CEP Risk Analysis & Regulatory Compliance 3 — Questions and Answers
Question 1: An energy buyer wants to limit downside price exposure while retaining upside benefit if prices fall. Which derivative instrument best achieves this?
- Fixed-for-floating swap
- Energy call option (bought)
- Energy put option (bought)
- Energy cap (Correct answer)
Correct answer: Energy cap
An energy price cap sets a maximum price the buyer will pay, protecting against price spikes while allowing the buyer to benefit if prices fall below the cap.
Question 2: Under the Dodd-Frank Act, which type of energy derivative transactions became subject to mandatory clearing?
- Exchange-traded futures only
- Standardized OTC swaps designated by the CFTC (Correct answer)
- All bilateral energy contracts
- Spot market purchases only
Correct answer: Standardized OTC swaps designated by the CFTC
Dodd-Frank required standardized OTC swaps designated by the CFTC to be cleared through central counterparties to reduce systemic risk.
Question 3: A procurement team uses Monte Carlo simulation for energy price forecasting. What is the primary advantage of this method?
- It produces a single definitive price forecast
- It models a range of possible outcomes by running thousands of scenarios (Correct answer)
- It eliminates the need for historical data
- It guarantees regulatory compliance
Correct answer: It models a range of possible outcomes by running thousands of scenarios
Monte Carlo simulation generates probability distributions of outcomes by running many randomized scenarios, giving a fuller picture of price risk.
Question 4: What is the primary purpose of NERC (North American Electric Reliability Corporation) standards in energy procurement?
- Setting retail electricity prices for consumers
- Ensuring the reliability and security of the bulk power system (Correct answer)
- Regulating natural gas pipeline tariffs
- Overseeing commodity futures markets
Correct answer: Ensuring the reliability and security of the bulk power system
NERC develops and enforces mandatory reliability standards to ensure the safe and reliable operation of the bulk North American power system.
Question 5: A municipal utility is evaluating counterparty credit risk for a long-term energy supply contract. Which metric is most directly relevant?
- The supplier's market share in renewable generation
- The supplier's credit rating and financial statements (Correct answer)
- The supplier's geographic footprint
- Historical spot price volatility
Correct answer: The supplier's credit rating and financial statements
Credit ratings and financial statements directly assess a counterparty's ability to fulfill its financial obligations under the contract.
Question 6: Which of the following is an example of regulatory risk in energy procurement?
- An unexpected spike in natural gas spot prices
- A state commission disallowing recovery of above-market contract costs (Correct answer)
- A supplier failing to deliver contracted volumes
- Weather-driven demand exceeding forecast
Correct answer: A state commission disallowing recovery of above-market contract costs
Regulatory risk includes the possibility that a regulatory body may disallow cost recovery, leaving a utility unable to pass contract costs to ratepayers.
Question 7: What does a 'heat rate contract' allow an energy buyer to hedge?
- The spread between electricity prices and the fuel cost required to generate that electricity (Correct answer)
- Only natural gas price volatility
- Only power price volatility
- Weather-related demand fluctuations
Correct answer: The spread between electricity prices and the fuel cost required to generate that electricity
A heat rate contract locks in the spark spread — the relationship between power prices and the fuel input cost — effectively hedging the economics of power generation.
CEP Risk Analysis & Regulatory Compliance 3
An energy buyer wants to limit downside price exposure while retaining upside benefit if prices fall.
Which derivative instrument best achieves this?