2015
ERP Practice Exam 2
Energy Risk Professional Examination (ERP®) Practice Exam 2
TABLE OF CONTENTS
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1
ERP Practice Exam 2 Candidate Answer Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
ERP Practice Exam 2 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5
ERP Practice Exam 2 Answer Sheet/Answers Sheet/Answers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17
ERP Practice Exam 2 Explanations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19
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i
Energy Risk Professional Examination (ERP®) Practice Exam 2
Introduction
1. Plan a date and time to take the practice exam.
The ERP Exam is a practice-oriented examination. Its ques-
Set dates appropriately to give sufficient study/review
tions are derived from a combination of theory, as set forth
time for the practice exam prior to the actual exam.
in the core readings, and “real-world” work experience. Candidates are expected to understand energy risk man-
2. Simulate the test environment as closely as possible.
agement concepts and approaches and how they would
•
Take the practice exam in a quiet place.
apply to an energy risk manager’s day-to-day activities.
•
Have only the practice exam, candidate answer
The ERP Examination is also a comprehensive examina-
sheet, calculator, and writing instruments (pencils,
tion, testing an energy risk professional on a number of risk management concepts and approaches. It is very rare that
erasers) available. •
Minimize possible distractions from other people,
an energy risk manager will be faced with an issue that can
cell phones, televisions, etc.; put away any study
immediately be slotted into just one category. In the real
material before beginning the practice exam.
world, an energy risk manager must be able to identify any
•
Allocate 2 minutes per question for the practice
number of risk-related issues and be able to deal with them
exam and set an alarm to alert you when a total of
effectively.
50 minutes have passed Complete the entire exam but
The ERP Practice Exam 2 has been developed to aid candidates in their preparation for the ERP Examination.
note the questions answered after the 50-minute mark. •
Follow the ERP calculator policy. Candidates are only
This practice exam is based on a sample of actual questions
allowed to bring certain types of calculators into the
from past ERP Examinations and is suggestive of the ques-
exam room. The only calculators authorized for use
tions that will be in the 2015 ERP Examination.
on the ERP Exam in 2015 are listed below, there will
The ERP Practice Exam 2 contains 25 multiple choice
be no exceptions to this policy. You will not be allowed
questions. The 2015 ERP Examination will consist
into the exam room with a personal calculator other
of a morning and afternoon session, each containing 70
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 2 does not necessarily cover
and Hewlett Packard 20B.
all topics to be tested in the 2015 ERP Examination. For a complete list of topics and core readings, candidates should refer to the 2015 ERP Examination Study Guide.
3. After completing the ERP Practice Exam 2 •
Calculate your score by comparing your 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 50
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 practice exam Answers and Explanations 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 2015 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
To maximize the effectiveness of the practice exams, candidates are encouraged to follow these recommendations:
•
Remember: pass/fail status for the actual exam is based on the distribution of scores from all candidates, so use your scores only to gauge your own progress and level of preparedness.
© 2015 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.
1
Energy Risk ® Professional(ERP ) Examination Practice Exam 2 Answer Sheet
Energy Risk Professional Examination (ERP®) Practice Exam 2
a.
b.
c.
d.
a.
b.
c.
d.
1.
18.
2.
19.
3.
20.
4.
21.
5.
22.
6.
23.
7.
24.
8.
25.
9.
10.
11.
12.
13.
14.
Correct way to complete
15.
1.
16.
Wrong way to complete
17.
1.
© 2015 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.
3
Energy Risk ® Professional(ERP ) Examination Practice Exam 2 Questions
Energy Risk Professional Examination (ERP®) Practice Exam 2
1.
The table below summarizes the projected crude oil production and annual expenses related to the development of a new oil reserve:
Year 0 (now)
Year 1
Year 2
Year 3
Exploration
10
0
0
0
Upstream Development
8
25
8
0
Operating and Transportation
3
30
15
12
Crude Oil Production (in BBLs)
0
800,000
350,000
200,000
* Expenses in USD millions
Use the following assumptions to calculate the project’s NPV assuming that all cash flows occur at the end of each year: • •
Projected average price of crude oil produced: USD 88/bbl Risk-adjusted discount rate: 12%
a.
USD -1,486,000
b.
USD -1,338,000 USD 2,751,000 USD 2,954,000
c. d.
2.
A newly discovered offshore natural gas field extends across the territorial waters of two countries. Both nations seek to develop the field in order to meet domestic demand and earn LNG export revenues. How can the two countries best maximize the future commercial viability of the natural gas reserve while minimizing the potential for a conflict over mineral rights?
b.
Establish independent drilling rights on the reserve and designate a third-party arbitrator to settle future production disputes. Establish a sliding scale production arrangement based on a pro-rata allocation of the total projected
c.
recoverable gas volume pe r square nautical mi le. Establish a joint development zone that includes the shared portion of the reserve before either country
a.
d.
begins exploitation. Establish a proportional claim on mineral rights development based on the United Nations Convention on the Law of the Sea.
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5
Energy Risk Professional Examination (ERP®) Practice Exam 2
3.
Consider a very complex refinery with long-term crude oil supply contracts established with several producers in the Persian Gulf, Venezuela, and West Africa. What type of shipping arrangement offers the refinery the greatest economic flexibility and control over its product inventory?
b.
CIF DES
c.
EFP
d.
FOB
a.
4.
Which of the following legal structures will most evenly allocate risk among a group of individual investors who participate in the development of an LNG liquefaction terminal that is attached to a natural gas field with an expected life of 30 years? a.
Joint venture agreement
b.
Master limited partnership Project bond Unitization contract
c. d.
5.
An African nation exports domestically-produced crude oil with an API of 36° and a sulfur content of 0.73%. Assuming the London ICE Brent futures contract is the benchmark, how will the country’s crude oil exports most likely be priced? a.
At a discount to the Brent crude oil contract.
b.
At parity with the Brent crude oil contract. At a premium to the Brent crude oil contract.
c. d.
6
Crude oil of this grade will have little price correlation with Brent making the Brent futures contract a poor benchmark.
© 2015 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.
Energy Risk Professional Examination (ERP®) Practice Exam 2
6.
A state-owned electric power company in China operates several coal-fired steam generation plants. The generator purchases its fuel supply from a local coal mine that produces moist coal with a low heating value. What type of coal has the power company most likely purchased?
b.
Anthracite Bituminous
c.
Lignite
d.
Sub-Bituminous
a.
7.
An LNG export terminal has negotiated a long-term supply contract with a utility company in Asia. What contractual arrangement will best protect the LNG producer against economic loss if the utility refuses delivery of the contracted volume of LNG? a.
A credit support annex
b.
A force majeure clause A quick sale provision with liquidated damages A take-or-pay provision
c. d.
8.
The production manager for a natural gas producer is evaluating a range of potential storage options for several recently discovered reserves. Which natural gas storage option provides the greatest flexibility and ease of use during extraction? a.
Above-ground tank storage
b. c.
Aquifer storage Depleted reservoir storage
d.
Salt cavern storage
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7
Energy Risk Professional Examination (ERP®) Practice Exam 2
9.
Ocean Wind Authority (OWA) is the project sponsor for High Cliffs Wind (HCW), a new 1,000 MW offshore wind turbine installation. HCW has a BBB credit rating based on the results of an initial feasibi lity study. OWA has secured a Power Purchase Agreement (PPA) from Acme Power and Light (APL), a AA rated local electric utility. Under terms of the PPA, APL has made a firm ten year commitment to purchase up to 90% of the power generated by the facility after its expected completion in five years. Assuming OWA arranges bank loans to fund the project, what will most likely be the terms of the lending arrangement? a. b. c. d.
A fifteen year amortizing term loan with recourse to the assets of HCW, priced as a BBB credit. A five year construction loan that converts to a ten year fully amortizing term loan, priced as a AA credit with recourse to the assets of HCW. A fifteen year amortizing, non-recourse term loan, priced as a AA credit. A five year construction loan that converts to a ten year fully amortizing, non-recourse term loan, priced as a AA credit.
10.
Use the data below to calculate the implied market heat rate for a power grid supplied by a series of natural gas-fired generators. •
Grid load: 240,000 MWh
• •
Market clearing price: USD 65.85/MWh Natural gas price (daily average): USD 4.60/MMBtu
a.
8.87 MMBtu/MWh 12.91 MMBtu/MWh
b. c. d.
11.
In the electricity markets, a financial tolling agreement is most similar to what type of contract?
b.
An Asian-style option on electricity futures A fixed-for-floating swap
c.
An option on a commodity spread
d.
A strip of sequentially-dated futures
a.
8
14.32 MMBtu/MWh 16.15 MMBtu/MWh
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Energy Risk Professional Examination (ERP®) Practice Exam 2
12.
The equilibrium price for electricity on a power grid with total demand of 450 MW is USD 52/MWh. Assuming a merit order curve is used to set the equilibrium price, which of the following plants will be dispatched?
a.
Plant B only
b.
Plant C only Plant A and Plant C All plants are dispatched
c. d.
13.
Plant
Variable Cost
Capacity
A
USD 51/MWh
300 MW
B
USD 56/MWh
150 MW
C
USD 45/MWh
200 MW
NuPower Electric purchased a 50 MW Financial Transmission Right (FTR) to mitigate the potential economic impact of transmission congestion between Node A (Injection) and Node B (Sink). The purchase price of the FTR is USD 5/MW. LMP = USD 40/MW
A
LMP = USD 20/MW
B
At settlement, the Locational Marginal Price (LMP) for power at Nodes A and B is USD 40/MW and USD 20/MW respectively. Calculate the net profit or loss NuPower realized on the transaction. a.
- USD 9,000,000
b.
- USD 1,000,000 USD 1,000,000 USD 9,000,000
c. d.
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9
Energy Risk Professional Examination (ERP®) Practice Exam 2
Questions 14 – 15 use the information below In early March 2014 the spot price of Brent crude oil is USD 107.90 and estimated monthly crude oil storage costs are USD 0.75/bbl. Traders are using the following market data to identify potential market opportunities. Brent crude oil futures contract prices: • October 2014: USD 112.65 •
October 2015: USD 104.86
US Treasury zero-coupon bond yi elds: • March 2014 through September 2014: 2.50% •
14.
What best approximates the breakeven forward price required for a 6-month storage arbitrage to be profitable assuming storage costs are paid at the beginning of each month with no market convenience yield?
c.
USD 111.09/bbl USD 113.79/bbl USD 115.73/bbl
d.
USD 118.53/bbl
a. b.
15.
October 2015: 3.75%
What best approximates the zero coupon bond position required to synthetically replicate a long 18-month forward position on 250,000 barrels of Brent crude oil? a. b. c. d.
10
USD 24,781,000 USD 25,982,000 USD 26,270,000 USD 27,732,000
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Energy Risk Professional Examination (ERP®) Practice Exam 2
16.
17.
Use the temperature data below to calculate Cooling Degree Days (CDD) for a 7-day period:
a.
9.5
b. c.
12 14.5
d.
17
High Temperature 71°F
Low Temperature 62°F
Average Temperature 66.5°F
75°F
63°F
69.0°F
72°F 69°F 64°F
65°F 67°F 61°F
68.5°F 68°F 62.5°F
65°F 64°F
59°F 58°F
62°F 61°F
What makes a hedging strategy based on purchasing options a more efficient risk management tool for producers and end-users than forwards, futures, or swaps? a. b. c. d.
18.
Certainty of cash outflows Counterparty netting arrangements Minimal collateral thresholds Physical settlement
Assume an energy commodity position has an average 10-day price return of 0.75% and a daily standard deviation of 1.25%. If daily price returns are independent and normally distributed, what is the portfolio’s 10-day, 95% VaR? a.
5.75%
b. c.
6.27% 6.43%
d.
7.00%
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11
Energy Risk Professional Examination (ERP®) Practice Exam 2
19.
A crude oil trader holds a long position in 100 call options on Brent Crude oil futures. The trader has identified a second option on the same underlying contract that can be used to hedge market risk in her position. What combination of the hedge option and the underlying futures contract will best neutralize the delta and gamma of the trader’s position assuming the following market risk characteristics for the positions: Long Option Delta Gamma a. b. c. d.
20.
0.613 0.0723
Hedge Option -0.55 -0.0950
Buy 76 options and sell 19 futures contracts. Sell 76 options and buy 19 futures contracts. Sell 111 options and buy 3 futures contracts. Buy 111 options and buy 3 futures contracts.
The following table represents the distribution of operational loss events from a sample of drilling companies over a 6-month period: Loss Events 0 1 2 3
Percentage of Observations 18% 36% 29% 13%
4
4%
Calculate the standard deviation for the distribution of operational loss events assuming a mean of 1.49. a. b. c. d.
12
1.05 1.11 1.22 1.34
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Energy Risk Professional Examination (ERP®) Practice Exam 2
21.
A risk analyst has performed a regression analysis on ICE National Balancing Point (NBP) natural gas spot price returns over the past 500 days in order to estimate the parameters for a simple mean reversion model. The regression analysis includes the following coefficients for a linear relationship where: y = 0.0285 x (Log of daily NBP Spot Prices) + 0.0188 Using terms from the linear relationship above, what is the best estimate of the mean reversion rate for NBP natural gas spot prices? a. b. c. d.
22.
2 9 14 21
Use data from the credit report below to approximate the original exposure on the underlying bond position. •
Obligor: XYZ Energy
• • •
Recovery rate: 32% Loss given default: USD 5,850,000 Expected loss: USD 3,910,500
a.
USD 4,620,000
b. c.
USD 6,174,000 USD 8,603,000
d.
USD 11,197,000
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13
Energy Risk Professional Examination (ERP®) Practice Exam 2
23.
Which of the following actions, if taken by a central counterparty, will most likely increase risk on an exchange traded futures contract?
24.
25.
a.
Invoke netting agreements on contracts that are in default.
b. c.
Reduce margin requirements on contracts with low volatility and high liquidity. Auction the right to replace contracts that are in default.
d.
Increase margin requirements on contracts with large, highly concentrated positions.
What OTC derivative transaction provides the greatest economic benefit (to the counterparty identified) in a bilateral netting arrangement? a.
A crude oil producer long a put option on WTI futures
b. c.
A gas-fired electric power generator long a natural gas swap A natural gas producer long a floor on natural gas
d.
A refinery long a straddle on gasoline futures
What best describes the correct application of Key Performance Indicators (KPIs) and Key Risk Indicators (KRIs) in the context of an organization’s risk management process? a. b.
14
Use KPIs exclusively to develop an effective forward looking assessment of trends in operational risk factors. Integrate KPI objectives and KRI limits to create a single comprehensive risk-weighted metric.
c.
Monitor KRIs to assess shifts in risk exposure and adjust business strategy and operational procedures to better meet return on risk objectives identified by KPIs.
d.
Replace KPIs with KRIs and adjust company-wide risk capital allocations to account for the change in risk monitoring procedures.
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Energy Risk ® Professional(ERP ) Examination Practice Exam 2 Answers
Energy Risk Professional Examination (ERP®) Practice Exam 2
a.
b.
c.
d.
a.
b.
c.
d.
1.
18.
2.
19.
3.
20.
4.
21.
5.
22.
6.
23.
7.
24.
8.
25.
9.
10.
11.
12.
13.
14.
Correct way to complete
15.
1.
16.
Wrong way to complete
17.
1.
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17
Energy Risk ® Professional(ERP ) Examination Practice Exam 2 Explanations
Energy Risk Professional Examination (ERP®) Practice Exam 2
1.
The table below summarizes the projected crude oil production and annual expenses related to the development of a new oil reserve:
Year 0 (now)
Year 1
Year 2
Year 3
Exploration
10
0
0
0
Upstream Development
8
25
8
0
Operating and Transportation
3
30
15
12
Crude Oil Production (in BBLs)
0
800,000
350,000
200,000
* Expenses in USD millions
Use the following assumptions to calculate the project’s NPV assuming that all cash flows occur at the end of each year: • •
Projected average price of crude oil produced: USD 88/bbl Risk-adjusted discount rate: 12%
a.
USD -1,486,000
b.
USD -1,338,000 USD 2,751,000 USD 2,954,000
c. d.
Answer: d Explanation: The correct answer is d. We must first figure out the total cash inflow or outflow expected for the four year period, as follows:
Year 0
Year 1
Year 2
Year 3
Total Income (USD/ millions)
0
70.4
30.8
17.6
Total costs (USD/ millions)
21
55
23
12
-21
+15.4
Cash flow
+7.8
+5.6
The discount factors for the four years would be: Year 0: 1, Year 1: 1/(1+0.12) or 0.901, Year 2: 1/(1+0.12)2 or 0.812, and Year 3: 1/(1+0.12)3, or 0.731. Then multiply each cash flow by the discount factor and sum the results to get NPV: NPV = -37 + (15*0.893) + (8*0.797) + (6*0.712) = USD 2,954,000. Reading reference: Andrew Inkpen and Michael H. Moffett. The Global Oil and Gas Industry: Management, Strategy and Finance, chapter 4, p. 142-143.
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19
Energy Risk Professional Examination (ERP®) Practice Exam 2
2.
A newly discovered offshore natural gas field extends across the territorial waters of two countries. Both nations seek to develop the field in order to meet domestic demand and earn LNG export revenues. How can the two countries best maximize the future commercial viability of the natural gas reserve while minimizing the potential for a conflict over mineral rights? a.
Establish independent drilling rights on the reserve and designate a third-party arbitrator to settle future production disputes.
c.
Establish a sliding scale production arrangement based on a pro-rata allocation of the total projected recoverable gas volume per square nautical mile. Establish a joint development zone that includes the shared portion of the reserve before either country
d.
begins exploitation. Establish a proportional claim on mineral rights development based on the United Nations Convention on
b.
the Law of the Sea. Answer: c Explanation: Answer c is correct. The best strategy, and one that has been used successfully in many occasions, is for the two nations to establish a joint development zone (JDZ) that encompasses the portions of the reserve in both country’s territorial waters. The JDZ will include definitions of each nation’s claim and a unitization agreement to maximize production for the entire reserve. Reading reference: Andrew Inkpen and Michael Moffett. The Global Oil and Gas Industry: Management, Strategy and Finance, Chapter 4, pages 138-141.
3.
Consider a very complex refinery with long-term crude oil supply contracts established with several producers in the Persian Gulf, Venezuela, and West Africa. What type of shipping arrangement offers the refinery the greatest economic flexibility and control over its product inventory? a. b. c. d.
CIF DES EFP FOB
Answer: d Explanation: The correct answer is d: under the terms of the FOB contract, the buyer is responsible for arranging shipping and insurance charges providing flexibility in making these arrangements in the manner that they wish and allowing for the possibility of saving money. Reading reference: Andrew Inkpen and Michael Moffett. The Global Oil and Gas Industry: Management, Strategy and Finance, Chapter 9, pages 346-347.
20
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Energy Risk Professional Examination (ERP®) Practice Exam 2
4.
Which of the following legal structures will most evenly allocate risk among a group of individual investors who participate in the development of an LNG liquefaction terminal that is attached to a natural gas field with an expected life of 30 years?
b.
Joint venture agreement Master limited partnership
c.
Project bond
d.
Unitization contract
a.
Answer: a Explanation: The correct answer is a, a joint venture structure is typically used in large scale oil and gas projects to share risk among project participants. Reading reference: Andrew Inkpen and Michael Moffett, The Global Oil & Gas Industry: Management, Strategy and Finance, Chapter 9, pages 351-356.
5.
An African nation exports domestically-produced crude oil with an API of 36° and a sulfur content of 0.73%. Assuming the London ICE Brent futures contract is the benchmark, how will the country’s crude oil exports most likely be priced? a. b. c. d.
At a discount to the Brent crude oil contract. At parity with the Brent crude oil contract. At a premium to the Brent crude oil contract. Crude oil of this grade will have little price correlation with Brent making the Brent futures contract a poor benchmark.
Answer: a Explanation: Benchmark crudes serve as a pricing standard against which the value of other crude oils can be set. This crude oil would be classified as intermediate crude with a sulfur level slightly higher than Brent, making it likely to sell at a small discount to Brent. Reading reference: Vincent Kaminski, Energy Markets, Chapter 17.
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21
Energy Risk Professional Examination (ERP®) Practice Exam 2
6.
A state-owned electric power company in China operates several coal-fired steam generation plants. The generator purchases its fuel supply from a local coal mine that produces moist coal with a low heating value. What type of coal has the power company most likely purchased?
b.
Anthracite Bituminous
c.
Lignite
d.
Sub-Bituminous
a.
Answer: c Explanation: The correct answer is c; lignite is a type of soft coal with the lowest carbon content of the four major types and a high moisture content. Reading reference: Vincent Kaminski, Energy Markets, Chapter 26, p. 798.
7.
An LNG export terminal has negotiated a long-term supply contract with a utility company in Asia. What contractual arrangement will best protect the LNG producer against economic loss if the utility refuses delivery of the contracted volume of LNG? a. b. c. d.
A credit support annex A force majeure clause A quick sale provision with liquidated damages A take-or-pay provision
Answer: d Explanation: The correct answer is d. A take-or-pay provision forces the customer to either take the volume of gas specified by the contract — whether it is needed or not — or pay for the gas, even if it is never delivered. Answer c is incorrect because while a spot market is developing for LNG, it cannot be considered fully liquid in that the exporter cannot be guaranteed that there would be a buyer available for this cargo. Reading reference: Andrew Inkpen and Michael Moffett. The Global Oil and Gas Industry: Management, Strategy and Finance, Chapter 9, page 336.
22
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Energy Risk Professional Examination (ERP®) Practice Exam 2
8.
The production manager for a natural gas producer is evaluating a range of potential storage options for several recently discovered reserves. Which natural gas storage option provides the greatest flexibility and ease of use during extraction?
b.
Above-ground tank storage Aquifer storage
c.
Depleted reservoir storage
d.
Salt cavern storage
a.
Answer: d Explanation: The correct answer is d. Since salt caverns allow for the quickest withdrawal of stored gas among all of the underground storage options, withdrawal can begin much more quickly than either aquifers or depleted reservoirs. Above ground tanks are typically not used for the storage of natural gas. Reading reference: Vivek Chandra. Fundamentals of Natural Gas: An International Perspective, Chapter 2, pages 72-73.
9.
Ocean Wind Authority (OWA) is the project sponsor for High Cliffs Wind (HCW), a new 1,000 MW offshore wind turbine installation. HCW has a BBB credit rating based on the results of an initial feasibi lity study. OWA has secured a Power Purchase Agreement (PPA) from Acme Power and Light (APL), a AA rated local electric utility. Under terms of the PPA, APL has made a firm ten year commitment to purchase up to 90% of the power generated by the facility after its expected completion in five years. Assuming OWA arranges bank loans to fund the project, what will most likely be the terms of the lending arrangement? a.
A fifteen year amortizing term loan with recourse to the assets of HCW, priced as a BBB credit.
b.
A five year construction loan that converts to a ten year fully amortizing term loan, priced as a AA credit with recourse to the assets of HCW.
c.
A fifteen year amortizing, non-recourse term loan, priced as a AA credit. A five year construction loan that converts to a ten year fully amortizing, non-recourse term loan, priced
d.
as a AA credit. Answer: d Explanation: Project finance lending structures typically include an initial construction loan that converts to a term loan. As a separate project company, the execution of a PPA with Acme Power and Light would be typical of a project finance agreement, a benefit to OWA is that they may then be able to use the utility’s higher credit rating to reduce their own borrowing costs. The basic premise of a project finance agreement is that the loan is based on the future cash flows of the project (in this case the PPA) and that lenders have little or no recourse in the case of a default. Reading reference: Chris Groobey, John Pierce, Michael Faber and Greg Broome. Project Finance Primer for Renewable Energy and Clean Tech Projects .
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23
Energy Risk Professional Examination (ERP®) Practice Exam 2
10.
Use the data below to calculate the implied market heat rate for a power grid supplied by a series of natural gas-fired generators. •
Grid load: 240,000 MWh
• •
Market clearing price: USD 65.85/MWh Natural gas price (daily average): USD 4.60/MMBtu
a. c.
8.87 MMBtu/MWh 12.91 MMBtu/MWh 14.32 MMBtu/MWh
d.
16.15 MMBtu/MWh
b.
Answer: c Explanation: The correct answer is c. The implied market heat rate is calculated by dividing the cost of the natural gas into the market clearing price for electricity: USD 65.85 / USD 4.60 = 14.32 Reading reference: Vincent Kaminski, Energy Markets, Chapter 22.
11.
In the electricity markets, a financial tolling agreement is most similar to what type of contract?
c.
An Asian-style option on electricity futures A fixed-for-floating swap An option on a commodity spread
d.
A strip of sequentially-dated futures
a. b.
Answer: c Explanation: The correct answer is c.In a financial tolling agreement, no physical delivery of electricity is required, the contract is instead settled against the market prices of fuel (usually natural gas) and electricity and a formula within the contract. The tolling agreement is therefore essentially an option on the heat rate spread between the input and output of the generator. Reading reference: Vincent Kaminski. Energy Markets. Chapter 23, Electricity Market Transactions, pages 860-862.
24
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Energy Risk Professional Examination (ERP®) Practice Exam 2
12.
The equilibrium price for electricity on a power grid with total demand of 450 MW is USD 52/MWh. Assuming a merit order curve is used to set the equilibrium price, which of the following plants will be dispatched?
a.
Plant B only
b.
Plant C only Plant A and Plant C All plants are dispatched
c. d.
Plant
Variable Cost
Capacity
A
USD 51/MWh
300 MW
B
USD 56/MWh
150 MW
C
USD 45/MWh
200 MW
Answer: c Explanation: The merit order curve dispatches generation in order of variable operating costs until total capacity for the system is met. The last plant dispatched that fulfills the capacity requirement will set the equilibrium price. In this case, Plant C’s entire capacity will be dispatched plus 125 MW of capacity from Plant A in order to fulfill total grid demand. Reading reference: Daniel Kirschen and Goran Strbac, Fundamentals of Power System Economics , Chapter 3.
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25
Energy Risk Professional Examination (ERP®) Practice Exam 2
13.
NuPower Electric purchased a 50 MW Financial Transmission Right (FTR) to mitigate the potential economic impact of transmission congestion between Node A (Injection) and Node B (Sink). The purchase price of the FTR is USD 5/MW. LMP = USD 40/MW
LMP = USD 20/MW
A
B
At settlement, the Locational Marginal Price (LMP) for power at Nodes A and B is USD 40/MW and USD 20/MW respectively. Calculate the net profit or loss NuPower realized on the transaction. a. b. c. d.
- USD 9,000,000 - USD 1,000,000 USD 1,000,000 USD 9,000,000
Answer: a Explanation: The correct answer is a: a total loss of USD 9,000,000. Financial Transmission Rights (FTRs) are financial instruments which pay the difference between prices at two locations; in this case NuPower will receive the Node B price and pay the Node A price, so the FTR payout is 20 – 40, or - $ 20 per MWh. NuPower already spent USD 5/MW to buy the FTR, so therefore, the net loss per MW is - USD 25. Total MWh for June 2014 = 30 * 24 * 50 = 36,000 MWh. Therefore, the total loss for NuPower is 36,000 * (-25) = - USD 9,000,000. Reading reference: Vincent Kaminski, Energy Markets, chapter 23, p. 849.
Questions 14 – 15 use the information below In early March 2014 the spot price of Brent crude oil is USD 107.90 and estimated monthly crude oil storage costs are USD 0.75/bbl. Traders are using the following market data to identify potential market opportunities. Brent crude oil futures contract prices: •
October 2014: USD 112.65
•
October 2015: USD 104.86
US Treasury zero-coupon bond yi elds: • March 2014 through September 2014: 2.50% • October 2015: 3.75%
26
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Energy Risk Professional Examination (ERP®) Practice Exam 2
14.
What best approximates the breakeven forward price required for a 6-month storage arbitrage to be profitable assuming storage costs are paid at the beginning of each month with no market convenience yield?
c.
USD 111.09/bbl USD 113.79/bbl USD 115.73/bbl
d.
USD 118.53/bbl
a. b.
Answer:
b
Explanation: The correct answer is b.
Minimum 6-month forward price = [USD 107.90 * exp (0.025)*(6/12)] + (Future value of storage (USD 4.53) = 113.79 Reading reference: Robert McDonald, Fundamentals of Derivatives Markets 3rd Edition , Chapter 6.
15.
What best approximates the zero coupon bond position required to synthetically replicate a long 18-month forward position on 250,000 barrels of Brent crude oil? a. b. c. d.
USD 24,781,000 USD 25,982,000 USD 26,270,000 USD 27,732,000
Answer: a Explanation: The correct answer is a. The formula to solve is:
S0 = F0e-rT S0 = 250,000*104.86 * e(-0.0375*1.5) = 24,781,112 Reading reference: Robert McDonald, Derivatives Markets, 3rd Editio n, Chp 6, pages 189 - 191.
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27
Energy Risk Professional Examination (ERP®) Practice Exam 2
16.
Use the temperature data below to calculate Cooling Degree Days (CDD) for a 7-day period:
a.
9.5
b. c.
12 14.5
d.
17
High Temperature 71°F
Low Temperature 62°F
Average Temperature 66.5°F
75°F
63°F
69.0°F
72°F 69°F 64°F
65°F 67°F 61°F
68.5°F 68°F 62.5°F
65°F 64°F
59°F 58°F
62°F 61°F
Answer: b Explanation: The correct answer is b. Cooling Degree Days are the difference between the daily average temperatures less 65°F, if more than 65 degrees. The average temperatures: 66.5, 69, 68.5, 68, 62.5, 62 and 61, for a total of 12 CDDs for the week. Reading reference: Robert McDonald, Derivatives Markets, 3rd Edition , Chapter 6. 17.
What makes a hedging strategy based on purchasing options a more efficient risk management tool for producers and end-users than forwards, futures, or swaps? a. b. c. d.
Certainty of cash outflows Counterparty netting arrangements Minimal collateral thresholds Physical settlement
Answer: a Explanation: The correct answer is a. Producers and end-users have shown an increasing interest in using option-based strategies. This trend can be explained by the relative certainty of cash outflow offered by options versus the ongoing margining and collateralization requirements associated with forwards, futures and swaps.. After an initial upfront cash flow (option premium), there are typically no other financial obligations related to an option contract. Reading reference: Vincent Kaminski. Energy Markets, Chapter 18, Page 667-668.
28
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Energy Risk Professional Examination (ERP®) Practice Exam 2
18.
Assume an energy commodity position has an average 10-day price return of 0.75% and a daily standard deviation of 1.25%. If daily price returns are independent and normally distributed, what is the portfolio’s 10-day, 95% VaR?
b.
5.75% 6.27%
c.
6.43%
d.
7.00%
a.
Answer: a Explanation: Correct answer is a. 10 day mean return=0.75% 10 day standard deviation =(square root of 10)x1.25%=3.9528% 10-Day, 95% VaR=-(0.75%-1.645x3.9528%)= 5.75%. B - Incorrect: Assumes daily mean price return multiplied by square root of 10 C - Incorrect: Assumes daily mean price return with no adjustment for time D - Incorrect: Assumes a two tailed test (confidence interval of 1.96) Reading reference: Allan Malz, Chapter 3.
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29
Energy Risk Professional Examination (ERP®) Practice Exam 2
19.
A crude oil trader holds a long position in 100 call options on Brent Crude oil futures. The trader has identified a second option on the same underlying contract that can be used to hedge market risk in her position. What combination of the hedge option and the underlying futures contract will best neutralize the delta and gamma of the trader’s position assuming the following market risk characteristics for the positions: Long Option Delta Gamma a. b. c. d.
0.613 0.0723
Hedge Option -0.55 -0.0950
Buy 76 options and sell 19 futures contracts. Sell 76 options and buy 19 futures contracts. Sell 111 options and buy 3 futures contracts. Buy 111 options and buy 3 futures contracts.
Answer: a Explanation: In order to do a delta - gamma hedge, the gamma must be neutralized first by using the option provided as a hedge. Since the delta and gamma of the given option are of the opposite side of the portfolio position, the options must be bought to neutralize the gamma. The number of contracts needed to neutralize the gamma are: (Gamma of position / Gamma of hedge) * Number of contracts, i.e. (0.0723/-0.0950) * 100, or 76.1. In other words, 0.76 of an option must be purchased to hedge the gamma of every existing option in the position. However, now that the gamma has been neutralized, there remains some residual delta due to the purchase of the option contracts required to hedge. The delta per contract is now: 0.613 + (-0.55*0.761), or 0.194. Delta can be hedged with the underlying futures Since the residual delta is positive, then 19 futures contracts must be sold to hedge the residual delta of the original 100 contract position. Choices c and d incorrectly neutralize delta first and then solve for residual gamma. Reading reference: Les Clewlow and Chris Strickland. Energy Derivatives: Pricing and Risk Management, chapter 9, pp. 967-968.
30
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Energy Risk Professional Examination (ERP®) Practice Exam 2
20.
The following table represents the distribution of operational loss events from a sample of drilling companies over a 6-month period: Loss Events
Percentage of Observations
0 1
18% 36%
2
29%
3 4
13% 4%
Calculate the standard deviation for the distribution of operational loss events assuming a mean of 1.49. a. b. c. d.
1.05 1.11 1.22 1.34
Answer: a Explanation: Correct answer is a. The first step is to calculate the variance, which is the probability weighted average of the squared difference between F and its mean. In other words, Variance = (0-1.49)2 * 18% + (1-1.49) 2 * 36% + (2-1.49) 2 * 29% + (3-1.49) 2 * 13% + (4-1.49) 2 * 4% = 1.110. The standard deviation is the square root of the variance, ie. 1.053. Reading reference: Michael Miller, chapter 3.
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31
Energy Risk Professional Examination (ERP®) Practice Exam 2
21.
A risk analyst has performed a regression analysis on ICE National Balancing Point (NBP) natural gas spot price returns over the past 500 days in order to estimate the parameters for a simple mean reversion model. The regression analysis includes the following coefficients for a linear relationship where: y = 0.0285 x (Log of daily NBP Spot Prices) + 0.0188 Using terms from the linear relationship above, what is the best estimate of the mean reversion rate for NBP natural gas spot prices? a. b. c. d.
2 9 14 21
Answer: c Explanation: The mean reversion rate can be estimated from the regression results as follows: α0 α1
= 0.0188 (Coefficient for Intercept) = 0.0285 (Coefficient for Slope)
Assuming 500 data points
Δt
= 1/500 = 0.0020
Therefore the mean reversion rate (α) can be estimated as (α1 0.0285/ Δt 0.0020) or 14.25 a is incorrect: α1 = 0.0285/
α0
b is incorrect:
Δt
α0
= 0.0188/
= 0.0188 = 1.5
0.0020 = 9
d is incorrect: fictitiously derived by adding a spread of 7 to answer c. Reading reference: Les Clewlow and Chris Strickland, Energy Derivatives: Pricing and Risk Management , Chapter 2, pages 28-29.
32
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Energy Risk Professional Examination (ERP®) Practice Exam 2
22.
Use data from the credit report below to approximate the original exposure on the underlying bond position. • •
Obligor: XYZ Energy Recovery rate: 32%
• •
Loss given default: USD 5,850,000 Expected loss: USD 3,910,500
a. c.
USD 4,620,000 USD 6,174,000 USD 8,603,000
d.
USD 11,197,000
b.
Answer: c Explanation: The correct answer is c. Since Loss Given Default = Exposure * (1-recovery rate), then the exposure is equal to the LGD divided by (1-recovery rate). Therefore the original exposure on the position is 5,850,000 / (1-0.32) or approximately USD 8,602,941. Reading reference: Allan Malz. Financial Risk Management, Models, History and Institutions , Chapter 6, pages 201 – 203.
23.
Which of the following actions, if taken by a central counterparty, will most likely increase risk on an exchange traded futures contract? a. b. c. d.
Invoke netting agreements on contracts that are in default. Reduce margin requirements on contracts with low volatility and high liquidity. Auction the right to replace contracts that are in default. Increase margin requirements on contracts with large, highly concentrated positions.
Answer: d Explanation: A CCP’s increasing of margin requirements could create destabilizing market impacts and therefore add systemic risk. An example of this is a contract with large concentrated positions. If the CCP were to increase the margin requirement, firms holding these positions might be placed into margin calls which could force them to sell the target security, creating even greater market impact and imposing strains on the funding system and market l iquidity. Reading reference: Jon Gregory. Counterparty Credit Risk: A Continuing Challenge for Global Financial Markets, Chapter 7, p. 110.
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33
Energy Risk Professional Examination (ERP®) Practice Exam 2
24.
What OTC derivative transaction provides the greatest economic benefit (to the counterparty identified) in a bilateral netting arrangement? a.
A crude oil producer long a put option on WTI futures
b. c.
A gas-fired electric power generator long a natural gas swap A natural gas producer long a floor on natural gas
d.
A refinery long a straddle on gasoline futures
Answer: b Explanation: Answer b is correct. To provide economic benefit in a netting arrangement, a derivative position must have the potential to have a negative mark-to-market. Long option positions in which the premium is paid upfront would be the least beneficial to a netting arrangement making a, b, and c incorrect. The long (fixed- rate payer) position in a natural gas swap would have the greatest likelihood of creating a negative MtM and therefore the greatest economic benefit in a netting arrangement. Reading reference: Jon Gregory. Counterparty Credit Risk: A Continuing Challenge for Global Financial Markets, Chapter 4.
25.
What best describes the correct application of Key Performance Indicators (KPIs) and Key Risk Indicators (KRIs) in the context of an organization’s risk management process? a. b.
Use KPIs exclusively to develop an effective forward looking assessment of trends in operational risk factors. Integrate KPI objectives and KRI limits to create a single comprehensive risk-weighted metric.
c.
Monitor KRIs to assess shifts in risk exposure and adjust business strategy and operational procedures to better meet return on risk objectives identified by KPIs.
d.
Replace KPIs with KRIs and adjust company-wide risk capital allocations to account for the change in risk monitoring procedures.
Answer: c Explanation: The correct answer is c. One problem with the use of KPIs for risk management is that they are backward-looking: they will only show how well the portfolio has met pre-determined goals. KRIs are an ongoing process of monitoring the portfolio performance to ensure that it stays within pre-determined risk measurements. Using them together as described in answer c is an effective risk-management strategy. Adjustments to the portfolio can be made in accordance to the KRIs that can ultimately help the portfolio reach the KPIs. Reading reference: John Fraser and Betty Simkins, Enterprise Risk Management: Today’s Leading Research and Best Practices for Tomorrow’s Executives , Chapter 8, page 128.
34
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