2011 - 2

Energy Risk Professional (ERP®) ExaminationPractice Exam 2

© 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 2

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

ERP Practice Exam 2 Candidate Answer Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3

ERP Practice Exam 2 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5

ERP Practice Exam 2 Answer Sheet/Answers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21

ERP Practice Exam 2 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 2 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 2 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 2 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 and the Anniversary

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

and Hewlett Packard 20B.

3. After completing the ERP Practice Exam 2

• Calculate your score by comparing your answer

sheet with the practice exam answer key. Only

include questions completed within the first 120

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 2

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. Which of the following is true regarding crude oil reservoirs?

a. Crude oil will naturally migrate upwards towards the Earth’s surface unless it encounters an impermeable material.

b. Crude oil will naturally migrate downwards towards the Earth’s crust unless it encounters an impermeable material.

c. Crude oil rarely migrates far from the place where it was formed.d. Only the salt residue of an ancient seabed will effectively contain crude oil in commercially

recoverable amounts.

2. You wish to use a bull spread strategy for heating oil using call and put option contracts. You decide to purchase option strikes at USD 1.91 and USD 1.97. Using the table below, what would the total net premium expense be, assuming no commissions or other transaction costs?

Exercise Price Call Premium Put PremiumUSD 1.85 USD 0.227 USD 0.158USD 1.91 USD 0.195 USD 0.186USD 1.97 USD 0.169 USD 0.220

December 2009 Heating Oil Futures Contract = USD 1.91 per gallon

a. USD 0.026b. USD 195c. USD 1,092d. USD 1,950

3. A natural gas producer sells a swing swap (10,000 MMBtu per day) at USD 5.50 for the last five days in January to an end-user.Calculate the cash settlement at the end of the swap based on the Gas Daily Index below:

Date High Price Low Price Gas Daily Index Jan 27 USD 5.70 USD 5.60 USD 5.65Jan 28 USD 5.60 USD 5.50 USD 5.55Jan 29 USD 5.80 USD 5.60 USD 5.70Jan 30 USD 5.90 USD 5.60 USD 5.75Jan 31 USD 6.20 USD 6.00 USD 6.10

a. USD 12,500 payment from the producer to the end-user.b. USD 12,500 payment from the end-user to the producer.c. USD 17,000 payment from the producer to the end-user.d. USD 17,000 payment from the end-user to the producer.

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.


4. According to the International Accounting Standards (IAS) Rule 39, for a derivative hedge to be considered effective, the correlation between changes in the price of derivative hedge and changes in the price of the underlying physical asset should be in which of the following ranges?

a. 80% to 125%b. 85% to 115%c. 80% to 120%d. 75% to 125%

5. Ethanol is a gasoline substitute made from biomass. E85 is a blend of vehicle fuel containing 85% ethanol and 15% gasoline. Thanks to government policies mandating its use, what country is the world’s largest consumer of E85?

a. Brazilb. Canadac. Chinad. United States

6. When compared globally, proven reserves of coal are estimated to contain __________ energy as contained by the world’s proven reserves of petroleum?

a. Half as muchb. Roughly the same amount ofc. Twice as muchd. Three times as much

7. An analyst from PB Energy Trading is implementing a VaR model and needs to choose between a Monte Carlo based model and a variance-covariance based model. Compared to the analytical method, what is the main advantage of Monte Carlo simulation?

a. Ability to handle energy portfolios containing large number of risk factors.b. Low price of computing large numbers of risk factors.c. Simplicity and ease of handling large energy portfolios.d. Ability to estimate VaR for energy portfolios that contain nonlinear assets.

8. Pierre is about to enter into a long-term energy contract with an unfamiliar counterparty and is concerned about their creditworthiness. Which of the following techniques will be the most effective in reducing Pierre’s credit risk?

a. Margining agreementb. Additional collateralizationc. Countertraded. Price adjustment



9. Charlene is the supply manager for Opechee Petroleum Refinery. Opechee needs to acquire 100,000 barrels of crude oil for delivery in December. In October the December futures contract is trading at USD 85 per barrel. Charlene decides to implement a cap strategy and buys 100 December call options with a strike of USD 85 per barrel and a premium of USD 850 per option contract. If the December futures price hits USD 90 per barrel what is the effective cost per barrel of crude after accounting for the option contract?

a. USD 84.15b. USD 85.00c. USD 85.85d. USD 89.15

10. In recent years, new LNG projects in West Africa that capture associated gas from oil fields currently in production have been launched. What has been the primary motivation behind the sudden development of these LNG projects in West Africa?

a. To provide an alternative fuel source for motor vehicles in the region.b. Government policy in the region to eliminate gas flaring from oil wells.c. Fears that the oil fields will soon run dry.d. Heavy foreign investment in LNG, particularly from China.

11. Which of the following best describes royalties on an LNG project?

a. Payments made on a percentage of the sales revenues.b. Payments based on a percentage of the profits.c. Payments based on profits minus local tax payments.d. Payment based on varying unit costs.

12. Consider a manufacturing plant that consumes a large amount of electricity each month. Monthly on-peak forwards are currently available at USD 75/MWh for a 100MW contract. If the plant manager purchases a monthly on-peak power forward contract, how many megawatt hours will the plant receive, assuming there are 20 business days per month?

a. 2,000 MWhb. 16,000 MWhc. 32,000 MWhd. 48,000 MWh



13. On July 20, Merg Refining knows it will need to purchase 20,000 barrels of crude in November. Merg decides to hedge using NYMEX oil futures contracts for mid-December contract. The futures price on July 20 is USD 60.00/bbl. On November 12, Merg is ready to purchase their needed crude and closes out its futures contract on that day; at this time the spot price is USD 62.00/bbl and the futures price is USD 61.10/bbl.

In this scenario, the effective price paid per barrel is


14. Time series analysis is necessary for 1 , while distribution analysis is important in 2 .

1 2a. Constant drift-term calibration Average volatility calculationb. Option modeling Spot price modelingc. Comparing long-term price behavior to Calibrating model parameters

model-implied behaviord. Calibrating model parameters Comparing long-term price behavior to model-implied behavior

15. Which of the following statements regarding Value-at-Risk (VaR) is true?

a. VaR assumes the portfolio does not change over time.b. VaR can be represented by multiple numbers of risk measurements.c. VaR accounts for the absolute worst-case scenario.d. VaR models are best used to predict future market behavior.

16. There are four power plants which can be dispatched to a power grid, their operating costs and capacities are shown in the table below. The system operator will use a merit order curve to minimize the cost of running the system. Based on this information, how many megawatts can be dispatched by the system operator while keeping the equilibrium price below USD 35/MWh?

Plant Cost/MWh Capacity (MW)A USD 20 500B USD 40 100C USD 30 150D USD 44 300

a. 500 MWsb. 650 MWsc. 700 MWsd. 750 MWs



17. Victor is offered the four qualities of crude oil below. Assuming no basis differences, for which of the following should he be willing to pay the most?

a. API = 38 and Sulfur = 0.3%b. API = 38 and Sulfur = 1.2%c. API = 23 and Sulfur = 0.3%d. API = 23 and Sulfur = 1.2%

18. Consider a natural gas futures contract trading at USD 2.00 with an initial margin requirement of USD 3,000 which supports a decrease in the price of the futures contract to USD 1.70. What is the additional margin requirement if the futures price falls to USD 1.60?

a. USD 1,000b. USD 2,000c. USD 3,000 d. USD 4,000

19. How will the Smart Grid help to lower the operating costs of electric utility companies?

a. By reducing the usage of peaker facilities.b. By reducing the need to build high-capacity transmission lines.c. By reducing fuel costs.d. All of the above.

20. Crude oils from West Africa are often sold based on a formula indexed to Brent crude plus a premium or discount depending on the quality of the crude. Which of the following risks could be mitigated if a West African producer executes a futures contract on Brent?

a. Basis risk and supply riskb. Basis risk and directional riskc. Supply riskd. Market price risk

21. Which of the following statements correctly describes a weakness in using single factor mean-reverting models for option valuation?

a. Black-equivalent volatility approaches zero with increasing time to expiration.b. Black-equivalent volatility grows with increasing time to expiration.c. Black-equivalent volatility decreases with increasing time to expiration.d. Black-equivalent volatility changes in proportion to spot price volatility.



22. Bob Burns would like to understand the term floor as it relates to energy commodity trading strategies.Which of the following positions has the characteristics of a floor?

a. Short call optionb. Long call optionc. Short put optiond. Long put option

23. Which of the following is the key driver of volatility in the natural gas market in the United Kingdom?

a. Demandb. Infrastructurec. Storaged. Supply

24. Suppose it is January and the spot price of Brent crude on the ICE exchange is USD 106. The annual risk-free interest rate is 6%, and monthly storage cost is USD 0.50 per barrel. If the crude can be stored for three months but cannot be sold out of storage before the three month storage term ends, what breakeven forward price per barrel supports a storage strategy?

a. USD 107.51 b. USD 108.03c. USD 109.11d. USD 109.78

25. Which of the following statements correctly describes cogeneration?

a. The generation of electricity using two forms of fossil fuel. b. The generation of electricity using a combination of two distinct types of generating units,

with combined output.c. A generating unit that produces both electricity and heat.d. A generating unit that has more than one owner resulting in shared electricity output.

26. Several notable firms have been driven out of business because a single individual was in charge of both the execution and reconciliation of derivatives trades. This is an example of a failure in which risk control category?

a. Management controlb. Segregation of dutiesc. Risk Reportingd. Risk assessment



27. Refineries X, Y, and Z have complexity factors of 2, 5, and 10, respectively. Using industry accepted guidelines or thresholds, which of the following correctly classifies each refinery as “simple”, “complex”, or “very complex”.

a. X — simple, Y — simple, Z - complex b. X — very complex, Y — complex, Z — simplec. X — simple, Y — complex, Z — very complexd. X — simple, Y — very complex, Z — very complex

28. LNG pricing has historically been dependent on which of the following?

a. Specific conditions in the customers’ markets.b. Lack of a structured pricing arrangement.c. Processes set by the seller of the LNG.d. Price fixing by local governments.

29. A natural gas distributor is buying LNG from a gas trader using a bi-lateral contract that includes a force majeure clause. Which of the following is an implied outcome of the force majeure clause?

a. Derivatives contracts can be cancelled and not honored.b. The gas trader can sell the gas to another counterparty offering a higher price.c. The gas trader is free to not perform its obligation if the cost for sourcing the LNG is too high.d. There is a possibility that positions may actually disappear.

30. Markus has been studying nuclear power generation using the following technologies: Boiling Water Reactors (BWR’s), Pressurized Water Reactors (PWR’s) and Pebble-Bed Modular Reactors (PBMR’s). Which of the following statements regarding these methods of nuclear power generation is correct?

a. PBMR’s are the latest technology being advocated because it increases the output in terms of megawatt hours for the same capital cost.

b. PWR’s feeds steam directly from the reactor into the turbines thereby introducing low levels of radiation to the turbines, condensers and associated piping.

c. The high temperatures possible with a PWR design make it more thermally efficient than a BWR.d. One problem with a PBMR is that it operates at high temperatures, which raises safety issues.



31. Match the following characteristics of a distribution with the correct description:

1. Kurtosis A. Captures the width of a distribution2. Standard Deviation B. Reflects symmetry or imbalance of the distribution to the left or right of the mean3. Skew C. Characterizes the tails of the distribution

a. 1-A, 2-B, 3-Cb. 1-B, 2-A, 3-Cc. 1-C, 2-B, 3-Ad. 1-C, 2-A, 3-B

32. Thomas is trading electricity power options and has 90 days of price data. Which factor should he apply to the standard deviation of his data set to estimate annual volatility?

a. √90 b. 1/√90c. √250d. √365

33. The Fischer-Tropsch (FT) Process allows for the conversion of coal into what more valuable energy commodity?

a. Synthetic crude oilb. Natural gasc. Middle distillates like diesel and naphthad. A range of petroleum products depending on FT plant optimization

34. Consider a trade in which a futures contract on natural gas was purchased and a futures contract on crude oil was simultaneously sold at a lower price. Assuming the price of the futures on natural gas remains above the price of the futures on crude oil, but the spread between the two prices narrows you would expect that the trade will ________.

a. Make moneyb. Lose moneyc. Make money only if both prices rised. Lose money only if both prices fall



35. Ten days ago Rebecca, a gasoline option trader, sold 50 put contracts on gasoline futures with a strike price USD 0.012 cents/gallon and current delta of 0.7. Which of the following positions does Rebecca need to add to her portfolio to neutralize her position?

a. Long 35 Futures contractsb. Long 60 Futures contractsc. Short 35 Futures contractd. Short 60 Futures contracts

36. Which of the following describes gas basis?

a. The underlying cost of the commodityb. The price difference between locationsc. The tax rate for gas inventoryd. The convenience yield for gas ownership

37. Jean-Claude is the operator of a 100MW power plant. He has just performed a spark spread calculation and has gotten a negative result. What is the most practical economic course of action for Jean-Claude to take?

a. Perform the calculation again since spark spreads cannot yield negative values.b. Switch to a lower-cost fuel that will allow the plant to run profitably.c. Modernize the generation equipment at the plant to make it more efficient.d. Stop power production until electricity rates rise to a point where he can sell power profitably.

38. One common method of reducing credit risk between parties is the use of a countertrade. Which of the following statements about a countertrade is correct?

a. A countertrade increases settlement risk and reduces replacement risk.b. A countertrade reduces settlement risk and reduces replacement risk.c. A countertrade increases settlement risk and locks in replacement risk.d. A countertrade reduces settlement risk and locks in replacement risk.

39. Which of the following alternative energy sources can be classified as either passive or active?

a. Biofuelsb. Hydroelectricc. Solard. Wind



40. To ensure that the quality of imported LNG supplied to end users falls within prescribed parameters, which of the following actions should be taken?

I. Dilute the vaporized LNG with air or nitrogen.II. Enrich the vaporized LNG with higher heating value components such as ethane, propane, and butane. III. Establish a Wobbe index range and a heating value range for the LNG.

a. Ib. IIc. I and IIId. All of the above.

41. To calculate the historical volatility for use in a Geometric Brownian Motion (GBM) process you need to do which of the following?

I. Determine the commodity’s long run mean priceII. Calculate the standard deviation of the prices about the long-term meanIII. Calculate the standard deviation of the logarithmic price returnsIV. Annualize the standard deviation by the appropriate factor

a. I and IIb. II, and IVc. III and IVd. III only

42. In the crude oil market, what are paper barrels?

a. Statistical projections of a refinery’s profit and lossb. Projections on how much oil an unproven reservoir may holdc. Future contracts bought without the expectation of actual delivery of the productd. A new, environmentally-friendly container for crude oil

43. Rank the following countries in order of highest to lowest percentage of electricity produced from nuclear power (beginning with the highest percentage):

a. France, Japan, USA, Russiab. Japan, USA, France, Russiac. USA, Japan, Russia, Franced. USA, Russia, France, Japan



44. Which of the following statements regarding Value-at-Risk (VaR) is false?

a. VaR models assume portfolios do not change over time.b. VaR models provide a single measure of risk.c. VaR models estimate the absolute worst-case scenario.d. VaR models should not be used to predict future market behavior.

45. Alessandro Montano, ERP, is analyzing the recent sale of a pipeline owned by his company. Which of the following valuation methods should Alessandro use to record a financial gain or loss for the sale?

a. Economic valueb. Comparable salesc. Replacement costd. Book value

46. Which of the following factors has the greatest influence on day-to-day variations in demand for electricity in a given location?

a. Economic factorsb. Fuel costsc. Generation constraintsd. Weather

47. We assume that the heat rate of a natural gas peaking unit is 10,000 Btu/kWh. The price of electricity is USD 25.00per MWh, and the price of natural gas is USD 2.00. What is the “spark spread” for this plant in USD per kWh?


48. The principle of parallelism implies what type of relationship between spot and future prices?

a. A low level of correlation between spot and futures pricesb. A high level of correlation between spot and futures pricesc. A volatile correlation between spot and futures pricesd. No correlation between spot and futures prices



49. The cost of crude oil typically accounts for 70-80% of the total operating expenses associated with refined products. As a result procurement managers seek to purchase types or blends of crude oil that will offer the highest profit margin when used to create refined petroleum products. Which of the following is a method commonly used by refineries to evaluate crude oil?

a. Break-even analysisb. Proximate analysisc. Ultimate analysisd. Fischer-Tropsch analysis

50. Given a flat volatility term structure for the entire WTI forward price curve at 35%, the Black-equivalent volatility of a look-back cash-settled average price option with a 3-month averaging period would 1 over the last three months ofthe option’s life because 2 .

1 2a. Increase Volatility of the underlying forward price tends to grow as option expiration time decreases.

b. Decrease Volatility of the underlying forward price tends to drop as option expiration time decreases.

c. Increase As we begin collecting the daily forward price settlements to ultimately determine the average price at option settlement, the uncertainty around the value of the average price settlement value drops.

d. Decrease As we begin collecting the daily forward price settlements to ultimately determine the average price atoption settlement, the uncertainty around the value of the average price settlement value drops.

51. Your company is calculating Value-at-Risk (VaR) using an historical simulation method, with a 97.5% confidence level and two day holding period. In order to assess the validity of the method used to measure price risk, back-testing is also put in place. Assuming there are 260 business days in a year, which of the following loss scenarios (e.g. number of times portfolio losses exceed VaR) would you consider an acceptable threshold?

a. Once every two monthsb. 2.5 times each monthc. 2 times each monthd. 130 times in six months



52. Blockhead Cement Company has historically consumed an average of 30MWh of electric power per day and typically purchases power at prevailing spot market prices. In an effort to hedge price exposure the company’srisk management team has decided to use electricity swaps. They are planning to test the strategy in the month of August by engaging in a fixed-for-floating electricity swap with a local power provider for 30MWh of power at USD 120/MWh. What will Blockhead’s net cash flow be if the cost of power for August is USD 105,681 and the floating leg of the swap is set at USD 108,240?

a. Pay USD 102,321b. Receive USD 102,321c. Pay USD 109,041d. Receive USD 109,041

53. A generating plant has a nameplate rating of 650 megawatts and is expected to be offline for 720 hours for a scheduled outage during the year. A typical year is comprised of 8,760 hours. Actual generation during the year was 4,270,500 megawatt hours. What is the plant’s load factor?

a. 81.7%b. 75.0%c. 72.76%d. 76.0%

54. The Risk Manager of a power generation company is reviewing the parameters under which analytical VaR is calculated and the nature of the company’s price exposures. She believes that the hypothesis of a one-day holding period is not realistic, and requires a 5-day holding period instead. Traders complain that in this case the calculated VaR will be much higher and they will not be able to respect the company VaR limit of ten million. She proposes to review the VaR limit in a manner consistent with the new holding period; consequently, the new VaR limit will be approximately:

a. 50 Millionb. 22 Million c. 2 Milliond. 10 Million



55. Prior to drilling a well, an assessment is made as to the reserves a reservoir may contain based on data derived from a current or prior well production or geophysical data. Which of the following makes the technicalprocess for estimating reserves complex?

a. The subjective nature of the process.b. The quantitative methodologies used.c. The publication of reserve estimates is often biased.d. The reserves are not considered assets

56. Consider the statements below regarding delivery costs as a percentage of the cost of electricity charged to the end-use customer. Which of the following statements is false?

a. Distribution accounts for about 30 to 50 percent of the total delivery cost.b. Generation accounts for about 35 to 50 percent of the total delivery cost.c. Transmission accounts for about 5 to 15 percent of the total delivery cost.d. Delivery operations vary wildly from plant-to-plant, thus no generalizations about the percentage of

costs can be made.

57. A landman is used to determine the legal rights of a company to drill for petroleum and natural gas, and to facilitate mandatory legal requirements. Of the landman's responsibilities, which of the following is NOT one of his/her roles?

a. Conduct seismological tests to locate minerals.b. Locate mineral owners.c. Verify mineral ownership via title searches.d. Negotiate leasing terms necessary for drilling.

58. A refiner is negotiating the sale of 10,000 tons of jet fuel to an airline. By giving a discount on the current market price, the refiner has secured the possibility to sell and deliver, at their discretion, an additional volume of 10% at the previously agreed upon price. This price is finally set at USD 450/ton. At the time of delivery, the prevailing market price is USD 400/ton, and the refiner decides to deliver also the additional 10% volume. The refiner’s position can be described as:

a. Purchase of a call option for free, and exercise (strike) price at USD 400/ton.b. Purchase of a put option for free, and exercise (strike) price at USD 450/ton.c. Purchase of a put option with premium equal to the discount, and exercise (strike) price at USD 450/ton.d. Purchase of a call option with premium equal to the discount, and exercise (strike) price at USD 450/ton.



59. The round-the-clock forward contract for single day delivery on February 10 and February 11 currently trades at USD 60 and USD 50 respectively. The three-day forward contract for round-the-clock delivery for the period starting February 10 and ending February 12 also trades at USD 50. Assuming a zero-percent discount rate, what is the round-the-clock forward price for a single day of delivery occurring on February 12?

a. USD 40b. USD 45c. USD 50d. USD 55

60. You run a lucrative kerosene business and wish to hedge your exposure to kerosene price changes on a contract that is close to delivery. By implementing this hedge using heating oil derivatives you are exposed to changes in _______ basis.

a. Locationb. Storagec. Productd. Intermarket


Answers



a. b. c. d.

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Explanations



1. Which of the following is true regarding crude oil reservoirs?

a. Crude oil will naturally migrate upwards towards the Earth’s surface unless it encounters an impermeable material.

b. Crude oil will naturally migrate downwards towards the Earth’s crust unless it encounters an impermeable material.

c. Crude oil rarely migrates far from the place where it was formed.d. Only the salt residue of an ancient seabed will effectively contain crude oil in commercially

recoverable amounts.

Correct answer: a

Reading reference: The Petroleum Industry: A Nontechnical Guide, Conaway; Chapter 2.Explanation: Because of subsurface pressure, crude oil will naturally migrate towards the surface, unless it iscontained by a layer of impermeable material (a “trap”) to form a reservoir, thus a is the correct answer.

2. You wish to use a bull spread strategy for heating oil using call and put option contracts. You decide to purchase option strikes at USD 1.91 and USD 1.97. Using the table below, what would the total net premium expense be, assuming no commissions or other transaction costs?

Exercise Price Call Premium Put PremiumUSD 1.85 USD 0.227 USD 0.158USD 1.91 USD 0.195 USD 0.186USD 1.97 USD 0.169 USD 0.220

December 2009 Heating Oil Futures Contract = USD 1.91 per gallon

a. USD 0.026b. USD 195c. USD 1,092d. USD 1,950

Correct answer: c

Reading reference: Fundamentals of Trading Energy Futures & Options, 2nd Edition, Errera and Brown:Chapter 7, p. 114.Explanation: Answer C is correct as per the following formula; prices are per gallon, so the answer is 42,000gallons × (USD 0.195 − USD 0.169) = USD 1,092.



3. A natural gas producer sells a swing swap (10,000 MMBtu per day) at USD 5.50 for the last five days in January to an end-user.Calculate the cash settlement at the end of the swap based on the Gas Daily Index below:

Date High Price Low Price Gas Daily Index Jan 27 USD 5.70 USD 5.60 USD 5.65Jan 28 USD 5.60 USD 5.50 USD 5.55Jan 29 USD 5.80 USD 5.60 USD 5.70Jan 30 USD 5.90 USD 5.60 USD 5.75Jan 31 USD 6.20 USD 6.00 USD 6.10

a. USD 12,500 payment from the producer to the end-user.b. USD 12,500 payment from the end-user to the producer.c. USD 17,000 payment from the producer to the end-user.d. USD 17,000 payment from the end-user to the producer.

Correct answer: a

Reading reference: Trading Natural Gas: A Nontechnical Guide, Sturm; Chapter 4, P. 38-42.Explanation: Answer a is correct, if the average gas daily index for the five days is USD 5.75 and is USD 0.25above the contract price, the producer would effectively be receiving a price of USD 5.50 and paying a priceof USD 5.75, a net payment of USD 0.25/MMBtu. Multiplying the USD 0.25 MMBtu payment by the total contractquantity of gas of 50,000 MMBtu results in a payment of USD 12,500 from the producer to the end-user. Theproducer should be able to sell its physical gas in the market at a price near the USD 5.75 Gas Daily Indexaverage and result in a net receipt of USD 5.50 an MMBtu if the hedge was 100% effective.

4. According to the International Accounting Standards (IAS) Rule 39, for a derivative hedge to be considered effective, the correlation between changes in the price of derivative hedge and changes in the price of the underlying physical asset should be in which of the following ranges?

a. 80% to 125%b. 85% to 115%c. 80% to 120%d. 75% to 125%

Correct answer: Answer a is correct; as per definition the range should be between 80% to 125%, according to IAS 39.

Reading reference: Tom James. Energy Markets: Price Risk Management and Trading, Chapter 17: Accounting for Energy Derivatives Trades, p. 352-3.



5. Ethanol is a gasoline substitute made from biomass. E85 is a blend of vehicle fuel containing 85% ethanol and 15% gasoline. Thanks to government policies mandating its use, what country is the world’s largest consumer of E85?

a. Brazilb. Canadac. Chinad. United States

Correct answer: a

Reading reference: Fisher Investments on Energy, Chapter 6, p. 159.Explanation: In an effort to become energy independent, Brazil’s government has pursued a policy to fueltheir nation’s motor vehicles with E85, using ethanol refined from Brazil’s ample supplies of sugar cane.

6. When compared globally, proven reserves of coal are estimated to contain __________ energy as contained by the world’s proven reserves of petroleum?

a. Half as muchb. Roughly the same amount ofc. Twice as muchd. Three times as much

Correct answer: d

Reading reference: Producing Liquid Fuels from Coal: Prospects and Policy Issues, Bartis; Chapter 2, p. 5, 12.Explanation: According to the World Energy Council, when compared to global petroleum reserves, globalcoal reserves contain roughly three times as much energy, making d the correct answer.



7. An analyst from PB Energy Trading is implementing a VaR model and needs to choose between a Monte Carlo based model and a variance-covariance based model. Compared to the analytical method, what is the main advantage of Monte Carlo simulation?

a. Ability to handle energy portfolios containing large number of risk factors.b. Low price of computing large numbers of risk factors.c. Simplicity and ease of handling large energy portfolios.d. Ability to estimate VaR for energy portfolios that contain nonlinear assets.

Correct answer: d

Reading reference: Leppard; Chapter 10, p. 200-205.Explanation: Answer d is correct. The advantages of Monte Carlo simulations include the ability to modelevolution of risk factors over the holding period. Furthermore, there is no need to approximate portfolio val-ues in this method—they are computed exactly. Hence, the method can be used for estimating VaR in themost nonlinear portfolio, which is a valuablecharacteristic for energy portfolios with assets.

8. Pierre is about to enter into a long-term energy contract with an unfamiliar counterparty and is concerned about their creditworthiness. Which of the following techniques will be the most effective in reducing Pierre’s credit risk?

a. Margining agreementb. Additional collateralizationc. Countertraded. Price adjustment

Correct answer: a

Reading reference: Managing Energy Risk: An Integrated View on Power and Other Energy Markets, Burger,Chapter 6.3, p. 268.Explanation: Answer a is the best selection, since it transfers cash to the “upside” counterparty from the“downside” counterparty. Cash in hand is the best solution. While answers b, c and d would mitigate risk,they are not the best solution in this scenario. For example, “additional collateralization” is not the same ascash, and there may be monetization costs to convert it to cash.



9. Charlene is the supply manager for Opechee Petroleum Refinery. Opechee needs to acquire 100,000 barrels of crude oil for delivery in December. In October the December futures contract is trading at USD 85 per barrel. Charlene decides to implement a cap strategy and buys 100 December call options with a strike of USD 85 per barrel and a premium of USD 850 per option contract. If the December futures price hits USD 90 per barrel what is the effective cost per barrel of crude after accounting for the option contract?


Correct answer: c

Reading reference: Fundamentals of Trading Energy Futures & Options, 2nd Edition, Errera, Chapter 7, p. 123.Explanation: The correct answer is c since, Charlene longs the call options, and since at expiry date the crudeprice is USD 90 per barrel, which is larger than the strike price of call options, she will execute the call optionsand buy crude at USD 85 per barrel. She also paid premium for the call options, so the total amount she paidis: USD 85 per barrel*100,000 barrels+100 call options *USD 850 per option=USD 8,585,000 . Then the averagecost per barrel is USD 8,585,000 /100,000 barrels=USD 85.85 per barrel.

10. In recent years, new LNG projects in West Africa that capture associated gas from oil fields currently in production have been launched. What has been the primary motivation behind the sudden development of these LNG projects in West Africa?

a. To provide an alternative fuel source for motor vehicles in the region.b. Government policy in the region to eliminate gas flaring from oil wells.c. Fears that the oil fields will soon run dry.d. Heavy foreign investment in LNG, particularly from China.

Correct answer: b

Reading reference: LNG: A Nontechnical Guide, Tusiani and Shearer; Ch. 11, p. 301-302. Explanation: Associated fields produce both oil and natural gas. For years companies in the oil fields of WestAfrica routinely flared off the natural gas that emerged from the oil wells as a waste product. In recent years,over environmental concerns, governments in the region mandated that this natural gas be captured to elimi-nate gas flaring, spurring the development of LNG projects and making b the correct answer.



11. Which of the following best describes royalties on an LNG project?

a. Payments made on a percentage of the sales revenues.b. Payments based on a percentage of the profits.c. Payments based on profits minus local tax payments.d. Payment based on varying unit costs.

Correct answer: a

Reading reference: LNG: A Nontechnical Guide, Tusiani and Shearer: Chapter 11, p. 303.Explanation: Answer a is correct. Typically speaking, in the upstream, royalties are a common device bywhich governments cansecure a share of a project's revenue. High royalties can be onerous to an LNG proj-ect, since they involve a payment tothe sovereign made directly out of the sales revenues irrespective of theproject’s actual earnings. These royalties canbe on oil and/or gas; in the case of an LNG project, any liquidsproduced are often subject to the same royalties as oilproduction. Royalties are usually expressed as a per-centage of initial revenue. For current LNG projects, they generallyfall in a range of 5%–20%. Less commonly,they can be calculated as a fixed unit cost (USD /MMBtu).

12. Consider a manufacturing plant that consumes a large amount of electricity each month. Monthly on-peak forwards are currently available at USD 75/MWh for a 100MW contract. If the plant manager purchases a monthly on-peak power forward contract, how many megawatt hours will the plant receive, assuming there are 20 business days per month?

a. 2,000 MWhb. 16,000 MWhc. 32,000 MWhd. 48,000 MWh

Correct answer: c

Reading reference: Energy Modelling: Advances in the Management of Uncertainty, Kaminski: Chapter 2, p. 59.Explanation: Answer c is correct: 16 hours per day times 20 days, times 100 MWs = 32,000.



13. On July 20, Merg Refining knows it will need to purchase 20,000 barrels of crude in November. Merg decides to hedge using NYMEX oil futures contracts for mid-December contract. The futures price on July 20 is USD 60.00/bbl. On November 12, Merg is ready to purchase their needed crude and closes out its futures contract on that day; at this time the spot price is USD 62.00/bbl and the futures price is USD 61.10/bbl.

In this scenario, the effective price paid per barrel is


Correct answer: b

Reading reference: James: Chapter 13, p. 263. Explanation: The effective price paid (in dollars per barrel) is the final spot price less the gain on the futures,or 62.00 – 1.10 = 60.90This can also be calculated as the initial futures price plus the final basis, 60.00 + 0.90 = 60.90

14. Time series analysis is necessary for 1 , while distribution analysis is important in 2 .

1 2a. Constant drift-term calibration Average volatility calculationb. Option modeling Spot price modelingc. Comparing long-term price behavior to Calibrating model parameters

model-implied behaviord. Calibrating model parameters Comparing long-term price behavior to model-implied behavior

Correct answer: d

Reading reference: Energy Risk, Pilipovic: Chapter 5, p. 72-3.Explanation: Time series analysis is specifically used in calibrating model parameters while distribution analy-sis is important in testing model-implied behavior against actual long-term price behavior. Hence, answer d isthe correct answer.

Drift term calibration is one of the results of time series analysis. However, other model parameters are alsocalibrated. Similarly, while average volatilities can be implied through distribution analysis, this can be only apart of the process of performing a distribution analysis. So while answer a is somewhat appropriate, it doesnot provide the best answer. Answers b and c are both incorrect, as the opposite of the statements is true.



15. Which of the following statements regarding Value-at-Risk (VaR) is true?

a. VaR assumes the portfolio does not change over time.b. VaR can be represented by multiple numbers of risk measurements.c. VaR accounts for the absolute worst-case scenario.d. VaR models are best used to predict future market behavior.

Correct answer: a

Reading reference: Energy Risk Management: A Non-technical Introduction to Energy Derivatives, Leppard:Chapter 8, p. 195. Explanation: Answer a is true VaR assumes the portfolio does not change over time. Answer b is false: VaR isa single number measure of risk. Answer c is false: VaR does not estimate the absolute worst-case scenario.Answer d is false: VaR uses some model of what constitutes normal market behavior. Since the future cannotbe known (or there would be no need to VaR) the model must be based on statistical assumptions for howthe market will behave.

16. There are four power plants which can be dispatched to a power grid, their operating costs and capacities are shown in the table below. The system operator will use a merit order curve to minimize the cost of running the system. Based on this information, how many megawatts can be dispatched by the system operator while keeping the equilibrium price below USD 35/MWh?

Plant Cost/MWh Capacity (MW)A USD 20 500B USD 40 100C USD 30 150D USD 44 300

a. 500 MWsb. 650 MWsc. 700 MWsd. 750 MWs

Correct answer: b

Reading reference: Electricity Markets: Pricing, Structures and Economics, Chris Harris, Chapter 6, p. 197.Explanation: Answer b is correct. The merit order curve involves selecting the least expensive power first upto the required system capacity. The market equilibrium price is set by the most expensive power plant usedto meet the system capacity. The merit order curve would dispatch the least expensive plants first. Plant Awould be dispatched for up to 500 MW at USD 20 and then Plant C would be dispatched for up to an addi-tional 150 MWs at USD 30. Any additional energy needs would require dispatching Plant B at USD 40/MW,which would set the price above USD 35. Therefore, up to 650 MWs could be dispatched to keep the pricebelow USD 35/MWh.



17. Victor is offered the four qualities of crude oil below. Assuming no basis differences, for which of the following should he be willing to pay the most?

a. API = 38 and Sulfur = 0.3%b. API = 38 and Sulfur = 1.2%c. API = 23 and Sulfur = 0.3%d. API = 23 and Sulfur = 1.2%

Correct answer: a

Reading reference: Nontechnical Guide to Petroleum, Geology, Exploration, Drilling, and Production, 2ndEdition, Hyne: Chapter 1, p. 5.Explanation: Answer a is correct because a higher API is more valuable, while higher sulfur is less valuable.Answer a combines the higher API with the lowest sulfur content from the four choices available.

18. Consider a natural gas futures contract trading at USD 2.00 with an initial margin requirement of USD 3,000 which supports a decrease in the price of the futures contract to USD 1.70. What is the additional margin requirement if the futures price falls to USD 1.60?

a. USD 1,000b. USD 2,000c. USD 3,000 d. USD 4,000

Correct answer: a

Reading reference: Trading Natural Gas: A Nontechnical Guide, Sturm; Chapter 4, p. 37-38.Explanation: Answer a is correct. a trader will receive notice of a margin call if the value of their position hasdeteriorated beyond the initial margin requirement. In the example above, the value of USD 1.70*10,000 =USD 17,000 requires an initial margin of USD 3,000 giving USD 17,000 + USD 3,000 = USD 20,000 worth ofnatural gas. Hence, when the futures contract price falls to USD 1.60, we have USD 1.60*10,000 + USD 3,000= USD 19,000, which requires an additional payment of USD 1,000 to maintain the initial value of the position.

19. How will the Smart Grid help to lower the operating costs of electric utility companies?

a. By reducing the usage of peaker facilities.b. By reducing the need to build high-capacity transmission lines.c. By reducing fuel costs.d. All of the above.

Correct answer: d

Reading reference: The Smart Grid, An Introduction; US Department of Energy, p. 23.Explanation: By providing a detailed, on-going assessment of consumer power usage, the Smart Grid willallow utility companies to better anticipate demand and will lessen the need to run “peaker” generationplants. Since these plants require fuel bought on the spot market, overall fuel costs will also go down. TheSmart Grid will allow electric utilities to fully utilize existing transmission lines, sending perhaps 300% moreelectricity through existing lines, lessening the need to build new transmission corridors; therefore d — all ofthe above — is the correct answer.

20. Crude oils from West Africa are often sold based on a formula indexed to Brent crude plus a premium or discount depending on the quality of the crude. Which of the following risks could be mitigated if a West African producer executes a futures contract on Brent?

a. Basis risk and supply riskb. Basis risk and directional riskc. Supply riskd. Market price risk

Correct answer: d

Reading reference: Surviving Energy Prices, Beutel: Chapter 3, p. 19-21 (and much of the entire chapter).Explanation: Answer d is correct. Futures can only be used to reduce the impact of price volatility with noimpact on supply risk or basis risk.



21. Which of the following statements correctly describes a weakness in using single factor mean-reverting models for option valuation?

a. Black-equivalent volatility approaches zero with increasing time to expiration.b. Black-equivalent volatility grows with increasing time to expiration.c. Black-equivalent volatility decreases with increasing time to expiration.d. Black-equivalent volatility changes in proportion to spot price volatility.

Correct answer: a

Reading reference: Energy Risk, Pilipovic: Chapter 5, p. 105-09.Explanation: The correct answer is a. One stated drawback of a single-factor, mean-reverting model is that itforces the implied Black-equivalent average of the price distribution to approach zero over a long period oftime, requiring caution when using a single-factor mean-reverting model when valuing longer-term options.

22. Bob Burns would like to understand the term floor as it relates to energy commodity trading strategies.Which of the following positions has the characteristics of a floor?

a. Short call optionb. Long call optionc. Short put optiond. Long put option

Correct answer: d

Reading reference: Energy Options Strategies, Errera, Chapter 7, p. 123.Explanation: Answer d is correct because a “floor” or put option protects against energy prices falling toundesirable levels.

23. Which of the following is the key driver of volatility in the natural gas market in the United Kingdom?

a. Demandb. Infrastructurec. Storaged. Supply

Correct answer: a

Reading reference: The Handbook of Commodity Investing, Fabozzi (ed.); Chapter 36, p. 842-43.Explanation: Demand elasticity, particularly from domestic users, is the key driver of volatility in the UK.





24. Suppose it is January and the spot price of Brent crude on the ICE exchange is USD 106. The annual risk-free interest rate is 6%, and monthly storage cost is USD 0.50 per barrel. If the crude can be stored for three months but cannot be sold out of storage before the three month storage term ends, what breakeven forward price per barrel supports a storage strategy?

a. USD 107.51 b. USD 108.03c. USD 109.11d. USD 109.78

Correct answer: c

Reading reference: Fundamentals of Derivatives Markets, McDonald, Chapter 6, p.182.Explanation: Answer c is correct because, it incorporates the future value of the commodity (.0053 = futurevalue factor of 1.0151 x current spot price of USD 106 = USD 107.60) and the future value of 3 months storage(USD 1.5075). All other answers are incorrect and not based on any calculation.

25. Which of the following statements correctly describes cogeneration?

a. The generation of electricity using two forms of fossil fuel. b. The generation of electricity using a combination of two distinct types of generating units,

with combined output.c. A generating unit that produces both electricity and heat.d. A generating unit that has more than one owner resulting in shared electricity output.

Correct answer: c

Reading reference: Making Competition Work in Electricity, Hunt, Chapter 2, p. 18-20.Explanation: Answer c is correct, in cogeneration, both electricity and heat (for use in various businessprocesses) is produced.



26. Several notable firms have been driven out of business because a single individual was in charge of both the execution and reconciliation of derivatives trades. This is an example of a failure in which risk control category?

a. Management controlb. Segregation of dutiesc. Risk Reportingd. Risk assessment

Correct answer: b

Reading reference: Energy Markets: Price Risk Management and Trading, Tom James; Chapter 10, p. 183-84.Explanation: Proper risk control dictates that the same individual not be in charge of the execution of trades(front office duties) and reconciliation of trades and generation of reports (back office duties); if one personhas both front and back office duties, it is possible for them to hide bad trades and not properly inform sen-ior management about outstanding positions, making b, segregation of duties, the correct answer.

27. Refineries X, Y, and Z have complexity factors of 2, 5, and 10, respectively. Using industry accepted guidelines or thresholds, which of the following correctly classifies each refinery as “simple”, “complex”, or “very complex”.

a. X — simple, Y — simple, Z - complex b. X — very complex, Y — complex, Z — simplec. X — simple, Y — complex, Z — very complexd. X — simple, Y — very complex, Z — very complex

Correct answer: a

Reading reference: Petroleum Refining in Nontechnical Language, 3rd Edition, Leffler: Chapter 20, p. 194.Explanation: Answer a is correct. Refineries are classed by complexity type using the categories: “simple” (2 < complexity <= 5); “complex” (8 < complexity < 12); and “very complex” (complexity > 15).



28. LNG pricing has historically been dependent on which of the following?

a. Specific conditions in the customers’ markets.b. Lack of a structured pricing arrangement.c. Processes set by the seller of the LNG.d. Price fixing by local governments.

Correct answer: a

Reading reference: LNG: A Nontechnical Guide, Tusiani and Shearer: Chapter 3, p. 74.Explanation: Answer a is correct. Pricing of LNG has until recently depended on the specific conditions of thecustomers’ markets. In markets that have utility buyers and essentially no pipeline gas supplies, such as Japanand Korea, prices have been mainly set by reference to crude oil as a proxy price for LNG. In turn, these sup-ply arrangements were subject to approval by the governmental authorities that permitted the utilities torecover their fuel cost (but no associated profit) from their captive customers.

29. A natural gas distributor is buying LNG from a gas trader using a bi-lateral contract that includes a force majeure clause. Which of the following is an implied outcome of the force majeure clause?

a. Derivatives contracts can be cancelled and not honored.b. The gas trader can sell the gas to another counterparty offering a higher price.c. The gas trader is free to not perform its obligation if the cost for sourcing the LNG is too high.d. There is a possibility that positions may actually disappear.

Correct answer: d

Reading reference: Energy Risk Management: A Non-technical Introduction to Energy Derivatives, Leppard:Chapter 8, p. 206.Explanation: Answer d is correct. A contract for physical delivery cannot have impacts on derivatives con-tracts, and those normally do not include force majeure clauses, hence a is wrong. Force majeure includedcases, not market related, which are out of the control of the counterparties, hence b and c are wrong. Forcemajeure corresponds to positions disappearing, a risk arising from extreme weather, other natural or man-made events, so only answer d is correct.



30. Markus has been studying nuclear power generation using the following technologies: Boiling Water Reactors (BWR’s), Pressurized Water Reactors (PWR’s) and Pebble-Bed Modular Reactors (PBMR’s). Which of the following statements regarding these methods of nuclear power generation is correct?

a. PBMR’s are the latest technology being advocated because it increases the output in terms of megawatt hours for the same capital cost.

b. PWR’s feeds steam directly from the reactor into the turbines thereby introducing low levels of radiation to the turbines, condensers and associated piping.

c. The high temperatures possible with a PWR design make it more thermally efficient than a BWR.d. One problem with a PBMR is that it operates at high temperatures, which raises safety issues.

Correct answer: c

Reading reference: Roy L. Nersesian. Energy for the 21st Century: A Comprehensive Guide to Conventionaland Alternative Sources (Armonk, NY: M.E. Sharpe, 2007): Chapter 8, p. 283. Explanation: Answer c is correct; PWR’s are more thermally efficient than BWR’s because PWR’s operate athigher temperatures. Answer a is incorrect because PBMR’s are actually best suited for smaller applications.Answer b is incorrect because it is BWR’s that inject low levels of radiation into equipment. Finally, answer dis incorrect because excessive heat within PBMR’s will shut down reactions.

31. Match the following characteristics of a distribution with the correct description:

1. Kurtosis A. Captures the width of a distribution2. Standard Deviation B. Reflects symmetry or imbalance of the distribution to the left or right of the mean3. Skew C. Characterizes the tails of the distribution

a. 1-A, 2-B, 3-Cb. 1-B, 2-A, 3-Cc. 1-C, 2-B, 3-Ad. 1-C, 2-A, 3-B

Correct answer: d

Reading reference: Energy Risk, Pilipovic: Chapter 4, p. 75-76.Explanation: Each moment of a distribution captures various characteristics of the variable behavior.Standard deviation measures the width of a distribution, skew is an estimate of whether the variable ‘favors’values to the left or the right of the mean or is perfectly symmetric, and kurtosis captures the behavior of thevariable when it takes on very large or very small values — hence the ‘tails’ of the distribution. Therefore, thecorrect answer is d.



32. Thomas is trading electricity power options and has 90 days of price data. Which factor should he apply to the standard deviation of his data set to estimate annual volatility?

a. √90 b. 1/√90c. √250d. √365

Correct answer: d

Reading reference: Energy Derivatives: Pricing and Risk Management, Clewlow and Strickland, Chapter 3.2.1 p. 40.Explanation: For most products that are only traded on weekdays, like natural gas, one normally scales the his-torical volatility by the number of trading days. The exact number of trading days varies by market and by prod-uct, but 250 is commonly used as an average figure. Choice d is correct however because, unlike natural gas,power is traded every day so the factor needed to annualize the volatility is the square root of 365. Choices aand b use the square root of 90 (the days in Thomas’ data set), not the total number of trading days.

33. The Fischer-Tropsch (FT) Process allows for the conversion of coal into what more valuable energy commodity?

a. Synthetic crude oilb. Natural gasc. Middle distillates like diesel and naphthad. A range of petroleum products depending on FT plant optimization

Correct answer: c

Reading reference: Producing Liquid Fuels from Coal: Prospects and Policy Issues, Bartis; Chapter 3, p. 17.Explanation: The FT process converts coal into middle distillates like diesel, jet fuel and naphtha, making cthe correct answer. Since the FT process only creates middle distillates, d is incorrect, while synthetic crudeis created from upgraded tar sands crude and is not a product of the FT process.



34. Consider a trade in which a futures contract on natural gas was purchased and a futures contract on crude oil was simultaneously sold at a lower price. Assuming the price of the futures on natural gas remains above the price of the futures on crude oil, but the spread between the two prices narrows you would expect that the trade will ________.

a. Make moneyb. Lose moneyc. Make money only if both prices rised. Lose money only if both prices fall

Correct answer: b

Reading reference: Fundamentals of Trading Energy Futures & Options, 2nd Edition, Errera: Chapter 4, p. 60.Explanation: Answer b is correct. If the spread between two contracts narrows, a loss will occur if the lower-priced contract has been sold and the higher-priced contract purchased.

35. Ten days ago Rebecca, a gasoline option trader, sold 50 put contracts on gasoline futures with a strike price USD 0.012 cents/gallon and current delta of 0.7. Which of the following positions does Rebecca need to add to her portfolio to neutralize her position?

a. Long 35 Futures contractsb. Long 60 Futures contractsc. Short 35 Futures contractd. Short 60 Futures contracts

Correct answer: c

Reading reference: Managing Energy Risk: An Integrated View on Power and Other Energy Markets, Burger:Chapter 2, p. 57-8.Explanation: Rebecca is short put options. The quantity to sell is calculated by the delta, hence 0.7 Future forevery put, so 35 Future contracts in total. Answer c is the correct one.



36. Which of the following describes gas basis?

a. The underlying cost of the commodityb. The price difference between locationsc. The tax rate for gas inventoryd. The convenience yield for gas ownership

Correct answer: b

Reading reference: Energy Risk, Pilipovic: Chapter 2, p. 32.Explanation: Answer b is correct. Decentralization introduces geographic “basis risk,” which is unique toenergies. 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 holdstrue for natural gas. Location is a fundamental driver of price. Pilipovic defines “basis risk” as: The differencein prices between identical products but in two different markets.

37. Jean-Claude is the operator of a 100MW power plant. He has just performed a spark spread calculation and has gotten a negative result. What is the most practical economic course of action for Jean-Claude to take?

a. Perform the calculation again since spark spreads cannot yield negative values.b. Switch to a lower-cost fuel that will allow the plant to run profitably.c. Modernize the generation equipment at the plant to make it more efficient.d. Stop power production until electricity rates rise to a point where he can sell power profitably.

Correct answer: d

Reading reference: Energy Trading and Investing, Edwards; Chapter 4.3, p. 274.Explanation: Jean-Claude is most likely to simply shut the plant off until the electric rates rise to a pointwhere he can sell his power profitably, making answer d correct. Spark spread calculations can yield negativevalues; and while answers b and c would change the inputs for the spark spread calculation, which may thengive a positive value, neither may be a practical course of action nor can either action be done as quickly ascan the decision to shut the power plant down temporarily.



38. One common method of reducing credit risk between parties is the use of a countertrade. Which of the following statements about a countertrade is correct?

a. A countertrade increases settlement risk and reduces replacement risk.b. A countertrade reduces settlement risk and reduces replacement risk.c. A countertrade increases settlement risk and locks in replacement risk.d. A countertrade reduces settlement risk and locks in replacement risk.

Correct answer: d

Reading reference: Managing Energy Risk: An Integrated View on Power and Other Energy Markets, Burger:Chapter 6, p. 268.Explanation: Countertrade: If there is a netting agreement, the conclusion of a countertrade with the samecounterpartyreduces the settlement risk of sold forward contracts and locks the actual replacement risk.Since the countertrade isconcluded at the actual market price and the replacement risk cannot be reduced.

39. Which of the following alternative energy sources can be classified as either passive or active?

a. Biofuelsb. Hydroelectricc. Solard. Wind

Correct answer: c

Reading reference: Fisher Investments on Energy: Chapter 6, p. 152.Explanation: Solar energy systems come in two types: active, which uses mechanical systems to collect anddistribute solar energy; and passive which absorbs and distributes solar heat without the use of machinery (i.e.through heat-abosorbing materials or careful design of buildings to maximize the potential for solar heating).



40. To ensure that the quality of imported LNG supplied to end users falls within prescribed parameters, which of the following actions should be taken?

I. Dilute the vaporized LNG with air or nitrogen.II. Enrich the vaporized LNG with higher heating value components such as ethane, propane, and butane. III. Establish a Wobbe index range and a heating value range for the LNG.

a. Ib. IIc. I and IIId. All of the above.

Correct answer: d

Reading reference: LNG: A Nontechnical Guide, Tusiani and Shearer, Ch. 7, pp. 180-182.Explanation: Gas interchangeability may require dilution or enrichment to ensure calorific value requirements.The Wobbe index is a measure of gas quality and burner performance and may also be prescribed bypipeline tariffs. Therefore all three items are steps that may be necessary to ensure the quality of the LNGdelivered to end users, making d the correct choice.

41. To calculate the historical volatility for use in a Geometric Brownian Motion (GBM) process you need to do which of the following?

I. Determine the commodity’s long run mean priceII. Calculate the standard deviation of the prices about the long-term meanIII. Calculate the standard deviation of the logarithmic price returnsIV. Annualize the standard deviation by the appropriate factor

a. I and IIb. II, and IVc. III and IVd. III only

Correct answer: c

Reading reference: Energy Derivatives: Pricing and Risk Management, Clewlow and Strickland: Chapter 3.2.1, p. 40.Explanation: For historical volatility that will be used in a GBM process, you need to calculate the standard devi-ation of thelogarithmic price returns and then to scale it by the appropriate factor to annualize the volatility.



42. In the crude oil market, what are paper barrels?

a. Statistical projections of a refinery’s profit and lossb. Projections on how much oil an unproven reservoir may holdc. Future contracts bought without the expectation of actual delivery of the productd. A new, environmentally-friendly container for crude oil

Correct answer: C

Reading reference: The Role of WTI As A Crude Oil Benchmark, Purvin&Gertz, p. 24.Explanation: Answer c is correct. Paper barrels are crude oil futures contracts purchased for hedging or speculative purposes; the buyer does not have intention on taking delivery and will eventually cancel out the contract with an opposite transaction.

43. Rank the following countries in order of highest to lowest percentage of electricity produced from nuclear power (beginning with the highest percentage):

a. France, Japan, USA, Russiab. Japan, USA, France, Russiac. USA, Japan, Russia, Franced. USA, Russia, France, Japan

Correct answer: a

Reading reference: Energy for the 21st Century, Nersesian; Chapter 8, p. 284-285.Explanation: Answer a is correct. Europe has the highest percentage of electricity produced by nuclearpower, followed by North America, FSU (Russia and Ukraine), and Asia. Countries with the highest percent-age of electricity generated by nuclear power are France (78 percent), Japan (26 percent), and the UnitedStates (20 percent). Russia’s nuclear generation amounts to about 17% of its electricity needs.

44. Which of the following statements regarding Value-at-Risk (VaR) is false?

a. VaR models assume portfolios do not change over time.b. VaR models provide a single measure of risk.c. VaR models estimate the absolute worst-case scenario.d. VaR models should not be used to predict future market behavior.

Correct answer: c

Reading reference: Energy Risk Management: A Non-technical Introduction to Energy Derivatives, Leppard:Chapter 8, p. 195.Explanation: c is correct; as per definition.



45. Alessandro Montano, ERP, is analyzing the recent sale of a pipeline owned by his company. Which of the following valuation methods should Alessandro use to record a financial gain or loss for the sale?

a. Economic valueb. Comparable salesc. Replacement costd. Book value

Correct answer: d

Reading reference: Oil and Gas Pipelines: In Nontechnical Language, Miesner and Leffler: Chapter 10, p. 228.Explanation: Answer d is correct. Book value is used by sellers to allow them to understand if they need torecord a financial gain or loss for the sale. It is not particularly useful for purchasers, since book value has lit-tle relevance to what the asset is currently worth. Sometimes it is used to reallocate ownership between jointventure partners if the venture was set to provide for this approach.

46. Which of the following factors has the greatest influence on day-to-day variations in demand for electricity in a given location?

a. Economic factorsb. Fuel costsc. Generation constraintsd. Weather

Correct answer: d

Reading reference: Energy Trading and Investing, Edwards; Chapter 4.1, p. 250.Explanation: Weather is considered the single largest factor in affecting day-to-day variations in demand forelectricity — for example, people using more air conditioners on an unexpectedly hot day, making d the cor-rect answer. Note that answers b and c would be factors affecting supply, not demand.



47. We assume that the heat rate of a natural gas peaking unit is 10,000 Btu/kWh. The price of electricity is USD 25.00per MWh, and the price of natural gas is USD 2.00. What is the “spark spread” for this plant in USD per kWh?


Correct answer: a

Reading reference: Managing Energy Price Risk, Kaminski (Kaminski, et al): Chapter 3, p. 120.Explanation: Answer a is correct: Output price — USD 25/MWh = USD 25/1,000 kWh = USD 0.025/kWh. Inputprice — 10,000 Btu/kWh x USD 2.00/MMBtu= 10,000 Btu/kWh X USD 2.00/1,000,000 Btu= USD 2.00/100kWh=USD 0.02/kWh.The spark spread istherefore USD 0.005/kWh.

48. The principle of parallelism implies what type of relationship between spot and future prices?

a. A low level of correlation between spot and futures pricesb. A high level of correlation between spot and futures pricesc. A volatile correlation between spot and futures pricesd. No correlation between spot and futures prices

Correct answer: b

Reading reference: Fundamentals of Trading Energy Futures & Options, Errera: Chapter 3 p. 32.Explanation: Answer b is correct. Parallelism occurs because the same factors that impact cash prices tendalso to impact the price ofthe commodity for future delivery.



49. The cost of crude oil typically accounts for 70-80% of the total operating expenses associated with refined products. As a result procurement managers seek to purchase types or blends of crude oil that will offer the highest profit margin when used to create refined petroleum products. Which of the following is a method commonly used by refineries to evaluate crude oil?

a. Break-even analysisb. Proximate analysisc. Ultimate analysisd. Fischer-Tropsch analysis

Correct answer: a

Reading reference: Petroleum Refining: Technology and Economics, Gary, et al: Chapter 14, p. 302-03.Explanation: Answer a is correct. Break-even analysis involves determining the difference in value of incre-ments of crude oils when compared to a reference crude oil — a type or blend previously processed by therefinery whose characteristics and costs are known.

50. Given a flat volatility term structure for the entire WTI forward price curve at 35%, the Black-equivalent volatility of a look-back cash-settled average price option with a 3-month averaging period would 1 over the last three months ofthe option’s life because 2 .

1 2a. Increase Volatility of the underlying forward price tends to grow as option expiration time decreases.

b. Decrease Volatility of the underlying forward price tends to drop as option expiration time decreases.

c. Increase As we begin collecting the daily forward price settlements to ultimately determine the average price at option settlement, the uncertainty around the value of the average price settlement value drops.

d. Decrease As we begin collecting the daily forward price settlements to ultimately determine the average price atoption settlement, the uncertainty around the value of the average price settlement value drops.

Correct answer: d

Reading reference: Energy Risk, Pilipovic: Chapter 11, p. 314-317, 321-322.Explanation: d is correct. In case of an Asian option, once we begin taking in the forward price settles thatultimately willdefine the final average price for option settle, the volatility of that average price starts drop-ping significantly. Hence, thecorrect answer is answer d.



51. Your company is calculating Value-at-Risk (VaR) using an historical simulation method, with a 97.5% confidence level and two day holding period. In order to assess the validity of the method used to measure price risk, back-testing is also put in place. Assuming there are 260 business days in a year, which of the following loss scenarios (e.g. number of times portfolio losses exceed VaR) would you consider an acceptable threshold?

a. Once every two monthsb. 2.5 times each monthc. 2 times each monthd. 130 times in six months

Correct answer: a

Reading reference: Managing Energy Risk: An Integrated View on Power and Other Energy Markets, Burger:Chapter 6.2, p. 253, 264.Explanation: a is the correct answer. In 2.5 % of the cases the real losses have to exceed the VaR, as it is cal-culated with 97.5% confidence level. This corresponds to 6.5 days in a year, hence about once every twomonths. Answer 1 is correct and all the others are wrong.



52. Blockhead Cement Company has historically consumed an average of 30MWh of electric power per day and typically purchases power at prevailing spot market prices. In an effort to hedge price exposure the company’srisk management team has decided to use electricity swaps. They are planning to test the strategy in the month of August by engaging in a fixed-for-floating electricity swap with a local power provider for 30MWh of power at USD 120/MWh. What will Blockhead’s net cash flow be if the cost of power for August is USD 105,681 and the floating leg of the swap is set at USD 108,240?

a. Pay USD 102,321b. Receive USD 102,321c. Pay USD 109,041d. Receive USD 109,041

Correct answer: c

Reading reference: Steve Leppard. Energy Risk Management: A Non-technical Introduction to EnergyDerivatives (London: Risk Books, 2005). Chapter 4, p. 50.Explanation: Answer c is correct. An electricity swap is an example of a commodity swap where thehedger/buyer makes fixed payments in exchange for floating income based on the spot prices. To computethe cash flow of the cement factory, we name the following variables:Actual Cost of Power = USD 105,681Floating leg payment = USD 108,240Fixed payment = 31 days x 30MWh/day x USD 120/MWh = USD 111,600Being an electricity consumer, the factory pays the spot market the actual cost of power and the swapprovider separately. It also earns the floating leg payment of the swap. The formula therefore is:Cash Flow = Floating leg payment — Fixed Payment — Actual Cost of power= USD 108,240 - USD 111,600 - USD 105,681= - USD 109,041

53. A generating plant has a nameplate rating of 650 megawatts and is expected to be offline for 720 hours for a scheduled outage during the year. A typical year is comprised of 8,760 hours. Actual generation during the year was 4,270,500 megawatt hours. What is the plant’s load factor?

a. 81.7%b. 75.0%c. 72.76%d. 76.0%

Correct answer: b

Reading reference: Electricity Markets: Pricing, Structures and Economics, Harris: Chapter 2, p. 28.Explanation: Answer b is correct per the formula below.4,270,500𝑀𝑊ℎ650𝑀𝑊ℎ × 8,760ℎ𝑟 − 720ℎ𝑟 = 81.7%



54. The Risk Manager of a power generation company is reviewing the parameters under which analytical VaR is calculated and the nature of the company’s price exposures. She believes that the hypothesis of a one-day holding period is not realistic, and requires a 5-day holding period instead. Traders complain that in this case the calculated VaR will be much higher and they will not be able to respect the company VaR limit of ten million. She proposes to review the VaR limit in a manner consistent with the new holding period; consequently, the new VaR limit will be approximately:

a. 50 Millionb. 22 Million c. 2 Milliond. 10 Million

Correct answer: b

Reading reference: Managing Energy Risk: An Integrated View on Power and Other Energy Markets, Burger:Chapter 6.2, p. 252, 257.Explanation: b is the correct answer. a Value-at-Risk calculated with the analytical model can be easily recal-culated under any holding period by using the square root rule, i.e. by multiplying the one day VaR by thesquare root of the new holding period. As in the question it is assumed that the new holding period is 5 days,the new VaR will be approximately 2.2 times the one day VaR, i.e. about 22 Million. Consequently answer 2 isthe correct one.

55. Prior to drilling a well, an assessment is made as to the reserves a reservoir may contain based on data derived from a current or prior well production or geophysical data. Which of the following makes the technicalprocess for estimating reserves complex?

a. The subjective nature of the process.b. The quantitative methodologies used.c. The publication of reserve estimates is often biased.d. The reserves are not considered assets

Correct answer: a

Reading reference: Oil, Gas Exploration, and Production, Institut Francais: Chapter 3, p. 100.Explanation: a is correct. Many uncertainties occur in the various stages of exploring and appraising an oil orgas field. The approaches produce a probability that a particular prospect does indeed contain hydrocarbons.This is a probability because the estimates of the uncertainties involved are themselves formulated byexperts in the light of their own experience, based on their own hypotheses. The probability estimates aretherefore described as subjective, or as a priori probabilities.



56. Consider the statements below regarding delivery costs as a percentage of the cost of electricity charged to the end-use customer. Which of the following statements is false?

a. Distribution accounts for about 30 to 50 percent of the total delivery cost.b. Generation accounts for about 35 to 50 percent of the total delivery cost.c. Transmission accounts for about 5 to 15 percent of the total delivery cost.d. Delivery operations vary wildly from plant-to-plant, thus no generalizations about the percentage of

costs can be made.

Correct answer: d

Reading reference: Making Competition Work in Electricity, Hunt: Chapter 2, p. 17, 20-1.Explanation: d is false, thus correct. Generally speaking, since electricity (the end product) is standardized,generalizations of cost breakdowns, like the ones listed above, can be made.

57. A landman is used to determine the legal rights of a company to drill for petroleum and natural gas, and to facilitate mandatory legal requirements. Of the landman's responsibilities, which of the following is NOT one of his/her roles?

a. Conduct seismological tests to locate minerals.b. Locate mineral owners.c. Verify mineral ownership via title searches.d. Negotiate leasing terms necessary for drilling.

Correct answer: a

Reading reference: Fundamentals of Oil & Gas Accounting, Wright & Gallun; Chapter 1.Explanation: It is the job of a landman to identify and locate mineral rights owner of fee land. This is done bysearching through the county or parish courthouse records. Commercial land ownership maps that are fre-quently updated are used to determine the status of a leases, the names of lessees and the identity of sur-face right and mineral rights owners. A title opinion can be obtained from an attorney who determines themineral rights owner and attempts to persuade the owner to sign a lease. It is the company's responsibility topartake in exploration geophysics. The landman's responsibilities are strictly legal.



58. A refiner is negotiating the sale of 10,000 tons of jet fuel to an airline. By giving a discount on the current market price, the refiner has secured the possibility to sell and deliver, at their discretion, an additional volume of 10% at the previously agreed upon price. This price is finally set at USD 450/ton. At the time of delivery, the prevailing market price is USD 400/ton, and the refiner decides to deliver also the additional 10% volume. The refiner’s position can be described as:

a. Purchase of a call option for free, and exercise (strike) price at USD 400/ton.b. Purchase of a put option for free, and exercise (strike) price at USD 450/ton.c. Purchase of a put option with premium equal to the discount, and exercise (strike) price at USD 450/ton.d. Purchase of a call option with premium equal to the discount, and exercise (strike) price at USD 450/ton.

Correct answer: c

Reading reference: Managing Energy Price Risk, Kaminski, Chapter 2.Explanation: Answer c is correct. The refiner will exercise this option when market prices are lower than USD 450/ton, because it will sell to the airline at USD 450/ton a good which has lower value in the market,consequently its position similar to the purchase of a put.

59. The round-the-clock forward contract for single day delivery on February 10 and February 11 currently trades at USD 60 and USD 50 respectively. The three-day forward contract for round-the-clock delivery for the period starting February 10 and ending February 12 also trades at USD 50. Assuming a zero-percent discount rate, what is the round-the-clock forward price for a single day of delivery occurring on February 12?

a. USD 40b. USD 45c. USD 50d. USD 55

Correct answer: a

Reading reference: Energy Risk, Pilipovic: Chapter 7, p. 179-182.Explanation: The relationship between the three-day forward price contract for 7x24 delivery and the dailyforward price contracts, assuming a zero-percent discount curve is given by:

Plugging in the values provided by the problem statement and simplifying the above equation, we have:

The price for the third day of the delivery then must be USD 40.00, answer a.


60. You run a lucrative kerosene business and wish to hedge your exposure to kerosene price changes on a contract that is close to delivery. By implementing this hedge using heating oil derivatives you are exposed to changes in _______ basis.

a. Locationb. Storagec. Productd. Intermarket

Correct answer: c

Reading reference: Fundamentals of Trading Energy Futures & Options, 2nd Edition, Errera: Chapter 3 p. 49.Explanation: Answer c is correct. The difference between the futures price and the price of a similar cashcommodity is called product basis.


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