ERAC Market Analysis & Financial Reporting 3 — Questions and Answers
Question 1: Which regulatory framework primarily governs financial reporting disclosures for publicly traded US energy companies regarding commodity price risk?
- FERC Order 2000
- SEC Regulation S-K Item 305 (Correct answer)
- NERC CIP Standards
- FASB ASC 932
Correct answer: SEC Regulation S-K Item 305
SEC Regulation S-K Item 305 requires quantitative and qualitative disclosures about market risk, including commodity price risk, for public companies.
Question 2: A 'contango' market structure in crude oil futures implies which of the following for a storage operator?
- Negative carry for holding inventory
- Profitable cash-and-carry arbitrage opportunity (Correct answer)
- Backwardation in the forward curve
- Declining demand expectations
Correct answer: Profitable cash-and-carry arbitrage opportunity
In contango, future prices exceed spot prices, so a storage operator can buy spot, store the commodity, and sell forward at a higher price, creating a cash-and-carry profit if storage costs are covered.
Question 3: When auditing an energy trading desk, which of the following would be MOST concerning regarding value-at-risk (VaR) model reliability?
- VaR is calculated daily
- The model uses a 95% confidence interval
- Back-testing shows exceptions far exceed the expected frequency (Correct answer)
- The holding period is set to one day
Correct answer: Back-testing shows exceptions far exceed the expected frequency
Excessive back-testing exceptions indicate the VaR model underestimates actual risk, meaning the model's confidence intervals are not reliable.
Question 4: The 'dark spread' in electricity market analysis measures the profit margin for which type of generating unit?
- Nuclear power plant
- Coal-fired power plant (Correct answer)
- Natural gas peaker plant
- Wind farm
Correct answer: Coal-fired power plant
The dark spread is the power price minus the cost of coal needed to produce that electricity, representing the gross margin for coal-fired generation.
Question 5: Which accounting method allows energy companies to defer recognition of unrealized gains and losses on qualifying cash flow hedges?
- Fair value hedge accounting
- Cash flow hedge accounting under ASC 815 (Correct answer)
- Mark-to-market accounting
- Accrual basis accounting
Correct answer: Cash flow hedge accounting under ASC 815
Under cash flow hedge accounting (ASC 815), the effective portion of changes in fair value is recorded in other comprehensive income (OCI) and reclassified to earnings when the hedged transaction affects income.
Question 6: An energy risk auditor reviews a pipeline company's revenue reports and finds significant 'imbalance' charges. These charges most directly relate to:
- Differences between scheduled and actual gas volumes delivered (Correct answer)
- Penalties for late financial reporting
- Fuel surcharge miscalculations
- Congestion fees on electricity transmission lines
Correct answer: Differences between scheduled and actual gas volumes delivered
Gas pipeline imbalances occur when actual deliveries differ from scheduled nominations, resulting in imbalance charges or penalties per tariff agreements.
Question 7: In analyzing an energy firm's financial statements, 'net open position' most directly represents:
- Total assets minus total liabilities
- Unhedged commodity price exposure remaining after hedging activity (Correct answer)
- Net income after tax adjustments
- Difference between physical and financial trading revenues
Correct answer: Unhedged commodity price exposure remaining after hedging activity
Net open position is the residual commodity exposure not covered by hedges, representing the firm's unprotected price risk.
ERAC Market Analysis & Financial Reporting 3
Which regulatory framework primarily governs financial reporting disclosures for publicly traded US energy companies regarding commodity price risk?