risk , Kaminski (Hampton): Chapter 2, p. 78. Explanation: Answer c is correct as per the formula on page 78: USD 2,400,000 = 600,000 x (70-65-1).


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54.

A call option has a premium of USD 5 and a strike price of USD 28. What is the time value of the call option if the current price of the underlying is USD 31? a.

USD 5

b. c.

USD 3 USD 2

d.

USD 0

Correct answer: c Reading reference: Energy Markets: Price Risk Management and Trading , James: Chapter 6, p. 137-8. Explanation: Answer a is incorrect, this is the premium. b is incorrect, this is the intrinsic value. c is correct. It is the premium less the intrinsic value: intrinsic value = USD 31 - USD 28 = 3, so USD 5 - USD 3 = USD 2, therefore time value = USD 2. d is incorrect. Only when the premium and intrinsic value are equal is the time value 0.

55.

Eloise, ERP, is the risk manager for a large natural gas company. The company uses a VaR model with a 95% confidence level to measure risk exposure and compliance. If Eloise is concerned with the impact of extreme events, she should: a. b. c.

d.

Continue VaR testing at the 95% confidence level. Move the VaR confidence level up to 97%. Move the VaR confidence level down to 90%. Implement stress testing to assess the impact of extreme events.

Correct answer: d Reading reference: Energy and Emissions Markets: Collision or Convergence? James and Fusaro: Chapter 11, p. 194. Explanation: Answer d is correct, VAR measures only possible realities given a set of inputs, it does not account for unexpected or “extreme” events.

56.

Which of the following “Greeks” measures the sensitivity of an option’s price to changes in the underlying instrument’s implied volatility?

c.

Delta Gamma Theta

d.

Vega

a. b.

Correct answer: d Reading reference: Energy Markets: Price Risk Management and Trading , James: Chapter 6, p. 141-3. Explanation: Answer d is correct, Vega measures the sensitivity of an option to a change in implied volatility.

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57.

Akiko, an ERP, is pricing a daily transportation deal between Henry Hub and Houston Ship Channel using the mean-reverting Ornstein-Uhlenbeck process to model gas prices. In order to calculate the at-the-money (ATM) implied volatilities for Henry Hub and Houston Ship Channel Akiko will need to do which of the following? a.

Calculate the correct volatilities since the implied volatilities from a Black-Scholes calculation are not the same volatilities used in the Ornstein-Uhlenbeck process.

b.

Scale the implied volatilities by 365250 since it is a daily deal.

c.

Roughly estimate implied volatilities. Nothing else needs to be done. Scale the implied volatilities by 250365 since it is a daily deal.

d.

Correct answer: a Reading reference: Energy Derivatives: Pricing and Risk Management , Clewlow and Strickland: Chapter 3.2.2, p. 41. Explanation: Answer a is correct. Volatility has to be estimated in the context of the stochastic process assumption. The volatility for an Ornstein-Uhlenbeck process has different units to that which is used in the Black-Scholes model. The volatility for the Ornstein-Uhlenbeck process has units of dollars. The volatilities in Black-Scholes and Ornstein-Uhlenbeck are not interchangeable.

58.

The Cost of Alternative Transportation method of establishing pipeline shippi ng rates involves comparison against the costs of alternative forms of product transportation such as ship, barge, rail, and truck. Assuming the cost of shipping 1,000 bbl of crude from Tucson, AZ to St. Louis, MO via truck is USD 25/bbl, and by rail is USD 21/bbl, what would be the appropriate charge for transporting 1,000 bbl of crude by pipeline? a. b. c.

d.

USD 23.00 — USD 25.00/bbl USD 19.50 — USD 21.00/bbl USD 24.50 — USD 25.50/bbl USD 21.00 — USD 22.50/bbl

Correct answer: b Reading reference: Oil and Gas Pipelines: In Nontechnical Language, Miesner and Leffler: Chapter 10, p. 221. Explanation: The cost of alternative transportation method involves understanding the rates charged by the competing forms of transportation—ship, barge, rail, truck. The pipeline charge will be set equal to or slightly below those rates. Calculating rates using this method can be very favorable for the pipeline owner, especially for long-distance transportation.


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Energy Risk Professional Examination (ERP®) Practice Exam This 1 Page Left Blank

59.

Hydroelectric projects are not being pursued in many developed nations despite the fact they are an emissions-free source of power. What is the primary reason most developed countries are not building hydroelectric plants? a. b.

National environmental regulations make the construction of new hydro projects extremely difficult Without a global cap-and-trade emissions scheme, it is less-expensive to build fossil fuel-powered generation plants

c.

d.

Government incentives favor renewable projects like wi nd and solar over hydroelectric plants Most developed nations have already largely exploited their hydroelectric potential

Correct answer: d Reading reference: Renewable Energy in Nontechnical Language, Chambers; Chapter 6, pages 150-152. Explanation: While all are factors, d is the major reason. With the exception of Canada, most developed nations have already constructed hydroelectric plants at suitable sites within their national borders. Much of the future growth in hydropower will come from developing nations like China, Indonesia and Brazil.

60.

Which of the following statements regarding oil sands production are true? I. Extracting oil sands on a large scale has significant environmental impacts. II. Mining and in-situ operations in oil sands use a significant amount of water. III. Large tailing ponds are created in the production of oil sands and their management is one of the main challenges for the industry. a.

Statement I

b. c.

Statement III Statements I and III

d.

All are correct

Correct answer: d Reading reference: Toman: Chapter 4, p. 19-20. Explanation: d is correct. All statements are factual.

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2012 Erp Practice Exam1

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