Erp Practice Exam 1 2011

Energy Risk Professional (ERP®) ExaminationPractice Exam 1

© 2011 Global Association of Risk Professionals. All rights reserved. It is illegal to reproduce this material iin any format without prior written approval of GARP, Global Association of Risk Professionals, Inc.

Energy Risk Professional Examination (ERP®) Practice Exam 1

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

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

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

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

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

TABLE OF CONTENTS

© 2011 Global Association of Risk Professionals. All rights reserved. It is illegal to reproduce this material 1in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc.


INTRODUCTION

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

tions are derived from a combination of theory, as set forth

in the core readings, and “real-world” work experience.

Candidates are expected to understand energy risk man-

agement concepts and approaches and how they would

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

The ERP Examination is also a comprehensive examina-

tion, testing an energy risk professional on a number of risk

management concepts and approaches. It is very rare that

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

immediately be slotted into just one category. In the real

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

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

effectively.

The ERP Practice Exam 1 has been developed to aid

candidates in their preparation for the ERP Examination in

November 2011. This practice exam is based on a sample

of actual questions from the 2009 ERP Examination and

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

Examination.

The ERP Practice Exam 1 contains 60 multiple choice

questions. Note that the 2011 ERP Examination will consist

of a morning and afternoon session, each containing 90

multiple choice questions. The practice exam is designed to

be shorter to allow candidates to calibrate their prepared-

ness for the exam without being overwhelming.

The ERP Practice Exam 1 does not necessarily cover

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.

Core readings were selected in consultation with the Energy

Oversight Committee (EOC) to assist candidates in their

review of the subjects covered by the exam. Questions for

the ERP Examination are derived from these core readings

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

dates review all core readings listed in the 2011 ERP Study

Guide in-depth prior to sitting for the exam.

Suggested Use of Practice Exams

To maximize the effectiveness of the practice exams, candi-

dates are encouraged to follow these recommendations:

1. Plan a date and time to take the practice exam.

Set dates appropriately to give sufficient study/review

time for the practice exam prior to the actual exam.

2. Simulate the test environment as closely as possible.

• Take the practice exam in a quiet place.

• Have only the practice exam, candidate answer

sheet, calculator, and writing instruments (pencils,

erasers) available.

• Minimize possible distractions from other people,

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

material before beginning the practice exam.

• Allocate 2 minutes per question for the practice

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

120 minutes have passed (or 2-60 minute sessions

with a break in between to simulate the actual exam

conditions). Complete the entire exam but note the

questions answered after the 120-minute mark.

• Follow the ERP calculator policy. Candidates are only

allowed to bring certain types of calculators into the

exam room. The only calculators authorized for use

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

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

into the exam room with a personal calculator other

than the following: Texas Instruments BA II Plus

(including the BA II Plus Professional), Hewlett Packard

12C (including the HP 12C Platinum), Hewlett Packard

10B II, Hewlett Packard 10B II+ and Hewlett Packard 20B.

3. After completing the ERP Practice Exam 1

• Calculate your score by comparing your answer

sheet with the practice exam answer key. Only

include questions completed within the first 200

minutes in your score.

• Use the practice exam Answers and Explanations to

better understand the correct and incorrect answers

and to identify topics that require additional review.

Consult referenced core readings to prepare for

the exam.

• Remember: pass/fail status for the actual exam is

based on the distribution of scores from all candi-

dates, so use your scores only to gauge your own

progress and level of preparedness.

Energy RiskProfessional(ERP®)ExaminationPractice Exam 1

Answer Sheet



a. b. c. d.

1. � � � �2. � � � �3. � � � �4. � � � �5. � � � �6. � � � �7. � � � �8. � � � �9. � � � �10. � � � �11. � � � �12. � � � �13. � � � �14. � � � �15. � � � �16. � � � �17. � � � �18. � � � �19. � � � �20. � � � �21. � � � �22. � � � �23. � � � �24. � � � �25. � � � �26. � � � �27. � � � �28. � � � �29. � � � �30. � � � �31. � � � �32. � � � �

a. b. c. d.

33. � � � �34. � � � �35. � � � �36. � � � �37. � � � �38. � � � �39. � � � �40. � � � �41. � � � �42. � � � �43. � � � �44. � � � �45. � � � �46. � � � �47. � � � �48. � � � �49. � � � �50. � � � �51. � � � �52. � � � �53. � � � �54. � � � �55. � � � �56. � � � �57. � � � �58. � � � �59. � � � �60. � � � �Correct way to complete

1. � � � �Wrong way to complete

1. � � � �83


Questions



1. What would the market clearing price of electric power be if demand is 175 MW and an electricity power generator prices its output as follows for a given hour:

• 50 MW at USD 20 per MW• 100 MW at USD 25 per MW• 150 MW at USD 30 per MW• 250 MW at USD 40 per MW

a. USD 40.00/MWb. USD 26.25/MWc. USD 32.72/MWd. USD 30.00/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. USD 150c. USD 153d. USD 156

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. The refinery is classified as a simple refinery.c. The refinery is best suited for processing heavy crude oil.d. The refinery will produce nearly as much residual fuel as gasoline.

4. 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 dedicated pipeline.

b. Contamination is usually an issue when butane is transported via the same pipeline as gasoline and diesel.c. Ethane-propane mixtures are seldom transported via pipeline.d. Natural gasoline is typically transported through its own dedicated pipeline.

6 © 2011 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.


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. An amount paid by the contract holder to an independent agent for the right to exploit an asset. c. The money collected by the site inspector. d. A tax on production volume, independent of profits.

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

a. 5 x 16 contract for a weekb. On-peak contract for delivery over the entire monthc. Round-the-clock contract for delivery over a two-month periodd. A 5 x 8, 2 x 24 calendar year contract

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?

a. Risk Reportingb. Risk Review c. Risk Assessmentd. Risk Control

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. The use of convenience yield compensates for electricity price spikesc. Asian options are popular among electricity risk managers due to their averaging featured. The “no-arbitrage” argument can be applied to electricity in order to value derivatives

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?

a. 24 MWhb. 96 MWhc. 102 MWhd. 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?

a. 0.00b. 0.25c. 0.50d. 1.00

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

a. Clearing OTC energy derivatives b. Obtaining credit risk insurance c. Purchasing commodity futuresd. Securing a financial guarantee via an Irrevocable Standby Letter of Credit

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?

a. 4,300b. 5,909c. 6,842d. 7,523

13. 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.c. It is free of methane.d. It is consistent with the requirements of downstream gas customers.



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 BravoRequired emissions reductions 10 tons 10 tonsCost of emissions reductions USD 120 per ton USD 40 per tonTotal 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. USD 200b. USD 600c. USD 800d. USD 1,000

15. A trader at XYZ Bank has been asked by 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 for your client.

Contract Price Discount FactorJan Contract USD 79.10/bbl 0.95Feb Contract USD 85.60/bbl 0.92Mar Contract USD 83.90/bbl 0.88

a. USD 80.37b. USD 82.81 c. USD 75.91d. USD 90.40

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

a. Daily forward contractb. Daily futures contractc. OTC swap contractd. Balance-of-the-month contract



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

a. Credit ratings b. Missed deliveries or deadlines c. Poor commodity quality d. Default on a debt

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 congestion

a. I onlyb. II onlyc. Both I and II are correctd. Neither I or II are correct

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 applied to efficient computer simulation II. GBM is a stochastic process that captures the fat tails of price distributions




20. Consider the following yields from a simple, complex, and very complex refinery. Each is processing the same medium sour, heavy crude oil. Identify refineries X, Y, and Z by their complexity level.

Product Type/Refinery X Y ZGasoline 60 50 30Jet Fuel 15 15 15Distillate Fuel 25 25 20Residual Fuel – 5 30Coke 5 – –Refinery Fuel 15 10 8Gain (20 (5) (3)

a. X = simple, Y = complex, Z = very complex b. X = simple, Y = very complex, Z = complexc. X = complex, Y = simple, Z = very complex d. X = very complex, Y = complex, Z = simple

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 fieldsb. Aquifersc. Salt cavernsd. Storage tanks

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. USD 0.0125/kWhb. USD 0.1250/kWhc. USD -0.0125/kWhd. USD -0.1250/kWh

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 spreadb. Bear spreadc. Participating collard. 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?

a. Futuresb. Forwardsc. Swapsd. Options

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. c. 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.

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. backwardationb. contangoc. short-term disequilibriumd. extreme volatility

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. crude oil gas c. associated gas d. free gas



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

a. Asiab. Europec. Former Soviet Uniond. North America

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 8,000 MMBtu/kWh • SO2 price is USD 600 per ton (2,000 pounds/ton)• SO2 rate is 2.00 lbs per MMBtu

a. USD 2.40 per MWha. USD 8.25 per MWha. USD 9.60 per MWha. USD 4.80 per MWh

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 160,000b. USD 240,000c. USD 320,000d. USD 480,000

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

a. The risk of a natural gas price spike at peak electricity demand for a gas fired power generation plant.b. The risk of failure to comply with FERC financial reporting regulations.c. 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.



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 Riskb. Supply Riskc. Credit Riskd. 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 68.50b. USD 68.60c. USD 70.10d. USD 70.40

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

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

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. Independentb. Integratedc. Speculatived. Wildcat



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

a. Integrated modelb. Open access modelc. Wheeling modeld. Decentralized model

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. Purchase a forward contractc. Purchase either a call or a put optiond. By definition a gamma neutral portfolio is also delta neutral so no action is necessary

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 180b. USD 3,447c. USD 4,330d. USD 5,412

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

a. Spot priceb. Expected spot pricec. Strike priced. Forward price

40. Wet gas refers to ______________.

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



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: 100 MWAverage end-user load: 90 MWPercentage reserve margin: 10%

a. 10 MWb. 110 MWc. 100 MWd. 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 onlyb. II onlyc. Both I and IId. Neither I or II

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

I. QQ plotII. R-squaredIII. Autocorrelation test

a. I and IIb. I and IIIc. II and IIId. I, II and III



44. 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.


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 highest-to-lowest in terms of the ratio of hydropower-generated electricity to total national electricity generation:

a. Sweden, Norway, Brazil, Canadab. Canada, Norway, Brazil, Sweden c. Brazil, Canada, Sweden, Norwayd. Norway, Brazil, Canada, Sweden

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?

a. Short 40 March Peak Forward contractsb. Long 40 March Peak Forward contractsc. Short 60 March Peak Forward contractsd. Long 60 March Peak Forward contracts

47. A producer holding a commodity is said to be ______ and could hedge by going ______ a forward contract.

a. long, long b. long, shortc. short, short d. short, long



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?

a. 0.131 MMBtu/MWhb. 7.6 MMBtu/MWhc. 30.4 MMBtu/MWhd. 7,600 MMBtu/MWh

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.

b. 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.

c. A call option with the same contract specifications as the two options in the problem but with a strike of USD 7.00 must therefore be trading at a Black-implied volatility of 55%.

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

a. Deltab. Gammac. Thetad. Vega

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

a. Horizontal refiningb. Catalytic crackingc. Distillation processd. Vertical hydrolytic emersion



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

a. Distillationb. Treatmentc. Blendingd. Conversion

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 400,000b. USD 500,000c. USD 2,400,000d. USD 3,000,000

54. A call 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 5b. USD 3c. USD 2d. USD 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. Continue VaR testing at the 95% confidence level.b. 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.

56. 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, Indiab. Russia, United States, India, China, Australiac. United States, Russia, China, India, Australiad. China, United States, Australia, Russia, India



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. Tell her that implied volatilities from Black-Scholes calculation are not the same volatilities used in the Ornstein-Uhlenbeck process and you will need to calculate the correct volatilities.

b. You first need to scale the implied volatilities by 365250 as it is a daily deal.c. Provide her with the requested implied volatilities. Nothing else needs to be done.d. You first need to scale the implied volatilities by 250365 as it is a daily deal.

58. The cost of alternative transportation method involves setting rates against the costs of alternative forms of 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. USD 23.00 – USD 25.00/bbl b. USD 19.50 – USD 21.00/bblc. USD 24.50 – USD 25.50/bbld. 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. National environmental regulations make the construction of new hydro projects extremely difficultb. Without a global cap-and-trade emissions scheme, it is less-expensive to build fossil fuel-powered

generation plantsc. Government incentives favor renewable projects like wind and solar over hydroelectric plantsd. Most developed nations have already largely exploited their hydroelectric potential

60. By fitting a normal curve to the crude oil production profile of 48 American states, King Hubbert, then an engineer at Shell, forecast in 1960 that American crude oil production would reach its peak in 1969. Production would then decline in a manner symmetrical to the growth phase. The fact that his theory was vindicated for one particular example does not mean, however, that his model has been validated globally because:

a. Conventional crude oil and heavy oil are different. b. Probability estimates are not accurate. c. The method does not account for off shore reserves. d. There is no reason to believe that all production profiles will display this pattern.


Answers



a. b. c. d.

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a. b. c. d.

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Explanations



1. What would the market clearing price of electric power be if demand is 175 MW and an electricity power generator prices its output as follows for a given hour:

• 50 MW at USD 20 per MW• 100 MW at USD 25 per MW• 150 MW at USD 30 per MW• 250 MW at USD 40 per MW

a. USD 40.00/MWb. USD 26.25/MWc. USD 32.72/MWd. USD 30.00/MW

Correct Answer: a

Reading Reference: Advancements in the Management of Uncertainty, Kaminski, Chapter 2Explanation: Answer a is correct. Use the price quoted for 250 MW: apply this amount (USD 40) to any demandlevel 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. USD 150c. USD 153d. USD 156

Correct Answer: b

Reading Reference: Fundamentals of Derivatives Markets, McDonald, Chapter 6, p.171Explanation: Answer b is correct because, in creating a synthetic, we enter into a commodity forward contract andpurchase 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 incorrectbecause it is the investment, at time 0, in the zero bond.



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. The refinery is classified as a simple refinery.c. 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, 3th Edition, Leffler: Chapter 20.Explanation: The presence of a coker defines this as a “very complex” refinery; very complex refineries usually maketheir best margins in processing heavy crude, which the coker allows them to break down into more desirable lightpetroleum products. Very complex refineries produce little or no residual fuel oil. By comparison, hydroskimmingrefineries are classified as “simple refineries” that do not include cokers and usually cannot profitably refine heavycrude. Since you know your refinery includes a coker, this means that answer c is correct.

4. 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 dedicated pipeline.

b. Contamination is usually an issue when butane is transported via the same pipeline as gasoline and diesel.c. Ethane-propane mixtures are seldom transported via pipeline.d. Natural gasoline is typically transported through its own dedicated pipeline.

Correct Answer: a

Reading Reference: Fundamentals of Natural Gas Processing, Kidnay and Parish, Ch 12 Explanation: Answer a is correct; LPGs are typically transported through their own product-specific pipelines.

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. An amount paid by the contract holder to an independent agent for the right to exploit an asset. c. 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. 198-200Explanation: A royalty is an amount equal to a percentage of the value of production, paid by the holder to theState in cash or in kind. It is effectively a tax directly proportional to the value of production, that is, a tax onturnover, and independent of profits. The amount of the royalty depends not only on the percentage applying, butalso 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 single-day price spike created by an unplanned outage at a large generation plant during the delivery period?

a. 5 x 16 contract for a weekb. On-peak contract for delivery over the entire monthc. Round-the-clock contract for delivery over a two-month periodd. A 5 x 8, 2 x 24 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, aprice spike expected to occur for just one of the days in the period will have the greatest impact on the shorter thetime 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 theoff-peak markets (5 x 8, 2 x 24). Hence, in this regard, a is also the best answer.

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?

a. Risk Reportingb. Risk Review c. Risk Assessmentd. Risk Control

Correct Answer: a

Reading Reference: Energy Markets: Price Risk Management and Trading, Tom James; Chapter 10, page 183-84Explanation: 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 isnot 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. The use of convenience yield compensates for electricity price spikesc. Asian options are popular among electricity risk managers due to their averaging featured. 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.64Explanation: Answer c is correct—according to the authors Asian options are gaining in popularity among electricity managers for this reason.

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?

a. 24 MWhb. 96 MWhc. 102 MWhd. 120 MWh

Correct Answer: c

Reading Reference: Managing Energy Risk: An Integrated View on Power and Other Energy Markets, Burger,Graeber, and Schindlmayer, Chapter 4, page 166-177Explanation: The take-or-pay percentage refers to the percentage of the contract that must be paid for whetherthe importer economically wants to take the gas or not. For this contract, the minimum that must be paid for is85% 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?

a. 0.00b. 0.25c. 0.50d. 1.00

Correct Answer: c



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

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

a. Clearing OTC energy derivatives b. Obtaining credit risk insurance c. Purchasing commodity futuresd. Securing a financial guarantee via an Irrevocable Standby Letter of Credit

Correct Answer: c

Reading Reference: Energy Markets: Price Risk Management and Trading, James: Chapter 16, p. 319-21Explanation: 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.

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?

a. 4,300b. 5,909c. 6,842d. 7,523

Correct Answer: b

Reading Reference: Norman J. Hyne. Nontechnical Guide to Petroleum Geology, Exploration, Drilling, andProduction, 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 thegas-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. It is characteristic of the gas as it came from the reservoir.b. It meets the seller’s specifications.c. It is free of methane.d. 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. 180Explanation: 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 interconnectedgas transmission lines, which vary by region and by country.

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 BravoRequired emissions reductions 10 tons 10 tonsCost of emissions reductions USD 120 per ton USD 40 per tonTotal 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. USD 200b. USD 600c. USD 800d. USD 1,000

Correct Answer: a

Reading Reference: Energy and Emissions Markets: Collision or Convergence? James and Fusaro; Chapter 3, page 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 USD800. Bravo will receive a payment from Alpha of USD 600, making their final costs USD 200 (800 – 600 = 200).



15. A trader at XYZ Bank has been asked by 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 for your client.

Contract Price Discount FactorJan Contract USD 79.10/bbl 0.95Feb Contract USD 85.60/bbl 0.92Mar Contract USD 83.90/bbl 0.88

a. USD 80.37b. USD 82.81 c. USD 75.91d. USD 90.40

Correct Answer: b

Reading Reference: Markus Burger, Bernhard Graeber, and GeroSchindlmayr. 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 = 79.1 * 0.95 + 85.6 * 0.92 + 83.9 * 0.88

= 227.729

= 82.8100.95 + 0.92 + 0.88 2.75

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

a. Daily forward contractb. Daily futures contractc. OTC swap contractd. Balance-of-the-month contract

Correct Answer: d

Reading Reference: Fundamentals of Electricity Derivatives, Kaminski: chapter 2, p. 60Explanation: Most power markets, except perhaps the Nord Pool, do not have liquid markets for daily forward orfutures 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 fromtoday until end of current month.



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

a. Credit ratings b. Missed deliveries or deadlines c. Poor commodity quality d. Default on a debt

Correct Answer: a

Reading Reference: Fundamentals of Electricity Derivatives, Kaminski; Chapter 12, p. 348-9Explanation: Answer a is correct. Events and disputes that may come up with a physical contract include forcemajeure, 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 congestion


Correct Answer: a

Reading Reference: 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 excesspower in constrained zones through underutilized transmission assets, while statement II is false because throughbetter utilization of transmission lines during congestion, peaker plants within congested areas will not have to runjust to meet the demand.



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 applied to efficient computer simulation II. GBM is a stochastic process that captures the fat tails of price distributions


Correct Answer: a

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

20. Consider the following yields from a simple, complex, and very complex refinery. Each is processing the same medium sour, heavy crude oil. Identify refineries X, Y, and Z by their complexity level.

Product Type/Refinery X Y ZGasoline 60 50 30Jet Fuel 15 15 15Distillate Fuel 25 25 20Residual Fuel – 5 30Coke 5 – –Refinery Fuel 15 10 8Gain (20 (5) (3)

a. X = simple, Y = complex, Z = very complex b. X = simple, Y = very complex, Z = complexc. X = complex, Y = simple, Z = very complex d. X = very complex, Y = complex, Z = simple

Correct Answer: d

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



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 fieldsb. Aquifersc. Salt cavernsd. Storage tanks

Correct Answer: b

Reading Reference: Fundamentals of Natural Gas Processing, Kidnay and Parrish: Chapter 12, p. 257Explanation: 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. USD 0.0125/kWhb. USD 0.1250/kWhc. USD -0.0125/kWhd. USD -0.1250/kWh

Correct Answer: c

Reading Reference: Vincent Kaminski (ed). Managing Energy Price Risk, Chapter 3, p.120Explanation: Answer c is correct, the calculation is as follows:Spark Spread = Output Price – Input PriceOutput Price = 30USD/MWh x 1MWh/1000kWh =0.03 USD/kWhInput Price = 8500 Btu/kWh x USD5/MMBtu x 1MMBtu/1,000,000Btu = 0.0425USD/kWhTherefore, the Spark Spread = -0.0125



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 spreadb. Bear spreadc. Participating collard. Participating cap

Correct Answer: a

Reading Reference: Managing Energy Price Risk, Kaminski, Chapter 2, p.60Explanation: Answer a is correct since, a bull spread is comprised of buying a long call and selling the upside byselling 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. Futuresb. Forwardsc. Swapsd. Options

Correct Answer: d

Reading Reference: Energy Risk Management: A Non-technical Introduction to Energy Derivatives, Leppard; Chapter 4, p. 200-205Explanation: 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 linearlyon the risk factor changes. For example, a portfolio consisting of futures, forward and swaps is a linear portfolio. Onthe other hand, if there are many options in the portfolio it may be far from being linear. In fact, an energy portfoliois 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 arenot linear instruments.



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. c. 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. 301Explanation: 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 systemdesign. 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. backwardationb. contangoc. short-term disequilibriumd. extreme volatility

Correct Answer: a

Reading Reference: Risk Management in Commodity Markets, Geman: Chapter 2, p. 11Explanation: 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 anupward sloping forward price curve.



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. crude oil gas c. associated gas d. free gas

Correct Answer: c

Reading Reference: Nontechnical Guide to Petroleum Geology, Exploration, Drilling, and Production, Hyne: Chapter 1, p 11Explanation: c 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 ratio is the cubic feet of natural gasdissolved in one barrel of oil in that reservoir under subsurface conditions. The volume measurements are reportedunder surface conditions. In general, as the pressure of the reservoir increases with depth, the amount of naturalgas that can be dissolved in crude oil increases. When crude oil is lifted up a well to the surface, the pressure isrelieved, and the natural gas, called solution gas, bubbles out of the oil. The producing gas-oil ratio (GOR) of a wellis the number of cubic feet of gas the well produces per barrel of oil. Non-associated natural gas is gas that is notin contact with oil in the subsurface. A non-associated gas well produces almost pure methane. Associated naturalgas occurs in contact with crude oil in the subsurface. It occurs both as gas in the free gas cap above the oil andgas dissolved in the crude oil.

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

a. Asiab. Europec. Former Soviet Uniond. North America

Correct Answer: a

Reading Reference: Producing Liquid Fuels from Coal: Prospects and Policy Issues, Bartis; Chapter 2, page 6.Explanation: The chief importers of coal are Asian nations bordering the Pacific Ocean, including Japan, SouthKorea and China, making a the correct choice.



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 8,000 MMBtu/kWh • SO2 price is USD 600 per ton (2,000 pounds/ton)• SO2 rate is 2.00 lbs per MMBtu

a. USD 2.40 per MWha. USD 8.25 per MWha. USD 9.60 per MWha. USD 4.80 per MWh

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, c is Incorrect: use of1,000 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 160,000b. USD 240,000c. USD 320,000d. USD 480,000

Correct Answer: c

Reading Reference: Managing Energy Price Risk, Kaminski: chapter 2, p. 60Explanation: 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 ofUSD 160,000 (i.e. 32,000 MWH x USD5). b is incorrect, because it assumes all-hours of 48,000 MWH and premiumcost (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.



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

a. The risk of a natural gas price spike at peak electricity demand for a gas fired power generation plant.b. The risk of failure to comply with FERC financial reporting regulations.c. 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.

Correct Answer: c

Reading Reference: Energy Risk, Pilipovic: Chapter 2, p. 32Explanation: 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 identicalproducts 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 Riskb. Supply Riskc. Credit Riskd. Location Basis Risk

Correct Answer: a

Reading Reference: Surviving Energy Prices, Beutel, Chapter 3, p 29-30Explanation: Answer a is correct, the heating oil company is concerned about a colder than expected winter, butdoes 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.



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 68.50b. USD 68.60c. USD 70.10d. USD 70.40

Correct Answer: b

Reading Reference: Energy Markets: Price Risk Management, James: Chapter 13, p. 263Explanation: The effective price paid (in dollars per barrel) is the final spot price less the gain on the futures, or70.10 – 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. That there is a 90% probability the oil field will actually produce more than 50 Mbbl of oil.b. That there is a 90% probability the oil field contains 50 Mbbl of oil.c. That the oil field is 90% depleted.d. That 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. 91Explanation: In 1997 the Society of Petroleum Engineers (SPE) and the World Petroleum Council formulated andadopted standards of reserve definitions. Pxis defined as a number such that there is an x% likelihood that the truereserves exceed Px. For example, if the P10 of a field is 100 Mbbl, there is a 10% probability that the actual size ofthe field exceeds 100 Mbbl. Thus, in this case, P90 indicates a 90% probability the oil field will actually producemore than 50 Mbbl of oil. Other relevant classifications include P95, P50, P10 and P5.



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. Independentb. Integratedc. Speculatived. Wildcat

Correct Answer: a

Reading Reference: Fundamentals of Oil & Gas Accounting, Wright &Gallun; Chapter 1, page 1Explanation: 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 involvedin 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 modelb. Open access modelc. Wheeling modeld. Decentralized model

Correct Answer: b

Reading Reference: Making Competition Work in Electricity, Hunt: Chapter 7, p. 127-9Explanation: 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. Purchase a forward contractc. Purchase either a call or a put optiond. 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. 170Explanation: Answer b is correct. Call and put options have delta and gamma values. So the initial portfolio wouldbe constructed with calls and puts such that the gamma of the portfolio was zero. There is no guarantee that theportfolio 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.



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 180b. USD 3,447c. USD 4,330d. USD 5,412

Correct Answer: c

Reading Reference: Price Risk Management in the Energy Industry: The Value at Risk Approach, Mauro, Section 6Explanation: 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, notime 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. Spot priceb. Expected spot pricec. Strike priced. Forward price

Correct Answer: d

Reading Reference: Managing Energy Risk: A Nontechnical Guide to Markets and Trading, Wengler; Chapter 6, page 117Explanation: The forward price includes the cost of risk, cost of carry, cost of money and other factors includedwithin the concept of the convenience yield.

40. Wet gas refers to ______________.

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

Correct Answer: b

Reading Reference: LNG: A Nontechnical Guide, Tusiani and Shearer, Ch. 3, p. 70.Explanation: Answer b is correct. Wet gas contains a higher composition of higher-chain hydrocarbons such aspropane, 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: 100 MWAverage end-user load: 90 MWPercentage reserve margin: 10%

a. 10 MWb. 110 MWc. 100 MWd. 99 MW

Correct Answer: b

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


Correct Answer: b

Reading Reference: Energy Modelling: Advances in the Management of Uncertainty, Kaminski (Hampton): Chapter 2, p. 52Explanation: Answer b is correct: Statement I is false, all else equal, time value will be greatest when the underlyingis trading at the strike price; Statement II is true, by definition the time value of an option is equal to the differencebetween 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. QQ plotII. R-squaredIII. Autocorrelation test

a. I and IIb. I and IIIc. II and IIId. I, II and III

Correct Answer: b.

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

44. 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.


Correct Answer: c

Reading Reference: Fundamentals of Natural Gas Processing, Kidnay and Parish: Chapter 12, p. 254Explanation: Answer c 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 highest-to-lowest in terms of the ratio of hydropower-generated electricity to total national electricity generation:

a. Sweden, Norway, Brazil, Canadab. Canada, Norway, Brazil, Sweden c. Brazil, Canada, Sweden, Norwayd. 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. 299Explanation: The correct ranking from highest to lowest is d: Norway, Brazil, Canada, and Sweden. In Norwayreliance of hydropower is a national policy, nearly all the electricity in Norway is generated from hydroelectricplants.

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?

a. Short 40 March Peak Forward contractsb. Long 40 March Peak Forward contractsc. Short 60 March Peak Forward contractsd. Long 60 March Peak Forward contracts

Correct Answer: b

Reading Reference: Energy Derivatives: Pricing and Risk Management, Clewlow and Strickland: Chapter 9.2, p. 164-7Explanation: Answer b is correct. A Long Put is really a short position in the underlying, in this case March PeakPower. In order to make the delta of the complete portfolio neutral or equal to zero, the position in March PeakForward 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. long, long b. long, shortc. short, short d. short, long

Correct Answer: b

Reading Reference: Managing Energy Risk, Burger, Chapter 2Explanation: 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?

a. 0.131 MMBtu/MWhb. 7.6 MMBtu/MWhc. 30.4 MMBtu/MWhd. 7,600 MMBtu/MWh

Correct Answer: b

Reading Reference: Energy Trading & Investing, Edwards; Chapter 2.2, page 109Explanation: 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.

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.

b. 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.

c. A call option with the same contract specifications as the two options in the problem but with a strike of USD 7.00 must therefore be trading at a Black-implied volatility of 55%.

d. 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.

Correct Answer: b



Reading Reference: Energy Risk, Pilipovic: Chapter 8, p. 232Explanation: 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 generallydoes not capture the full spectrum of behavior of energy prices given a single volatility measure. Therefore the correct answer is b.

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

a. Deltab. Gammac. Thetad. Vega

Correct Answer: d

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

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

a. Horizontal refiningb. Catalytic crackingc. Distillation processd. Vertical hydrolytic emersion

Correct Answer: b

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



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

a. Distillationb. Treatmentc. Blendingd. Conversion

Correct Answer: a

Reading Reference: Refining: Technology and Economics, 5th Edition, Gary et al, Chapter 1, p. 2Explanation: Answer a is correct; refining begins with distillation by boiling crude, separating the resulting vaporand 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 400,000b. USD 500,000c. USD 2,400,000d. USD 3,000,000

Correct Answer: c

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

54. A call 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 5b. USD 3c. USD 2d. USD 0

Correct Answer: c

Reading Reference: Energy Markets: Price Risk Management and Trading, James: Chapter 6, p. 137-8Explanation: Answer a is incorrect, this is the premium. b is incorrect, this is the intrinsic value. c is correct. It is thepremium less the intrinsic value: intrinsic value = USD 31 - USD 28 = 3, so USD 5 - USD 3 = USD 2, therefore timevalue = 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. Continue VaR testing at the 95% confidence level.b. 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.

Correct Answer: d

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

56. 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, Indiab. Russia, United States, India, China, Australiac. United States, Russia, China, India, Australiad. China, United States, Australia, Russia, India

Correct Answer: c

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



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. Tell her that implied volatilities from Black-Scholes calculation are not the same volatilities used in the Ornstein-Uhlenbeck process and you will need to calculate the correct volatilities.

b. You first need to scale the implied volatilities by 365250 as it is a daily deal.c. Provide her with the requested implied volatilities. Nothing else needs to be done.d. You first need to scale the implied volatilities by 250365 as it is a daily deal.

Correct Answer: a

Reading Reference: Energy Derivatives: Pricing and Risk Management, Clewlow and Strickland: Chapter 3.2.2, p. 41Explanation: 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-Scholesmodel. The volatility for the Ornstein-Uhlenbeck process has units of dollars. The volatilities in Black-Scholes andOrnstein-Uhlenbeck are not interchangeable.

58. The cost of alternative transportation method involves setting rates against the costs of alternative forms of 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. USD 23.00 – USD 25.00/bbl b. USD 19.50 – USD 21.00/bblc. USD 24.50 – USD 25.50/bbld. 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. 221Explanation: 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.



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

generation plantsc. Government incentives favor renewable projects like wind and solar over hydroelectric plantsd. Most developed nations have already largely exploited their hydroelectric potential

Correct Answer: d

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

60. By fitting a normal curve to the crude oil production profile of 48 American states, King Hubbert, then an engineer at Shell, forecast in 1960 that American crude oil production would reach its peak in 1969. Production would then decline in a manner symmetrical to the growth phase. The fact that his theory was vindicated for one particular example does not mean, however, that his model has been validated globally because:

a. Conventional crude oil and heavy oil are different. b. Probability estimates are not accurate. c. The method does not account for off shore reserves. d. There is no reason to believe that all production profiles will display this pattern.

Correct Answer: d

Reading Reference: Oil, Gas Exploration, and Production, Institut Francais: Chapter 3, p. 99-100 Explanation: Answer d is correct. One glaring issue with Hubbert’s model is that it makes time the only explanatoryvariable for the production of a region, thereby disallowing the possibility of reserves (for instance) being createdas a result of technical progress.

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