Gas procurement optimization for a retailer

Categories: Oil & Gas, Risk Management
  • Situation

    A Dutch gas retailer has a 4 bcm gas portfolio of residential, small businesses and industrial customers. Based on the sales channels estimates at year end, it procured gas from the incumbent to satisfy its portfolio needs.

  • Complication
    The incumbent packages gas with transportation, flexibility and other risk protection products, and offers an oil-indexed pricing. The retailer can also buy directly from the futures gas market at a cheaper price, but needs to source transport and flexibility separately.
  • Solution
    We conducted a risk-return comparative analysis for both alternatives and proposed a strategy for optimal portfolio allocation amongst different procurement options, with suggestions of optimal times and volumes to source gas during the year. This resulted in cost savings of €40 millions in the first year of implementing the new strategy.

More details

  • 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

The risk/reward trade-off: what is cheaper ? what are the risks ?

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


Regional Oil-IC

Long-term gas contracts

Third party


Retail B2B

Reference market is TTF

Price components

  • Commodity cost
  • Service cost (includes flex cost)
  • Commodity cost
  • Service cost (includes flex cost)
  • Commodity cost
  • Flex cost
  • Imbalance cost
  • Quality conversion
  • Seasonal/weather risk

Transport included?

Yes Yes


Flexibility included?

Yes Yes


Temperature protection?


Yes / No


Main advantages

  • Includes significant flex
  • Provides full weather protection
  • Usually cheaper than Regional
  • Provides some flex and possible weather protection
  • Often the cheapest option
  • Full flexibility on resale, destination, storage, etc.

Main disadvantages

  • Typically most expensive
  • Cannot be resold
  • Strict destination rules, leaving buyer with little flexibility
  • Cannot be resold
  • Strict destination rules, leaving buyer with little flexibility
  • Requires access to flex
  • No weather protection

Estimating risk in both gas 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.
An optimal gas procurement strategy consists of taking advantage of the favorable spread between TTF and Oil-IC by purchasing as much third-party gas as access to flex capacity allows (either on the market or through own storage).
What is your risk appetite?

  • In order to optimize your purchasing strategy, the following has to be assessed as well:
    • What is your risk appetite?
    • Which mixture of sourcing between market and provider is optimal for your firm?
The model accordingly suggests different purchasing strategies based e.g. on the RAROC indicator
How does it work in practice?

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:

How does the model perform in real life?

  • 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.
What are the lessons learned?


What clients said aboutour projects

  • Bron Sharman Senior Oil Trader
    “Unlike many advisers I’ve worked with, Trading Integral Solutions don’t have to pretend to be interested in their clients: they focus on what really matters and strive to add value in an optimal way.” Bron Sharman, Senior Oil Trader at SOCAR Trading
  • Olga Kutuzova IFRS Group Manager
    "Trading Integral Solutions applied high quality standards when they delivered their project to us. We benefited greatly from our interaction with their highly skilled team of experts!" Olga Kutuzova, IFRS Group Manager at Novatek Gas & Power
  • Jaroslaw Wajer Partner
    "I have cooperated with Trading Integral Solutions several times. They supported us during the design and implementation of trading departments and company strategies for our power utilities clients. I appreciate their trading expertise and profound knowledge of risk management. I would truly recommend cooperation with Trading Integral Solutions." Jaroslaw Wajer, Partner Performance Improvement at Ernst & Young

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