Valuation of full load contracts: A RAROC-based approach

Julie Houe Magnussen

Student thesis: Master thesis

Abstract

This thesis focus on how to evaluate full load gas contracts in a way that compensates the supplier for the risky nature of the contract. A full load contract is a fixed-price contract giving the customer full flexibility regarding her gas load. This means that the supplier is exposed to spot price risk, volume risk and the risk due to the correlation between the gas spot price and the customer load, and as compensation he demands a risk premium. However, in order to withstand increased competition, prices must be calculated close to the profit frontier, which in turn calls for effective risk management procedures to ensure financial survival. We develop a consistent valuation method based on the RAROC concept and Monte Carlo simulation of the gas spot price and customer load. As an essential part of the thesis, we show how to build a stochastic model for the gas spot price and the customer load. The spot price model is calibrated such that it matches the observed term structure of forward prices. Finally, we evaluate a real-life full load contract using the RAROC-based approach and our stochastic spot price and load models.

EducationsMSc in Advanced Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2011
Number of pages122