The Evaluation of Multiple Year Gas Sales Agreement with Regime Switching

Research Paper Number: 288, Quantitative Finance Research Centre, University of Technology, Sydney

Posted: 27 Oct 2012

See all articles by Carl Chiarella

Carl Chiarella

University of Technology, Sydney - UTS Business School, Finance Discipline Group

Les Clewlow

Lacima; University of Warwick - Financial Options Research Centre (FORC); University of Technology Sydney (UTS) - School of Finance and Economics

Boda Kang

AMP

Date Written: March 1, 2011

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 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.

Keywords: gas sales agreement, swing contract, take-or-pay, make-up, carry forward, forward price curve, regime switching volatility, recombing pentanomial tree

Suggested Citation

Chiarella, Carl and Clewlow, Les and Kang, Boda, The Evaluation of Multiple Year Gas Sales Agreement with Regime Switching (March 1, 2011). Research Paper Number: 288, Quantitative Finance Research Centre, University of Technology, Sydney, Available at SSRN: https://ssrn.com/abstract=2167128

Carl Chiarella (Contact Author)

University of Technology, Sydney - UTS Business School, Finance Discipline Group ( email )

PO Box 123
Broadway, NSW 2007
Australia
+61 2 9514 7719 (Phone)
+61 2 9514 7711 (Fax)

HOME PAGE: http://www.business.uts.edu.au/finance/

Les Clewlow

Lacima ( email )

London
United Kingdom

HOME PAGE: http://www.lacimagroup.com

University of Warwick - Financial Options Research Centre (FORC)

Coventry CV4 7AL
United Kingdom

HOME PAGE: http://www.wbs.ac.uk/expertise/research_teaching/f

University of Technology Sydney (UTS) - School of Finance and Economics ( email )

Haymarket
Sydney, NSW 2007
Australia

HOME PAGE: http://www.business.uts.edu.au/finance/

Boda Kang

AMP ( email )

Sydney, NSW
Australia
0430976988 (Phone)
2154 (Fax)

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