Managing supply chain risk through take-or-pay gas contracts in the presence of buyers’ storage facilities

Abstract

Traditional take-or-pay contracts have been used to mitigate risks in energy supply chains for decades. More recently, the downstream segment of the natural gas industry has increased capital expenditure on storage facilities in order to enhance supply flexibility and minimize operational risks. In this paper, we study the enhanced value of a take-or-pay gas contract from a buyer’s perspective in the presence of spot market trading and local storage capability. We use a multistage stochastic program via a computationally efficient split-variable formulation and solve this procurement problem to delineate the impact of various key managerial levers on the design, valuation and usage of a take-or-pay contract. Among these, the net convenience yield, storage cost and take-or-pay contract terms are identified as being the most important. Further, we numerically show the subadditivity of values for take-or-pay and storage options. Practically relevant managerial insights are generated to assist decision makers in energy supply chains, where price and demand uncertainties are abundant.