Improving Electricity and Natural Gas Systems Coordination Using Swing Option Contracts

The trading of electricity and natural gas, according to the current organizational framework, takes place in independent and sequentially cleared trading floors. This setup leads to imperfect coordination between the two energy systems and it also separates the day-ahead scheduling from the real-time balancing decisions. Acknowledging these market inefficiencies, we propose defining standardized contracts in the form of swing options that allow for a flexible demand pattern according to a predetermined price. In this paper, swing option contracts are parameterized and priced on the gas system side and can be concluded by the power generators to hedge against gas price uncertainty. We perform the contract pricing using a stochastic bilevel optimization model that anticipates the reaction of both systems with respect to contract definition. Our analysis shows that if these contracts are properly priced and valuated by the gas and electricity system, respectively, they can improve inter-system, as well as inter-temporal, coordination and thus reduce the expected system cost.