ERP Practice Questions Summary: Determinants of Offshore Drilling Costs

Practice questions summary
This is a short summary of existing ERP practice questions (from the GARP ERP practice exam)
that I found the most difficult and some of my own notes that I used to study for the ERP exam
in 2010. In total, they are 78 questions. As in the Concept Checkers for the ERP exam, the
format is question-answer to help you find the answer faster if you are pressed for time.
I may offer a realistic practice exam and/or a practice webinar sometime soon in the future
before the next ERP exam. If you are interested, please let me know via email.
All the best for your ERP exam preparation!
Alex Janis
www.energyriskprofessional.com
alex.janis@energyriskprofessional.com
For more practice questions and information for the ERP exam, please go to www.energyriskprofessional.com
Determinant of cost in off-shore drilling.

______
For the development of an off-shore drilling project, the (blank) is the main determinant of
cost.
a.
b.
c.
d.
basic engineering survey

reservoir type
cost associated with transporting equipment and bulk material
water depth
Correct answer:
d.
Reason: The capital cost of developing an oil or gasfield may amount to several billion dollars. It
is crucial that the key parameters are identified and evaluated so that the project can be
properly defined and its viability assessed, because some of these parameters strongly
influence the costs. Onshore, the nature of the terrain is the main determinant of costs.
Offshore it is the water depth, which may be conventional (to 300 m), deep (to 1500 m) or
ultra-deep (over 1500 m). A basic engineering survey represents about 2% of the technical
costs of an off-shore drilling project, while transporting equipment and bulk material
represents about 7.5% of the total cost. Reservoir parameters determine the number of wells
required, and whether water or gas injection will be needed during the lifetime of the field.
Distinguish between the three types of water depth.

______
1. Conventional (0 to 300 m)
2. Deep (300 to 1500 m)
3. Ultra-deep (over 1500 m)
Effective price paid per barrel.

______
On July 20, Merg Refining knows it will need to purchase 20,000 barrels of crude in November.
On NYMEX, oil futures contracts are traded for delivery every month. Thus, Merg decides to
hedge using a mid-December contract. The futures price on July 20 is $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 $62.00/bbl and the futures price is $61.10/bbl.
In this scenario, the effective price paid per barrel is
a.
b.
c.
d.
$60.00
$60.90
$62.10
$62.90
Correct answer:
b.
Reason: The effective price paid (in dollars per barrel) is the final spot price less the gain on the
futures, or 62.00 1.10 = 60.90.
This can also be calculated as the initial futures price plus the final basis, 60.00 + 0.90 = 60.90.
If Merg waited until expiration of the futures contract and took delivery, then the price paid
would be $60.00, as gains on the futures perfectly offset the change in the spot.
Price hedging.
______
[] risk in the natural gas market can be hedged with a [].
a.
b.
c.
d.
Operational / futures contract

Counter-party / plain vanilla swap
Regulatory / letter of credit
Market price / forward contract
Correct answer:
d.
Reason: If a forward contract is used to make or take delivery of the underlying commodity,
then it has eliminated market risk by locking in the price of the physical commodity. A long
forward contract can effectively be closed out by selling a contract for the same physical
specification, location, volume and month before physical delivery commences; the mark-tomarket value of a forward contract tells us the value of doing so at the current market level.
Crude prices.
______
Given the following, simplified table of U.S. Gulf Coast refining margins at a given time, which is
NOT true:
Light Crude
Medium Crude
Heavy Crude
Crude Price $/bbl

21.00
20.00
15.00
Simple
0.10
(0.35)
(3.16)
Refining Margins$/bbl
Complex
Very Complex
0.30
0.35
0.65
1.52
3.60
4.60
a. Simple refineries break even more or less on light crude, but lose money handling heavier
crudes.
b. Medium crudes are profitable in complex refineries but not in simple ones.
c. Complex refineries are highly profitable running heavy crude, but they may have difficulty
competing for space against very complex refineries running the same crude.
d. Heavy crude is too expensive and may have to come down in price to compete with medium
and light crudes.
Correct answer:
d.
Reason: All of the above are true except for number four. In fact, the light crude may be too
expensive and may have to come down in price in order to compete with heavy crude.
Hedge effectiveness.
______
What measure of hedge effectiveness did FASB 133 recommend?
a.
b.
c.
d.
60/40 offset ratio

90/10 offset ratio
highly effective offset ratio
None of these
Correct answer:
c.
Reason: FASB has chosen to use a highly effective offset ratio as a measure of hedge
effectiveness, rather than specifying a numeric ratio.
If the fair value hedge is fully effective, the gain or loss on the hedging instrument, adjusted for
the component, if any, of that gain or loss that is excluded from the assessment of effectiveness
under the entitys defined risk management strategy for that particular hedging relationship (as
discussed in paragraph 63 in Section 2 of Appendix A), would exactly offset the loss or gain on
the hedged item attributable to the hedged risk. Any difference that does arise would be the
effect of hedge ineffectiveness, which consequently is recognized currently in earnings. The
measurement of hedge ineffectiveness for a particular hedging relationship shall be consistent
with the entitys risk management strategy and the method of assessing hedge effectiveness
that was documented at the inception of the hedging relationship, as discussed in paragraph
20(a).
Nevertheless, the amount of hedge ineffectiveness recognized in earnings is based on the
extent to which exact offset is not achieved. Although a hedging relationship must comply with
an entitys established policy range of what is considered highly effective pursuant to
paragraph 20(b) in order for that relationship to qualify for hedge accounting, that compliance
does not assure zero ineffectiveness. Section 2 of Appendix A illustrates assessing hedge
effectiveness and measuring hedge ineffectiveness. Any hedge ineffectiveness directly affects
earnings because there will be no offsetting adjustment of a hedged items carrying amount for
the ineffective aspect of the gain or loss on the related hedging instrument.
Default probability of bonds.

______
Taking into account a snapshot from the table below, one can calculate that the probability of a
B2 rated bond defaulting in the fourth year is (blank), and survive until the end of year three is
(blank).
Default probability in %
Moodys Rating Year
1
2
3
4
5
B1
4.680
8.3800 11.5800
13.8500 16.1200
B2
7.1600 11.6700 15.5500
18.1300 20.7100
B3
11.6200 16.6100 21.0300
24.0400 27.0500
Caa1
17.3816 23.2341 28.6386
32.4788 36.3137
a.
b.
c.
d.
2.58%; 84.45%
4.28%; 78.97%
5.91%; 71.36%
7.54%; 65.30%
Correct answer:
a.
Reason: The unconditional default probability of a B2 rated bond in year four is calculated as
18.13 15.55 = 2.58%. The probability the bond will survive to end of year three is calculated as
100 15.55 = 84.45%. Each probability represents a cumulative default probability or the
probability of default by that year.
Pipeline rates.
______
If the cost of shipping 1,000 bbl of crude from Tuscon, AZ to St. Louis, MO via truck is $25/bbl,
and by rail is $21/bbl, all things being equal, an ideal charge on a pipeline with existing capacity
to transport 1,000 bbl should be:
a.
b.
c.
d.
$21.00 - $25.00/bbl
$19.50 - $21.00/bbl
$24.50 - $25.00/bbl
$20.00 - $21.50/bbl
Correct answer:
b.
Reason: The cost of alternative transportation method involves understanding the rates
charged by the competing forms of transportationship, barge, rail, truck. The pipeline charge
will be set equal to or slightly below those rates. Calculating rates using this method can be
very favorable for the pipeline owner, especially for long-distance transportation.
EOG Resources has paid as much as $25/bbl to ship crude by truck, but have switched to rail
because this cost is just uneconomical (Reuters: March 12, 2009).
Single investments in the LNG chain.

______
Rank, in order of increasing costs, single investments of the liquefied natural gas chain.
a.
b.
c.
d.
Natural gas exploration; Receiving terminal; LNG ship; Liquefaction plant

LNG ship; Natural gas exploration; Liquefaction plant; Receiving terminal
Natural gas exploration; Liquefaction plant; LNG ship; Receiving terminal
Receiving terminal; LNG ship; Natural gas exploration; Liquefaction plant
Correct answer:
a.
Reason: The heart of an LNG project and the largest single investment in the chain is the
liquefaction plant.
Coal-to-liquid production plants.

______
Development of coal-to-liquid production plants in the United States is risky because
a. Technology to deal with concomitant carbon dioxide emissions have yet to be developed.
b. Coal is a relatively scarce resource in the U.S. and would require major transportation
infrastructure investments.
c. U.S. operators have limited experience with gasifying American coal.
d. Coal-to-liquid technology is virtually non-existent in the U.S. and worldwide.
Correct answer:
c.
Reason: CTL production based on FT or MTG synthesis is ready for commercial development in
the United States. There is, however, some risk that first-of-a-kind FT or MTG CTL plants could
experience severe performance shortfalls or other operational problems, especially during their
initial operating years. This risk stems from the limited commercial experience in gasifying U.S.
coals and the challenges associated with building a plant that is very large, highly integrated,
and technically complex.
Price of European put option.

______
On January 1, a European-type call option for WTI crude with a strike price of $60/bbl and an
expiration date of July 1 is priced at $3.90 per barrel. At the same time, July WTI futures are
priced $55/bbl. The risk free interest is 8% per annum. The price of a WTI European Put option
with a strike of $60/bbl and matures in 6 months is closest to:
a.
b.
c.
d.
$5.50
$6.50
$7.50
$8.50
Correct answer:
d.
Reason: This question relates two conceptsthe put call parity and the relationship between
the price of the physical commodity and its representation as a commodity futures contract.
The spot price of a commodity, S(t), is widely considered as the most important indicator of
future spot prices and such acts as the chief factor determining the shape of the futures price
curve. At maturity, the price of the physical, underlying, commodity and the financial
commodity future, F(t,T) should be equal to preclude arbitrage. Because of the equilibrium
assumption, the convergence of physical and financial prices holds true, which at expiration at
time (T) can be expressed as
F(T, T) = S(T).
Up to expiration, i.e., where t<T, the equilibrium relationship between the spot price and the
price of the futures contract can be expressed by the well-known cost-of-carry relationship: F(t,
T) = S(t)e[ r ( t ) + c ( t ) - y ( t ) ] ( T- t ) , where, r(t) is the risk-free rate at t, c(t) are the general storage,
warehousing and other, similar, costs associated with holding the physical commodity in
storage, and y(t) is the convenience yield earned from having the physical commodity in
possession. The above relationship implies that the current price of the commodity is $52.84,
55 * exp(-0.04) = $52.84, assuming that storage costs are zero and there is no convenience
yield.
The traditional put-call parity can be expanded to include the futures contract as the
underlying, and reads: C(t,T) P(t,T) = [S(t) K(T)] e-r (t)(T- t)
K(T) the strike price, S(t) the current price of the underlying, and C(t,T) and P(t,T) the prices of
call and put option respectively, at t with a strike price of K(T). The current price of the
underlying, S(t), WTI, is not given. Substituting in the put-call parity relation yields: 3.90 P(t,T)
= 55 e(-0.08 x 0.5) 60 e(-0.08 x 0.5) = (55 - 60) e(-0.08 x 0.5)
Which when solved for P gives $8.71125.
Volatility.
______
You are trading in an electricity market, where the volatility of electricity generated by peakperiod, gas fired plants is 28% and increasing. What volatility would you then expect from
electricity generated from baseload coal?
a.
b.
c.
d.
Greater than 28%

Less than 28%
Unknowable
Equal to 28%
Correct answer:
b.
In all likelihood the baseload material used for electricity generation is coal (see below), and
natural gas trades higher than coal. In this case, baseload coal is being used to provide a
constant energy and natural gas is being used to supplement peak load energy demands.
Of all the fossil fuels, coal is the most widely used. According to the EIA, during 2004, 50% of
the nations electric power was generated at coal-fired plants. Based upon 2004 net generation
shares by energy source, nuclear and natural gas are next in popularity after coal.
While base load is constant and fairly predictable, electric utilities must be prepared at all times
for the sometimes unpredictable demand seasonal weather changes cause. An increase in
demand is referred to as peak load and intermediate load.
Managing credit-risk exposure.

______
Which of the following is NOT a method for managing credit-risk exposure within energy
markets?
a.
b.
c.
d.
Clearing OTC energy derivatives

Obtaining credit risk insurance
Purchasing commodity futures
Securing a financial guarantee via an Irrevocable Standby Letter of Credit
Correct answer:
c.
Reason: Methods for managing credit-risk exposure include:
1. master netting
2. collateralization
3. financial guarantees
4.
5.
6.
7.
credit insurance
credit derivatives
assignment
clearing OTC energy derivatives.
The purchase of commodity futures is a hedging strategy.
Credit-risk hedging.
______
Emily Smith, ERP, manages the cost of jet fuel for a small charter airline company in the
Northeastern United States. The company is struggling, and a significant consideration for the
company is to hedge against anticipated increases in fuel costs in the coming six months. Due
to the companys poor financial standingit has limited ability to raise cash and its credit lines
are very close to being completely drawn down; Emilys ability to reduce the impact of adverse
price movements is largely limited. Given these constraints, which of the following alternatives
could best mitigate the adverse effect of a significant increase in jet fuel prices?
a.
b.
c.
d.
Buy out of money call options on jet fuel

Buy at the money call options on jet fuel
Enter into a long jet fuel futures position
Enter into a long jet fuel forward position
Correct answer:
a.
Reason: There are some companies whose credit risk is such that it is much easier for them to
buy options rather than sell options. This is because the option buyer normally pays the
upfront premium one or two business days after transacting, and thus poses a far lower credit
risk than an option seller, who does not settle his obligations until maturity (or upon early
exercise). Given smaller credit exposure, companies of lesser credit-standing can normally
transact on equal terms with top credits when they are pure options buyers. With limited credit
lines, futures and forwards (assuming they are margined) pose a potential collateral
requirement in the future which would be a problem for the company in the example.
Typical examples of companies using this kind of option strategy might be a privately owned
shipping company which buys an OTC fuel oil cap as a hedge against an increase in bunker fuel
prices, or a small charter airline that buys a jet fuel cap. Typically, these would settle in cash
against the monthly average price of an appropriate index.
In this scenario, an out-of-the-money call should be cheaper than an at-the-money call. On the
other hand, it only protects against significant price movements, and even then only a small
portion of the adverse movements negative effects will be offset.
For a futures position, the cash outlay would be smaller for the option than the futures margin
position, where collateral is required.
To trade forward, you should need to post collateral or reduce counterparty credit risk for the
other party.
Alternative energy risk.

______
Which of the following is NOT a main driver behind investments in alternative energy projects?
a.
b.
c.
d.
Labor disputes
Oil and natural gas prices
Tax incentives
Public sentiment
Correct answer:
a. Reason: The following items, while not comprehensive, serve as a good starting point for
understanding alternative energy drivers: oil and natural gas prices; taxes, politics, and
regulations; geopolitical environment; technological advancements; supply chain costs; and
sentiment.
What are the most common alternative energy drivers (7)?

______
1.
2.
3.
4.
5.
6.
7.
Oil and natural gas prices.

Taxes.
Politics and regulations.
Geopolitical environment.
Technological advancements.
Supply chain costs.
Sentiment.
Spot price volatility.

______
The spot price volatility of WTI crude is 0.3, or 30%, and the spot price is $71.21. Assuming the
return of WTI is normally distributed with zero drift, over the next year one can roughly expect
the price of WTI to be (blank) 66% of the time.
a.
b.
c.
d.
$45.57 - $96.85
$49.85 - $94.18
$49.85 - $92.57
$45.57 - $94.96
Correct answer:
c.
Reason: Volatility roughly represents the percentage of the price range within which we can
expect to see the prices 66% of the time. For example, if the spot price volatility is 0.1, or 10%,
and if the spot price is currently $20, then over the next year we can-very roughly-expect the
price to be within the $18 to $22 range 66% of the time.
For this problem, $49.85 and $92.57 represent the plus/minus 30% volatility range off of
$71.21.
FERC and EPA act.

______
The FERC and EPA Act of 2005 reasserts the Federal Energy Regulatory Commissions roles in all
of the following EXCEPT:
a.
b.
c.
d.
Supervising financial practices and corporate governance in energy markets

Supporting the principle of competition in wholesale power markets
Strengthening regulatory powers to ensure fair competition and avoid consumer exploitation
Developing a stronger energy infrastructure
Correct answer:
a.
Reason: Supervising financial practices and corporate governance are powers granted under
the Sarbanes-Oxley Act of 2002 and applies to all corporations and industries, not just those in
energy markets.
When futures prices for short maturities in the crude oil

market are more expensive than those maturing later, the
market is .
______
backwardated.
F<S
Which are the five events and disputes that come up with a
physical contract?
______
Events and disputes that may come up with a physical contract include:
1.
2.
3.
4.
5.
Force majeure
Quality of the commodity being delivered
Default on a debt
Missed payments
Missed deliveries
Credit ratings are not created in a contract but rather via third parties.
How often does one have to file an updated application to

maintain the position limit exemption for exposure associated
with NYMEX?
______
Annually, not quarterly.
Any person who has received from the Compliance Department written authorization to exceed
position limits imposed under Rule 9A.27 (Expiration and Current Delivery Month Position
Limits) must file with the Exchange an updated application annually not later than the
anniversary date of the initial authorization, or waive the exemption.
A landman's responsibilities are ... .

______
strictly legal
According to the Securities Exchange Commission (SEC), how

long must an accountant maintain all audit review records
after a review has concluded?
______
5 years.
What is the main advantage of Monte Carlo simulations?

______
The advantages of Monte Carlo simulations include the ability to model evolution of risk factors
over the holding period. Furthermore, there is no need to approximate portfolio values in this
methodthey are computed exactly.
Hence, the method can be used for estimating VaR in nonlinear portfolios, which is a valuable
characteristic for energy portfolios with assets.
However, Monte Carlo simulation can be very expensive if many risk factors are being
considered.
Futures can be used only to reduce the impact of ..., and they
do not have any impact on ... .
Futures can be used only to reduce the impact of ..., and they do not have any impact on ...
.______
Futures can be used only to reduce the impact of price volatility, and they do not have any
impact on the availability of a good. The producer is exposed to directional risk, i.e. the price of
Brent crude, and basis risk, i.e. the premiums and discounts in the price formula. Consequently,
by transacting futures he can only reduce the market risk, not the basis risk.
Example:
It is quite usual that crude oils extracted in West Africa are sold based on a formula indexed to
Brent crude plus premiums and discounts, decided case by case on each cargo. If a West African
producer is also executing futures on Brent, which type of risk is likely reduced?
a. Basis risk and supply risk
b. Basis risk and directional risk
c. Supply risk
d. Market risk
Correct answer:
d
Describe gas basis.

______
Gas basis is the price difference between locations.
Decentralization introduces geographic basis risk, which is unique to energies. In financial
markets, todays 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
holds true for natural gas. Location is a fundamental driver of price.
Pilipovic defines basis risk as: The difference in prices between identical products but in two
different markets.
Pilipovic defines basis risk as ... .

______
Basis risk is the difference in prices between identical products but in two different markets.
Which three methods can be used to evaluate crude oil for a

refinery? What is important to consider?
______
1. Break-even analysis
2. Crude oil replacement economics
3. Crude oil absolute economics
Because crude oil value can vary more than USD 12/bbl, depending on the evaluation method,
it is important to use an evaluation technique the closely resembles the method by which
crude oil will be processed.
EPAct gives the Commission [ civil / criminal ] penalty

authority.
EPAct gives the Commission [ civil / criminal ] penalty authority.______
EPAct gives the Commission civil penalty authority, which the Commission has indicated it will
exercise carefully by assuring that its market manipulation rules are clear.
This will make it easier for regulated entities to assure compliance, and make it easier for the
Commission to identify violations.
Calculating load factor, example.

______
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 has 8,760 hours. Actual
generation during the year was 4,270,500 megawatt hours. What is the plants load factor?
Correct answer:
75%.
4,270,500 MW / (650 MW x 8,760h) = 0.75.
Load factor = actual generation / possible generation = average load / peak load.
Scheduled outages are not reflected in the denominator.
What does SOX mandate for off-balance sheet transactions,

what for derivative or hedging instruments?
______
SOX stipulates that each annual and quarterly financial report filed with the SOX Commission
must disclose off-balance sheet transactions.
Sarbanes-Oxley Act plays no role in establishing accounting mechanisms for derivative or

hedging instruments.
Can a forward be resold without the approval of one party?

______
No, both parties have to approve the sale. It is not purchased on an exchange.
Which are cheaper, gas turbines or steam turbines?

______
Gas turbines are cheaper than steam turbines.
Steam turbines typically require boilers, boiler feed water makeup facilities, and steam
condensers, which drives up their price.
Which contracts do LNG buyers generally prefer?

______
LNG buyers typically seek multiple smaller LNG contracts to diversify their supply sources and
match the requirements of newly liberalizing and competitive LNG markets.
In contrast, the trend with the Qatari mega-trains has been to have the sponsors emerge as the
buyers for the entire train production and assume the risk of placing the LNG in the market.
What does an associated gas well and a non-associated gas

well produce?
______
Associated gas well: Methane and crude oil.
Non-associated gas well: Almost all pure methane.
What is the leading cause of dam failures?

______
Too much rain.
Poor construction, failure of inspections, etc. are contributing causes, but dam failure almost
always starts with heavy rains.
Describe the startup of the Oryx FT plant in Qatar.

______
The sheer size and complexity of an FT CTL plant brings additional risks. The unanticipated
difficulties experienced by Sasol in starting up its FT GTL Oryx plant in Qatar are a case in point.
A problem with the FT section of the plant seriously constrained initial operational capacity.
Post-construction modifications required to correct this problem caused the plant start-up
period, which normally requires a few months, to extend to at least 18 months during which
the Oryx joint venture only generated a marginal cash contribution. As Sasol reported, our
experience is that starting up technically complex and first-of-kind facilities takes time and is
inherently problematic.
Why do oil pipelines carry multiple products, and gas pipelines

do not?
______
Oil goes through major transformation at refineries before it is suitable for consumptions by
its various customers. Thus, oil products pipelines carry multiple products.
Natural gas is transported as is from the wellhead all the way to consumers, with the
exception of some minor processing at gas plants. Gas pipelines do not carry multiple products.
How does zonal transmission handle constraints and

redundancy?
______
Not well.
Zonal transmission does not handle more local issues such as constraints and redundancy very
well.
Where are energy forwards traded?

______
On the ICE. They are not standardized and not processed through clearinghouses.
For historical volatility that will be used in a GBM process, we

need to ... (2).
For historical volatility that will be used in a GBM process, we need to ... (2).______
For historical volatility that will be used in a GBM process, we need to:
1. calculate standard deviation of logarithmic price returns (ln S1/S0)
2. annualize the standard deviation by scaling it by the appropriate factor (t)
What is the largest risk in geothermal power generation?

______
Geothermal drilling activity ceased in Switzerland, for example, when a geothermal drilling
program was blamed for low-level earthquake activity. This risk can be fatal. Loss of reservoir
water can be overcome by pumping down water, and nationalization is always a risk, but
geothermal projects dont seem to rank high on a government
takeover list. Geothermal wells are 10-30 miles away from penetrating the earths crust.
Example:
The largest risk faced by geothermal power is:
a. Loss of reservoir water causing steam generation to diminish.
b. Inducing earthquakes.
c. Underground energy sources expropriated by a government.
d. Starting a volcanic eruption through the geothermal drill hole.
Correct answer:
b.
Geothermal wells are ... miles away from penetrating the

earths crust.
Geothermal wells are ... miles away from penetrating the earths crust.______
Geothermal wells are 10-30 miles away from penetrating the earths crust.
Explain a countertrade.
______
Countertrade means exchanging goods or services which are paid for, in whole or part, with
other goods or services, rather than with money. A monetary valuation can however be used in
counter trade for accounting purposes.
If there is a netting agreement, a countertrade reduces settlement risk of sold forward
contracts and locks actual replacement risk. Since the countertrade is concluded at the actual
market price and the replacement risk cannot be reduced.
What are the effects of a countertrade (2)?

______
If there is a netting agreement, a countertrade:

1. reduces settlement risk of sold forward contracts and
2. locks actual replacement risk.
Countertrade means exchanging goods or services which are paid for, in whole or part, with
other goods or services, rather than with money.
What were the goals (3) of the FERC Standards of Conduct for
Transmission Providers?
______
The vast majority agreed with the Commissions goals of simplifying the Standards in order to
achieve:
1. Greater clarity
2. Greater efficiencies of operation
3. Greater ease of compliance
The Commission therefore adopts the employee functional approach, as set forth in the
regulatory text, and eliminates the concept of energy affiliates.
Does the lognormal distribution represent the size distribution

of small fields well?
______
No.
Which standard requires disclosure of the fair values of

derivative instruments and their gains and losses in a tabular
format?
______
FASB Statement No. 161, not Sarbanes-Oxley, requires disclosure of the fair values of
derivative instruments and their gains and losses in a tabular format.
Which is the most sophisticated emissions trading market?

Which commodity is traded?
______
The sulfur dioxide (SO2) emissions-trading market is the most sophisticated emissions-trading
market in the world and one of the oldest. The SO 2 market is also the most liquid of all
environmental markets. SO2 has been actively traded daily in spot and forward markets since
the inception of the market and can now be traded on regulated futures markets. The annual
value of SO2 trades is USD 3billion.
Describe a royalty on an LNG project.

______
Typically speaking, in the upstream, royalties are a common device by which governments can
secure a share of a project's revenue. High royalties can be onerous to an LNG project, since
they involve a payment to the sovereign made directly out of the sales revenues irrespective
of the projects actual earnings. These royalties can be on oil and/or gas; in the case of an LNG
project, any liquids produced are often subject to the same royalties as oil production. Royalties
are usually expressed as a percentage of initial revenue. For current LNG projects, they
generally fall in a range of 5%20%. Less commonly, they can be calculated as a fixed unit cost
(USD /MMBtu).
Calculate net exposures in hedging, example.

______
Virgin Oil is a crude oil producer willing to hedge 100% of its future production along the next
calendar year. In order to achieve this objective, it sells a swap on Brent crude for 1 million
barrels at USD 60/bbl. Later the company discovers that the real production will be 20% lower
than estimated. Bank A offers to buy from Virgin Oil swaps Brent crude for 200,000 barrels, at
a price of USD 50/bbl. Bank B offers to buy from Virgin Oil swaps Brent crude for 500,000
barrels at a price of USD 53/bbl. Put in order the following four different options, from the least
to the riskiest:
I. Doing nothing.
II. Accept the offer from bank A.
III. Accept the offer from bank B.
IV. Unwind everything.
a. II, III, IV, I
b. II, I, III, IV
c. III, IV, II, I
d. I, III, II, IV
Solution:
B.
The net resulting exposure of the four options are: I (-200,000 bbls), II (0 bbls), III (+300,000
bbls), IV (800,000 bbls).
Measurement of natural gas, example.

______
The English unit of volume measurement for natural gas is a cubic foot (ft3). Because gas
expands/contracts with pressure and temperature changes, the measurement is made under or
is converted to standard conditions which is:
a. The way it has been done since natural gas was first used as a commodity.
b. The correct way to do it.
c. Defined by law.
d. Defined by the industry.
Correct answer:
c.
The English unit of volume measurement for natural gas is a cubic foot (cf). Because gas
expands/contracts with pressure and temperature changes, the measurement is made under or
is converted to standard conditions defined by law. It is usually 60F and 14.65 psi (15C and
101.325 kPa) and is called standard cubic feet (scf).
The abbreviation for 1000 cubic feet is Mcf, a million cubic feet is MMcf, a billion cubic feet is
Bcf and a trillion cubic feet is Tcf. Condensate content is measured in barrels per million cubic
feet of gas.
Describe standard cf. What is the convention?

______
Because gas expands/contracts with pressure and temperature changes, the measurement is
made under or is converted to standard conditions defined by law.
The convention of standard cubic feet (scf) is usually:
60F (15C)
14.65 psi (101.325 kPa)
What causes a volatility smile?

______
The reason there is such a thing as a volatility smile (or frown as the case may be) is that
differing Black-implied volatilities for options with same specifications but different strikes
are necessary to capture the true underlying price behavior and therefore traded option
prices.
Black option pricing model assumes log-normal price behavior for the underlying forward
prices, which generally does not capture the full spectrum of behavior of energy prices given a
single volatility measure.
Time series analysis is necessary for ... , distribution analysis is

important in ... .
______
Time series analysis is necessary for calibrating model parameters.
Distribution analysis is important in comparing long-term price behavior to model-implied

behavior.
What is instantaneous volatility?

______
Instantaneous volatility = historical volatility
Describe capital costs for an FT CTL plant.

______
Capital costs are defined as all outlays made after the decision to construct a commercial
plant and prior to the production of salable products.
Capital costs, as defined in this approach, do not include factors to account for either inflation
or interest accrued during construction. The effects of interest payments during construction
are accounted for in the discounted-cash-flow calculations. For an FT CTL plant, our capital
costs do not include investments associated with developing the mine or mines that will supply
coal to the plant. Instead, we assume that coal will be purchased via long-term contracts at
prices that account for the costs associated with developing and operating a coal mine.
Which criterium is most often used to asses the fair price of a

pipeline?
______
Economic value.
There are various ways of calculating economic value. Together they are the criteria most often
used to establish the sellers bottom acceptable price and the purchasers maximum purchase
price. Existing pipelines have a history of return. Potential purchasers may base the price they
are willing to pay on forecasts of volumes, rates, and expenses based on history. The forecasts
are used to develop a future stream of cash flows. These are then discounted to arrive at a
value, called net present value (NPV).
PUC, example.
______
Which of the following statements regarding public utility commissions (PUCs) is NOT true?
a. All states have PUCs to govern actions of state regulated utilities.
b. PUCs are considered quasi-judicial and quasi-legislative entities.
c. PUCs hold hearings to fix rates that may be charged by utilities, but may not investigate
service related issues.
d. PUCs hold hearings to fix rates that may be charged by utilities.
Correct answer:
C.
PUCs are considered to be quasi-judicial and quasi-legislative entities. There is no real
separation of power, since they act as administrator, judge, and legislator . Commissions act as
administrator when, for instance, they investigate rates or service. In a judicial capacity, PUCs
exercise this power when they hold hearings, examine evidence, and make final determinations
of a particular utilitys conduct.
What is the most glaring flaw of the Hubbert theory of

decline?
______
One glaring issue with Hubberts model is that it makes time the only explanatory variable for
the production of a region, thereby disallowing the possibility of reserves being created as a
result technical progress.
Around 1960, King Hubbert, then an engineer at Shell, forecast, by fitting a normal curve to the
production profile of 48 American states, that production would reach its peak in 1969.
Production would then decline in a manner symmetrical to the growth phase. The fact that his
theory was vindicated for one particular example does not mean, however, that his model has
been validated generally. Even if, in several regions of the world, production profiles are found
to be distributed normally, there is no reason to believe that all production profiles will
display a normally distributed pattern.
However attempts have been made to explain or justify the Hubbert phenomenon
mathematically. One such attempt appeals to one of the most celebrated theorems of
probability theory: the central limit theorem. This states that under certain regularity
hypotheses the sum of a large number of independent random phenomena (even if highly
asymmetric or multimodal) tends to produce a random variable with a normal distribution, that
is, symmetrical with a bell-shaped distribution, like that used in the Hubbert approach. But the
probability density of the sum is not equal to the sum of the probability density (in this case the
production profiles of the fields). Furthermore the Hubbert phenomenon does not fall within
the scope of this theorem. In the first place the production profiles summed are obviously not
independent of one another, particularly when they relate to the same geographical zone, and
secondly the theorem relates to numerical distributions rather than temporal distributions, as
in Hubberts model. Temporal distributions are subject to a completely different tool of
probability theory, namely time series analysis. Great care must therefore be taken not to
misuse this method which, however appealing it may seem on the basis of a few examples, has
no scientific basis. If certain aggregated profiles exhibit the characteristics of the normal
distribution, these are curiosities, the real reason for which it would be very interesting to
explore, rather than a phenomenon of general applicability as claimed by Hubbert and his
numerous followers. Hubbert himself ended up by repudiating the normal curve in favor of the
logistic curve which unfortunately is no more justified than the normal curve.
Explain Section 409 of Sarbanes-Oxley.

Section 409 of Sarbanes-Oxley.______
According to Section 409 of Sarbanes-Oxley, Real Time Issuer Disclosures:
Each issuer reporting under section 13(a) or 15(d) shall disclose to the public on a rapid and
current basis such additional information concerning material changes in the financial
condition or operations of the issuer, in plain English, which may include trend and qualitative
information and graphic presentations, as the Commission determines, by rule, is necessary or
useful for the protection of investors and in the public interest.
Calculating value of options positions, example.

______
Assume you hold a short put position with a strike price of EUR 40 and a long call position with
a strike price of EUR 40. At expiration, the spot price of the asset is EUR 50. What is the value of
your combined positions?
Correct answer:
The payoff from the short put is -max[K-S,0] = -max[40-50,0] = 0.
The payoff for the long call is max[S-K,0] = max[50-40,0] = EUR 10.
The sum is EUR 10.
Which options imply higher Black-equivalent volatilities, daily

or monthly-settled options?
______
Daily settled options imply generally much higher Black-equivalent volatilities than do monthlysettled options for the same month of delivery.
This is due to several factors. The fact that monthly settled options are options on an average of
daily forward prices that tend to exhibit non-perfect correlations allows for averaging effects
which diminish the effective volatility of the average relative to the daily-settled volatility. Also,
since daily settled volatilities settle into next day delivery, the daily option volatilities get the
benefit of riding up the steep volatility curve all the way to the day of delivery, whereas
monthly-settled options do not get this benefit as they expire prior to the first day of delivery in
the month.
How are monthly settled options and daily settled options

related?
______
Monthly settled options are options on an average of daily forward prices that tend to exhibit
non-perfect correlations allows for averaging effects which diminish the effective volatility of
the average relative to the daily-settled volatility.
Does the comparable sales method work well to assess the

market value of a pipeline?
______
No.
Establishing value based on sales of similar items works well where similar assets, like houses,
are sold every year, thus establishing a market value. It does not work well for pipelines. Too
many adjustments are needed to arrive at an appropriate valueage, throughput, and the
supply/demand outlook for the commodities being transported.
Buyers and sellers may use similar sales as indicators to help them understand the range of
values. However, this valuation method normally only complements the economic value
method in pipeline sales.
Calculate the spark spread, example.

______
We assume that the heat rate of a natural gas peaking unit is 10,000 Btu/kWh. The price of
electricity is USD 25.00 per MWh, and the price of natural gas is USD 2.00. What is the spark
spread in USD per kWh?
Correct answer:
USD 0.005/kWh.
Output price: USD 25/MWh = USD 25/1,000 kWh = USD 0.025/kWh.
Input price: 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 is therefore USD 0.005/kWh.
How can VaR be adjusted for extreme events?

______
With stress testing.
Accounting for futures, example.

______
During the entire period of a contract, the contract holder must:
a. Report revenues to the Commodities Futures Trading Commission.
b. Must not keep separate accounts for tax purposes.
c. Keep separate accounts in accordance with accounting procedures appended to the contract.
d. Notify local governing bodies (e.g. city council) that a contract has been made.
Correct answer:
C.
During the entire period of validity of the contract, the contract holder must keep separate
accounts in accordance with accounting procedures appended to the contract. These
procedures are set up in accordance with the rules applying in the country concerned, but may
be subjected to slight changes to allow them to cater for specific petroleum mechanisms, for
example depreciation procedures, the period of carry-forward of losses and the definition of
petroleum costs. The clause in the main agreement relating to the accounts of the contract
holder can therefore be quite short because it will refer to the accounting procedure in which
all the practical procedures are indicated. It will specify the currency in which accounts are to
be kept (often U.S. dollars), rules for conversion and the right of the government to have the
accounts audited.
The Federal Energy Regulatory Commission (FERC) is

responsible for the interstate transmission of ... (4).
______
1.
2.
3.
4.
Electricity
Natural gas
Oil
Licensing and inspecting LNG projects
The Federal Energy Regulatory Commission, or FERC, is an independent agency in the United
States that regulates the interstate transmission of natural gas, oil, and electricity. FERC also
regulates natural gas and hydropower projects.
What is used to assess whether to record a financial gain or

loss for a sale of a pipeline?
______
Book value is used by sellers to allow them to understand if they need to record a financial gain
or loss for the sale of pipelines. It is not particularly useful for purchasers, since book value has
little relevance to what the asset is currently worth. Sometimes it is used to reallocate
ownership between joint venture partners if the venture was set to provide for this approach.
Tank size = ... (formula).

______
Tank size = (Average daily demand x Cycle time)
+ Safety stock
+ Tank bottoms
+ Safe fill allowance
Calculating capacity requirement, example.

______
An electric market uses a capacity market to promote the building of new capacity. Given the
following information, how much capacity (MWs) would an end-use customer be required to
purchase?
Expected end-user peak load: 100 MW
Average end-user load: 90 MW
Percentage reserve margin: 10%
a. 10 MW
b. 110 MW
c. 100 MW
d. 99 MW
Correct answer:
b.
Capacity requirement = peak load time x (1+ reserve margin %).
Capacity requirement = ... (formula).

______
Capacity requirement = peak load time x (1 + reserve margin %)
Which specifications for the quality of the gas from an LNG

terminal must a supplier of LNG fulfill?
______
The quality of the gas that comes from an LNG import terminal must be consistent with the
requirements of downstream gas customers or meet the specifications of the interconnected
gas transmission lines, which vary by region and by country.
For example, receiving facilities located close to producing regions may be permitted to accept
LNG with wide-ranging and fairly high calorific values. The Lake Charles, LN, receiving terminal
can import lean LNG from places such as Trinidad, as well as rich LNG from Australia and Qatar.
This is because the regasified LNG immediately mingles downstream from the terminal with gas
production from the Gulf of Mexico and is often treated in NGL-processing plants before being
sent on to market. But LNG import terminals that are located in market areas or that serve
buyers with specific gas quality restrictions must closely monitor and, where necessary, adjust
the quality of the regasified LNG that is delivered into the local grid.
How are underground storage salt caverns formed (2)?

______
1. Dissolving with fresh water (leaching)
2. Hard rock mining
Underground gas storage caverns can be constructed by leaching with fresh water, as is
common in the U.S. Gulf Coast, or via hard rock mining, as popular in the Eastern U.S. and in
parts of Europe.
As the complexity of the refinery increases the gasoline yield [

increases / decreases ] and the residual fuel yield [ increases /
decreases ].
______
As the complexity of the refinery increases
the gasoline yield increases and
the residual fuel yield decreases (the residual fuel stream is being converted to
gasoline).
Vega for puts and calls with the same strike are ... .
______
Vegas for puts and calls with the same strike are the same. This follows from the put call parity
relation, X + c = S + p.
Describe the functions of an RTO (2).

______
Regional transmission organizations (RTO) help improve transmission to overcome locational
issues
For example, RTOs have coordinated planning for logical transmission expansion.
On-peak options.
______
You are concerned with high electricity prices for the upcoming month. Monthly on-peak
options are available at USD 75 per megawatt for a 100 MW contract. If you purchase a
monthly on-peak power option contract, how many megawatt hours will you receive, assuming
there are 20 business days per month?
a. 32,000 mWh
b. 48,000 mWh
c. 16,000 mWh
d. 2,000 mWh
Correct answer:
A.
16 hours per day times 20 days, times 100 MWs = 32,000.
b is incorrect, since calculations assume 24 hours per day. c is incorrect, since calculation
assumes 8 on-peak hours per day. d is incorrect, since calculation
assumes zero hours during the day.
Describe the volatility used in the Ornstein-Uhlenbeck

process.
______
The volatility for the Ornstein-Uhlenbeck process has units of dollars. The volatilities in BlackScholes and Ornstein-Uhlenbeck are not interchangeable. Volatility has to be estimated in the
context of the stochastic process assumption. The volatility for an Ornstein-Uhlenbeck process
has different units to that which is used in the Black-Scholes model.
The OrnsteinUhlenbeck process is also known as the mean-reverting process, is a stochastic
process. The process is one of several approaches used to model (with modifications) interest
rates, currency exchange rates, and commodity prices stochastically. The parameter
represents the equilibrium or mean value supported by fundamentals; the degree of volatility
around it caused by shocks, and the rate by which these shocks dissipate and the variable
reverts towards the mean. One application of the process is a trading strategy pairs trade. The
OrnsteinUhlenbeck process is a prototype of a noisy relaxation process.

ERP Practice Questions Summary: Determinants of Offshore Drilling Costs

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ERP Practice Questions Summary: Determinants of Offshore Drilling Costs

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Practice questions summary

Determinant of cost in off-shore drilling.

basic engineering survey

Distinguish between the three types of water depth.

Effective price paid per barrel.

Operational / futures contract

Crude Price $/bbl

60/40 offset ratio

Default probability of bonds.

Single investments in the LNG chain.

Natural gas exploration; Receiving terminal; LNG ship; Liquefaction plant

Coal-to-liquid production plants.

Price of European put option.

Greater than 28%

Managing credit-risk exposure.

Clearing OTC energy derivatives

The purchase of commodity futures is a hedging strategy.

Buy out of money call options on jet fuel

Alternative energy risk.

What are the most common alternative energy drivers (7)?

Oil and natural gas prices.

Spot price volatility.

FERC and EPA act.

Supervising financial practices and corporate governance in energy markets

When futures prices for short maturities in the crude oil

How often does one have to file an updated application to

A landman's responsibilities are ... .

According to the Securities Exchange Commission (SEC), how

What is the main advantage of Monte Carlo simulations?

Describe gas basis.

Pilipovic defines basis risk as ... .

Which three methods can be used to evaluate crude oil for a

EPAct gives the Commission [ civil / criminal ] penalty

Calculating load factor, example.

What does SOX mandate for off-balance sheet transactions,

Sarbanes-Oxley Act plays no role in establishing accounting mechanisms for derivative or

Can a forward be resold without the approval of one party?

Which are cheaper, gas turbines or steam turbines?

Which contracts do LNG buyers generally prefer?

What does an associated gas well and a non-associated gas

Non-associated gas well: Almost all pure methane.

What is the leading cause of dam failures?

Describe the startup of the Oryx FT plant in Qatar.

Why do oil pipelines carry multiple products, and gas pipelines

How does zonal transmission handle constraints and

Where are energy forwards traded?

For historical volatility that will be used in a GBM process, we

What is the largest risk in geothermal power generation?

Geothermal wells are ... miles away from penetrating the

What are the effects of a countertrade (2)?

If there is a netting agreement, a countertrade:

Does the lognormal distribution represent the size distribution

Which standard requires disclosure of the fair values of

Which is the most sophisticated emissions trading market?

Describe a royalty on an LNG project.

Calculate net exposures in hedging, example.

Measurement of natural gas, example.

Describe standard cf. What is the convention?

What causes a volatility smile?

Time series analysis is necessary for ... , distribution analysis is

Distribution analysis is important in comparing long-term price behavior to model-implied

What is instantaneous volatility?