Analysis of a multiple year gas sales agreement with make-up, carry-forward and indexation

A typical gas sales agreement, 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 strike price. The main constraint of such an agreement that makes them difficult to value is that there is a minimum volume of gas (termed the 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 where both the gas price and strike price (an index) are stochastic processes. With the help of a two-dimensional trinomial tree, we are able to price such swing contracts with both so-called make-up and carry-forward provisions; find optimal daily decisions and optimal yearly usage of both the make-up bank and the carry-forward bank. With the help of a number of numerical examples, we also provide a detailed analysis, not only of the different features these contracts have, but also how different model parameters will affect both the optimal value and the optimal decisions. •A gas sales agreement with make-up, carry-forward provisions and indexation has been evaluated and analyzed.•There is a minimum volume of gas for which the buyer will be charged regardless of the actual quantity of gas taken.•Both the underlying gas price and the strike price (index) are assumed to follow stochastic processes.•The contract is evaluated with the help of a two-dimensional trinomial tree.•How different model parameters will affect both the optimal value and the optimal decisions are analyzed.