CEP Risk Analysis & Regulatory Compliance 5 — Questions and Answers
Question 1: What is 'weather normalization' used for in energy procurement risk analysis?
- Adjusting historical energy consumption data to remove the effects of abnormal weather for more accurate load forecasting (Correct answer)
- Hedging against extreme weather events through derivatives
- Complying with EPA climate disclosure rules
- Calculating the thermal efficiency of gas-fired generation
Correct answer: Adjusting historical energy consumption data to remove the effects of abnormal weather for more accurate load forecasting
Weather normalization adjusts historical consumption data to what it would have been under average weather conditions, improving the accuracy of future load forecasts.
Question 2: Which type of risk arises when a retail electricity supplier cannot pass through all costs to customers due to a fixed-price retail contract?
- Credit risk
- Margin compression risk (Correct answer)
- Regulatory risk
- Counterparty default risk
Correct answer: Margin compression risk
Margin compression risk occurs when wholesale procurement costs rise above the fixed retail price, squeezing or eliminating the supplier's profit margin.
Question 3: Under CFTC rules implementing Dodd-Frank, which category of market participant is generally exempt from mandatory swap clearing requirements?
- Financial institutions with large swap portfolios
- Commercial end-users hedging bona fide business risk (Correct answer)
- Energy hedge funds
- Commodity pool operators
Correct answer: Commercial end-users hedging bona fide business risk
Commercial end-users that use swaps to hedge commercial risk (not for speculation) qualify for an exemption from mandatory clearing under Dodd-Frank.
Question 4: A natural gas buyer has contracted supply at a Henry Hub-indexed price but takes delivery at a different location. Basis has historically been -$0.20/MMBtu but suddenly widens to -$0.80/MMBtu. What should the buyer do next time?
- Switch to a fixed-price contract to eliminate all basis exposure
- Add a basis swap to lock in the spread between the delivery point and Henry Hub (Correct answer)
- Increase contract volumes to average down the basis cost
- File a FERC complaint about basis manipulation
Correct answer: Add a basis swap to lock in the spread between the delivery point and Henry Hub
A basis swap locks in the differential between the delivery location and the reference hub price, directly hedging basis risk.
Question 5: What is the significance of a 'net short' or 'net long' position in an energy procurement portfolio?
- It indicates the credit quality of the procurement team's counterparties
- It describes whether the portfolio has more supply contracted than load (net long) or more load than supply (net short) (Correct answer)
- It reflects the regulatory filing status of open contracts
- It measures the duration of fixed-price contracts versus floating contracts
Correct answer: It describes whether the portfolio has more supply contracted than load (net long) or more load than supply (net short)
A net long position means contracted supply exceeds expected load (creating surplus risk), while net short means load exceeds supply (creating price spike exposure).
Question 6: Which document is typically used as the industry standard master agreement for bilateral OTC energy derivative transactions in North America?
- EEI Master Power Purchase & Sale Agreement
- NAESB Base Contract for Sale and Purchase of Natural Gas
- ISDA Master Agreement with commodity schedules (Correct answer)
- FERC Standard Large Generator Interconnection Agreement
Correct answer: ISDA Master Agreement with commodity schedules
The ISDA Master Agreement with commodity annexes and schedules is the standard framework for OTC energy derivative (swap) transactions globally, including in North America.
Question 7: A state renewable portfolio standard (RPS) requires a utility to procure 30% of its supply from renewables by 2030. What compliance instrument is commonly used to demonstrate fulfillment of this requirement?
- Carbon offsets
- Renewable Energy Certificates (RECs) (Correct answer)
- Forward capacity contracts
- Congestion revenue rights
Correct answer: Renewable Energy Certificates (RECs)
Renewable Energy Certificates (RECs) represent the environmental attributes of one MWh of renewable generation and are the standard compliance instrument for RPS requirements.
CEP Risk Analysis & Regulatory Compliance 5
What is 'weather normalization' used for in energy procurement risk analysis?