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The Evaluation Of Multiple Year Gas Sales Agreement With Regime Switching

Author

Listed:
  • CARL CHIARELLA

    (Finance Discipline Group, UTS Business School, University of Technology, Sydney, PO Box 123, Broadway, NSW 2007, Australia)

  • 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)

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.

Suggested Citation

  • Carl Chiarella & Les Clewlow & Boda Kang, 2016. "The Evaluation Of Multiple Year Gas Sales Agreement With Regime Switching," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 19(01), pages 1-25, February.
    • Handle: RePEc:wsi:ijtafx:v:19:y:2016:i:01:n:s0219024916500059
    DOI: 10.1142/S0219024916500059
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    Cited by:

    1. Dong, Wenfeng & Kang, Boda, 2019. "Analysis of a multiple year gas sales agreement with make-up, carry-forward and indexation," Energy Economics, Elsevier, vol. 79(C), pages 76-96.

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