Analysis of a multiple year gas sales agreement with make-up, carry-forward and indexation

Wenfeng Dong and Boda Kang

Energy Economics, 2019, vol. 79, issue C, 76-96

Abstract: A typical gas sales agreement, also called a gas swing contract, is an agreement between a supplier and a purchaser for the delivery of variable daily quantities of gas, between specified minimum and maximum daily limits, over a certain number of years at a strike price. The main constraint of such an agreement that makes them difficult to value is that there is a minimum volume of gas (termed the take-or-pay or minimum bill) for which the buyer will be charged at the end of the year (or penalty date), regardless of the actual quantity of gas taken. We propose a framework for pricing such swing contracts where both the gas price and strike price (an index) are stochastic processes. With the help of a two-dimensional trinomial tree, we are able to price such swing contracts with both so-called make-up and carry-forward provisions; find optimal daily decisions and optimal yearly usage of both the make-up bank and the carry-forward bank. With the help of a number of numerical examples, we also provide a detailed analysis, not only of the different features these contracts have, but also how different model parameters will affect both the optimal value and the optimal decisions.

Keywords: Gas sales agreement; Swing contract; Indexation; Make-up, carry-forward; Forward price curve; Index price curve (search for similar items in EconPapers)
JEL-codes: C61 C63 C69 D81 Q41 Q49 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:eneeco:v:79:y:2019:i:c:p:76-96

DOI: 10.1016/j.eneco.2018.04.001

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