Contract Portfolio Optimization for a Gasoline Supply Chain

Major oil companies sell gasoline through three channels of trade: Branded (associated with long-term contracts), unbranded (associated with short-term contracts), and the spot market. The branded channel provides them with a long-term secured and sustainable demand source, but requires an inflexible long-term commitment with demand and price risks. The unbranded channel provides a medium level of allocation flexibility. The spot market provides them with the greatest allocation flexibility to the changing market conditions, but the spot market’s illiquidity mitigates this benefit. In order to sell the product in a profitable and sustainable way, they need a dynamic contract portfolio strategy that would enable them to adjust the supply contract portfolio over time in anticipation of the future market conditions in each individual channel while satisfying the contractual obligations. We propose a multi-period model to dynamically rebalance the contract portfolio according to changing market dynamics with the objective of maximizing total expected discounted profit. We represent the evolution of product prices using a common real option model. We characterize the structure of an optimal state-dependent base-share contract portfolio policy for both finite and infinite planning horizons. Our computational results provide managerial insights into the structure of optimal policies and the benefit of using dynamic rather than static policies, and illustrate the sensitivity of the optimal contract portfolio and corresponding profit value in terms of the different parameters of our model.