• Current market situation for most gas retailers
• What are your main risks & opportunities in gas sourcing?
• How to optimize your purchasing strategy?
• Lessons learned & key takeaways

• Current market situation for most gas retailers

• Gas retailers require large volumes of gas each year to fulfil their commitments to serve customers.
• Most gas needs are usually met primarily by one state-controlled gas provider and a handful of long-term supply contracts.
• Relying exclusively on bilateral long-term contracts raises the risk of being locked into high-price and/or rigid contractual terms.
• As such, an optimal gas sourcing portfolio can be conceived as a combination mix of open market structured contracts and bilateral agreements, in an integrated marketing/trading approach.
• In order to assess risk and return within this approach, a detailed understanding and comparison of the following is vital:
• Product offerings
• Price offerings
• Key characteristics of retailer gas needs

• What are your options in gas sourcing?

• Gas retailers have to book volumes of gas with suppliers by the end of each year.
• To source their gas, retailers have two main alternatives:
• Sourcing via oil-indexed contracts (Oil-IC), by which is it possible to source 100% of the portfolio
• Using own gas shipping (Third Party Gas -TPG), causing limitations such as being short of flexibility and market liquidity

• In the table below we compare the main characteristics of sourcing options:

• Cost estimation is based on quantitative analysis of historical data:
• We process 35 years of hourly weather data and load profiles
• We estimate the expected average per cost component and the worst case scenario

• The main choice between oil-indexed contracts (Oil-IC) and third-party sourcing boils down to a trade-off between:
• a usually relatively expensive source (oil-indexed contracts) with strict restrictions on buyer’s ability to resell or redirect gas, but providing good protection against temperature risk and does not require separate access to flex capacity; and
• third-party sources priced against TTF that provide excellent flexibility but require separate access to flex capacity if demand fluctuates and also leaves the company exposed to weather risk.

Yearly procurement optimization

• The gas portfolio volume requirements for each year and for each customer segment are estimated by sales channels and constitute inputs to this multi-year stochastic optimization scheme.
• Each year, cost distributions are estimated based on historical load profiles for each customer segment. The yearly revenues from each sales channel are obtained by simulating selling prices, taking into account current forward curves.
• The portfolio overall cost (C) and revenue (R) are respectively the present value of the costs and revenues for each year in the future. The objective is to maximize the risk-adjusted expected profit:

Intra-year procurement optimization

• Once the actual gas volume allocation is determined from the first step optimization, a further optimization is used to source the optimal volumes at profitable prices during the year.
• Since the Oil-IC prices fluctuate throughout the year (floating x, y and z), it is optimal to source gas from Oil-IC at times when the Oil-IC-TTF spread is low or negative.
• The model tries to identify days during year N when we consider Oil-IC prices to be cheap compared to what they are likely to be at year’s end. It does so by considering the spread between Oil-IC and TTF, for the reasons explained above.
• The cost of sourcing gas for year N is then equal to ΣwiPi, the weighted-average Oil-IC price at which we buy over year N.

• We show below the historical Oil-IC -TTF spread:

• On average, results from the model suggested that spreading the purchasing decision over the year(s) could result in an improved average purchasing price of:
• 1.2 cents/m3 if only one year is considered
• 1.4 cents/m3 if purchases are spread over three years.
• This could lead to savings in the order of EUR 40 million per year for a 4 bcm portfolio.
• Clearly, there are significant risks associated with the strategy:
• since early purchasing may well result in locking-in the wrong Oil-IC – TTF spread compared to competitors buying at the last possible moment;
• most fundamentally, the model and proposed strategy only hold if we believe that Oil-IC prices do not deviate too much from TTF, since the whole model rests on the assumption of a mean-reverting Oil-IC – TTF spread.