THE EVALUATION OF MULTIPLE YEAR GAS SALES AGREEMENT WITH REGIME SWITCHING

Carl Chiarella, Les Clewlow () and Boda Kang ()
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Les Clewlow: Lacima Group, Level 32, 1 Market Street, Sydney, NSW 2000, Australia
Boda Kang: Department of Mathematics, University of York, Heslington, York, YO10 5DD, United Kingdom

International Journal of Theoretical and Applied Finance (IJTAF), 2016, vol. 19, issue 01, 1-25

Abstract: A typical gas sales agreement (GSA), 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 specified set of contract prices. The main constraint of such an agreement that makes them difficult to value is that in each gas year there is a minimum volume of gas (termed 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 for an underlying gas forward price curve that follows a regime switching process in order to better capture the volatility behavior in such markets. With the help of a recombining pentanomial tree, we are able to efficiently evaluate the prices of the swing contracts, find optimal daily decisions and optimal yearly use of both the make-up bank and the carry forward bank at different regimes. We also show how the change of regime will affect the decisions.

Keywords: Gas sales agreement; swing contract; take-or-pay; make-up; carry forward; forward price curve; regime switching volatility; recombining pentanomial tree (search for similar items in EconPapers)
Date: 2016
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Working Paper: The Evaluation of Multiple Year Gas Sales Agreement with Regime Switching (2011)
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DOI: 10.1142/S0219024916500059

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