The Evaluation of Multiple Year Gas Sales Agreement with Regime Switching

Carl Chiarella, Les Clewlow, Boda Kang

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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 behaviour 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.
Original languageEnglish
Article number1650005
Number of pages25
JournalInternational Journal of Theoretical and Applied Finance
Issue number1
Early online date4 Feb 2016
Publication statusE-pub ahead of print - 4 Feb 2016

Bibliographical note

Date of acceptance: 05/10/2015

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