The Evaluation of Multiple Year Gas Sales Agreement with Regime Switching
AbstractA 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 are 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 behaviour in such markets. With the help of a recombing pentanonial tree, we are able to efficiently evaluate the prices of the swing contracts, find optimal daily decisions and optimaly early 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.
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Bibliographic InfoPaper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 288.
Date of creation: 01 Mar 2011
Date of revision:
gas sales agreement; swing contract; take-or-pay; make-up; carry forward; forward price curve; regime switching volatility; recombing pentanomial tree;
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