Take-or-pay contract valuation under price and private uncertainty

A take-or-pay contract for ethylene is valued for a chemical manufacturing facility. The private uncertainty of production, storage, and consumption requirements associated with the complex are coupled to the price uncertainty of the ethylene spot market. A Monte Carlo simulation is employed to model the private uncertainty and the dynamics of the stochastic ethylene prices is expressed through a binomial lattice. The take-or-pay contract is evaluated in terms of the maximum price payable for a marginal increase in the contract quantity, and the effect of the system parameters of storage capacity, liquefaction rate, and evaporation rate on the contract valuation is examined. The advantages and limitations of the model are also discussed. (C) 2003 Elsevier Inc. All rights reserved.