ERAC Audit Procedures & Risk Mitigation 3 — Questions and Answers
Question 1: Which regulatory body primarily oversees energy derivatives trading conducted by U.S. financial market participants?
- FERC
- CFTC (Correct answer)
- SEC
- NERC
Correct answer: CFTC
The Commodity Futures Trading Commission (CFTC) has primary jurisdiction over energy commodity derivatives and futures markets in the United States.
Question 2: An auditor reviewing a pipeline company's credit risk finds no netting agreements with counterparties. What risk does this create?
- Increased market risk exposure
- Gross rather than net credit exposure, inflating potential losses (Correct answer)
- Higher liquidity requirements only
- Regulatory non-compliance with FERC rules
Correct answer: Gross rather than net credit exposure, inflating potential losses
Without netting agreements, credit exposure is calculated on a gross basis, meaning gains and losses cannot offset each other, significantly overstating the true credit risk.
Question 3: When auditing an oil refinery's operational risk controls, which document best evidences that emergency shutdown procedures have been tested?
- The risk register
- Drill logs and post-exercise after-action reports (Correct answer)
- Insurance policy documents
- Board meeting minutes
Correct answer: Drill logs and post-exercise after-action reports
Drill logs and after-action reports provide direct evidence that emergency shutdown procedures have been executed and reviewed, confirming control effectiveness.
Question 4: A risk auditor is assessing basis risk in a natural gas hedge. Basis risk arises when:
- The hedging instrument perfectly offsets physical price movements
- The price of the hedged commodity and the hedging instrument do not move in lockstep (Correct answer)
- Interest rate changes affect the cost of the hedge
- Credit ratings of counterparties decline
Correct answer: The price of the hedged commodity and the hedging instrument do not move in lockstep
Basis risk occurs when the hedging instrument (e.g., Henry Hub futures) and the physical commodity price at the delivery location do not move in perfect correlation.
Question 5: Under CFTC rules, what is the primary obligation of a registered swap dealer when managing counterparty credit risk?
- To post unlimited collateral on demand
- To establish and maintain credit support annexes and initial margin requirements (Correct answer)
- To exclude all unrated entities from trading
- To obtain SEC approval for each swap transaction
Correct answer: To establish and maintain credit support annexes and initial margin requirements
Registered swap dealers must establish Credit Support Annexes (CSAs) and comply with initial and variation margin requirements to manage counterparty credit risk under CFTC regulations.
Question 6: An energy audit reveals that a wind farm operator relies on a single weather forecast provider for generation planning. This represents which type of operational risk?
- Market concentration risk
- Single-point-of-failure or vendor concentration risk (Correct answer)
- Regulatory compliance risk
- Credit counterparty risk
Correct answer: Single-point-of-failure or vendor concentration risk
Dependence on a single forecast provider creates a vendor concentration or single-point-of-failure risk, where disruption to that provider impacts the operator's ability to plan generation.
Question 7: What is the key difference between a risk audit and a financial audit in the energy sector?
- Risk audits only examine past financial performance
- Risk audits assess the effectiveness of risk management frameworks and controls, not just financial statements (Correct answer)
- Financial audits include assessment of trading strategies
- Risk audits are only required by commodity exchanges
Correct answer: Risk audits assess the effectiveness of risk management frameworks and controls, not just financial statements
A risk audit evaluates whether risk management policies, procedures, limits, and controls are effective, whereas a financial audit focuses on the accuracy of financial statements.
ERAC Audit Procedures & Risk Mitigation 3
Which regulatory body primarily oversees energy derivatives trading conducted by U.S. financial market participants?