OPTIMAL PRICING OF NATURAL GAS FLEXIBLE CONTRACTS
Overview
The big industrial consumers have played an important role in the development of the gas sector in Brazil,
becoming a firm source of demand for this fuel. In the electricity sector, diversification of generation sources
prioritized natural gas, therefore expanding significantly thermoelectric generation.
As hydro plants generate at lower costs, thermal units only produce when hydro electricity is insufficient, on
a complementary basis. This makes natural gas consumption highly volatile: Either all thermal units generate
together or don’t. When all units generate simultaneously, the gas trader has to buy LNG - Liquified Natural Gas at
the spot market to attend demand, therefore running big price risk. This risk can be mitigated if the gas trader is able
to sell flexible contracts to the industrial sector in a way that part of the industrial consumption can be interrupted in
case of necessity of thermal generation. Thus, gas volumes sold under flexible contracts are used either by thermal
generation or by the industrial sector, virtually reducing total demand and avoiding emergency LNG purchases. The
determination of the optimal price for these contracts is the aim of this work.
Methods
In order to create this flexible demand, the trader has to offer some sort of price differentiation to the
industrial consumer as a compensation for the disadvantage of having its supply interrupted when the supplier needs
it for power generation. This is the first trade-off to be considered. The supplier is giving up a firm demand willing to
pay full price in order to minimize his exposition to LNG spot prices.
Regardless of the contracts distribution, the actual consumption is going to be known only when the
dispatch occurs, on a second stage, and since the thermal plants operate complementarily to the hydro plants, the
dispatch depends essentially on how much it rains, and therefore is really hard to predict. Because of this
consumption dependence on an uncertain dispatch, we have here an uncertain revenue, and therefore a decision
under uncertainty.
The optimum price is to be set from the point of view of a monopolist, a price maker, not a price taker. And
the price to be chosen is the one that maximizes a metric representing the agent preferences regarding risk and
return.The determination model of the optimum flexible price will be the result of a maximization of a convex
combination of CVaR – Conditional Value at Risk and the NPV – Net Present Value of the trader’s profit. The
objective is to obtain a result compatible with the trader’s risk profile, as illustrated
bellow.
In the picture, there are S dispatch scenarios over a T period of time, and J price options for the trader to
chose. Each of them returns a value for the metric representing the trader’s utility. The Pi to be chosen is the one that
maximizes the metric.
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Results
Results are illustrated in the picture bellow:
0
0
1
2
3
4
5
6
7
8
-500
Métrica (MM US$)
-1000
Preço Monopolista,
6.45, -761.4
-1500
-2000
Monopolist Results
-2500
-3000
-3500
-4000
-4500
Preços do Interrupitível (US$/MMBTU)
Flexible Prices US$/ MMBtu
The metric assumes an ascending path as Pi (flexible contract price) approaches the full firm price from
bellow. The optimal flexible price for the trader is given at the point where the metric reaches its maximum, resulting
in PI*= 6,45 US$/MMBtu for a monopolist trader. For that price, the monopolist has a profit of -761,4 Million
dollars.
In order to determine the deviation due to monopoly, results for the monopolist were compared to the
results of competitive equilibrium. Monopoly power guarantees to the trader a result t 126 million dollars better. As
for the markets, the volume of flexible contracts commercialized raises from 5,96MMm³/dia to 7,0MMm³/dia.
(competitive equilibrium). At the same time, prices fall from 6,45 US$/MMBtu to 6,0 US$/MMBtu.
Conclusions
Flexible contracts will almost certainly play a key role in the future development of Brazilian gas industry
and its economic value will increase with thermal power demand. The results indicate that there is certainly a
price range for the flexible contracts in which the trader is better off having them, in spite of the discount they
present when compared to the firm contracts. The uncertainty of the LNG prices adds value to the flexible
contracts.
Flexible contracts will allow the reduction of the costs and risks associated with the supply of large amounts
of gas in a volatile demand, thus decreasing the electric system security cost.
Regarding industrial consumers, former works have shown that there is some level of discount for the
flexible contracts that makes them willing to share the risks with the trader. For the trader, besides the risk
mitigation, there’s a reduction on the costs associated with an idle gas pipeline through the shared use of
infrastructure between industrial and thermal power consumers.
The price determination adopted in this work indicates that there is a price range for the flexible fuel
contracts that make electricity consumers, gas traders and industrial consumers better than when flexible
contracts are not available.
References
Bezerra B., Barroso L.A., Granville S., Guimarães A., Street, A., Pereira M., Energy Call Options Auctions for
Moutinho, E., “A Regulação de Gasodutos no Brasil: O Difícil Equilíbrio entre Competição e Desenvolvimento de
Pereira, M. Barroso L.A., Rosenblatt J., Supply Adequacy in the Brazilian Power Market, Proceedings of the IEEE
General Meeting, Denver, 2004 – Available at http://www.psr-inc.com
de Energia Elétrica e Otimização Integrada de Ativos Físicos e Financeiros, Nota Técnica PSR, 2000.
Street,A. "On the Conditional Value-at-Risk Probability Dependent Utility Function: A relativistic pricing point of
view". Theory and Decision Journal, 2009.
Street,A., Barroso L.A., Chabar R. M., Mendes A.T.S., Pereira M. V. “Pricing Flexible Natural Gas Supply
Contracts Under Uncertainty in Hydrothermal Markets” IEEE Transactions on Power Systems, Vol.23(3),
Sítio ONS: www.ons.com.br
Sítio PSR Consultoria: www.psr-inc.com
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