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The Evaluation of Multiple Year Gas Sales Agreement with Regime Switching

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JournalInternational Journal of Theoretical and Applied Finance
DateAccepted/In press - 5 Oct 2015
DateE-pub ahead of print (current) - 4 Feb 2016
Issue number1
Volume19
Number of pages25
Early online date4/02/16
Original languageEnglish

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 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.

Bibliographical note

Date of acceptance: 05/10/2015

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