Robust strategies for natural gas procurement

Robust strategies for natural gas procurement

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Article ID: iaor20101880
Volume: 205
Issue: 1
Start Page Number: 151
End Page Number: 158
Publication Date: Aug 2010
Journal: European Journal of Operational Research
Authors: , ,
Keywords: gas, purchasing
Abstract:

In order to serve their customers, natural gas local distribution companies (LDCs) can select from a variety of financial and non-financial contracts. The present paper is concerned with the choice of an appropriate portfolio of natural gas purchases that would allow a LDC to satisfy its demand with a minimum tradeoff between cost and risk, while taking into account risk associated with modeling error. We propose two types of strategies for natural gas procurement. Dynamic strategies model the procurement problem as a mean-risk stochastic program with various risk measures. Naive strategies hedge a fixed fraction of winter demand. The hedge is allocated equally between storage, futures and options. We propose a simulation framework to evaluate the proposed strategies and show that: (i) when the appropriate model for spot prices and its derivatives is used, dynamic strategies provide cheaper gas with low risk compared to naive strategies. (ii) In the presence of a modeling error, dynamic strategies are unable to control the variance of the procurement cost though they provide cheaper cost on average. Based on these results, we define robust strategies as convex combinations of dynamic and naive strategies. The weight of each strategy represents the fraction of demand to be satisfied following this strategy. A mean–variance problem is then solved to obtain optimal weights and construct an efficient frontier of robust strategies that take advantage of the diversification effect.

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