ERAC Energy Risk Management Principles 2 — Questions and Answers
Question 1: Which risk metric measures the maximum expected loss over a given time horizon at a specified confidence level?
- Expected Shortfall
- Value at Risk (VaR) (Correct answer)
- Standard Deviation
- Beta Coefficient
Correct answer: Value at Risk (VaR)
Value at Risk (VaR) quantifies the maximum potential loss over a defined period at a given confidence level (e.g., 95% or 99%).
Question 2: A natural gas utility uses a weather derivative tied to heating degree days. This is an example of managing which type of risk?
- Credit risk
- Operational risk
- Volumetric risk (Correct answer)
- Regulatory risk
Correct answer: Volumetric risk
Volumetric risk arises from uncertainty in demand volumes due to weather; heating degree day derivatives hedge this exposure.
Question 3: In energy trading, 'basis risk' refers to:
- The risk that a counterparty defaults on a contract
- The difference between the spot price and the futures hedge price at delivery (Correct answer)
- The risk of regulatory changes affecting pricing
- The probability of equipment failure at a generation facility
Correct answer: The difference between the spot price and the futures hedge price at delivery
Basis risk is the residual price risk that remains when the hedge instrument does not perfectly match the exposure location or specification.
Question 4: Which of the following best describes the 'tolerable risk' threshold in an energy company's risk appetite framework?
- Risk level below which no mitigation is needed
- The maximum risk a company is willing to accept before taking action (Correct answer)
- Risk that is transferred to a third party via insurance
- Risk that is eliminated through operational controls
Correct answer: The maximum risk a company is willing to accept before taking action
The tolerable risk threshold defines the upper boundary of acceptable risk exposure before mandatory mitigation or escalation is triggered.
Question 5: A power plant operator experiences an unexpected outage during peak demand. Which risk category does this event primarily represent?
- Market risk
- Operational risk (Correct answer)
- Liquidity risk
- Counterparty risk
Correct answer: Operational risk
Unexpected equipment failures or process disruptions fall under operational risk, which covers losses from internal system failures.
Question 6: Expected Shortfall (ES), also called Conditional VaR, is preferred over VaR by some risk managers because it:
- Is simpler to calculate using historical data
- Captures the average loss in the tail beyond the VaR threshold (Correct answer)
- Always produces a lower risk estimate than VaR
- Requires no assumption about the return distribution
Correct answer: Captures the average loss in the tail beyond the VaR threshold
ES averages all losses exceeding the VaR cutoff, providing a fuller picture of tail risk that VaR alone does not capture.
Question 7: A risk register in energy risk management primarily serves to:
- Record hedging positions taken by the trading desk
- Identify, assess, and track risks along with their mitigation status (Correct answer)
- Store historical price data for commodity markets
- Document regulatory filings submitted to FERC
Correct answer: Identify, assess, and track risks along with their mitigation status
A risk register is a structured tool that catalogues identified risks, their likelihood, impact, owners, and current mitigation measures.
ERAC Energy Risk Management Principles 2
Which risk metric measures the maximum expected loss over a given time horizon at a specified confidence level?