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VALUE OF TRANSATLANTIC ARBITRAGE

Didier Holleaux Vice-president LNG Gaz de France Paris, France didier.holleaux@gazdefrance.com

ABSTRACT LNG Transatlantic Arbitrage (i.e. diversion of cargoes from Europe to the US or the other way round according to gas prices) is a must of any discussion on LNG Markets. The aim of the paper is first to demonstrate that arbitrage is a small-scale activity and second to assess the value, in terms of risks and reward of this activity. The truth is that real LNG arbitrage in the world is only a small part (around ) of spot and short-term LNG trades which themselves represent only around 13% of the global LNG trade. The relative scarcity of such arbitrage is mainly due to technical and contractual issues, which make LNG cargo diversion difficult, and are detailed in the paper. But even when these difficulties are overcome, the significant fixed costs involved, the high volatility of the arbitrage, and its sensitivity to market conditions, make transatlantic arbitrage a relatively high risk activity, save for the players who have a well sized and diversified portfolio of LNG supplies: for these players, securing arbitrage capacity could be a good risk hedging strategy.

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INTRODUCTION
LNG Transatlantic Arbitrage has become a fashionable subject of LNG players and experts. But in fact, very few are doing it, even at a modest scale. Is it possible to explain and reconcile the following facts and statements? First, the high volatility of the arbitrage and the significant fixed costs involved make transatlantic arbitrage a relatively high risk and small-scale activity. In fact, the number of cargoes actually diverted to North America seems to be very low compared to the total volume of the US Market On the other hand, some observers say that such arbitrages are setting the price of gas on the Spanish markets and were the reason of both high gas prices and gas shortages in Spain in 2005. Gaz de France, as one of the players involved in such arbitrage, together with some of its suppliers and partners, is particularly relevant to address this issue in depth. We will try in this paper, first, to assess the reality of spot arbitrage, second, to estimate the real value of such arbitrage.

1. The Reality of Spot Arbitrage

1.1 The Facts
1.1.1 LNG spot market in recent years

Huge investments are at stake in the LNG industry. This fact is shaping the whole structure of the Industry and leads producers to sell the bulk of LNG quantities under long-term contracts to various countries and buyers. This proven risk hedging strategy implies that only limited quantities may be available for arbitrage and spot operations. For instance, excess cargoes may be traded on a medium or short-term basis during commissioning or ramp-up periods. Other ones may be available because of scheduling mismatch between beginning of commercial production and sales and purchases agreements. In some cases debottlenecking of production may create uncommitted production. More marginally, some producers may also dedicate upfront some limited quantities to arbitrage or spot operations in order to diversify their sale portfolios and take the risk and chances of a highly volatile market. But this risky gamble implies to secure a physical access to the market and to sell to the final customer (for instance, through a partnership with a downstream player) or to sell those quantities on a very liquid market, otherwise the value of spot cargoes could be captured by the players controlling the access or the market. Over the last 10 years, the volume of spot and short-term transactions has been increasing (Figure 1) but has been closely linked to the number of newly commissioned LNG trains, as illustrated on Figure 2, and may also be partly explained by the evolution of supplies contracts number: 78 long-term and medium-term contracts were in force in 2005 (compared to 63 in 2004).

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Figure 1: Spot and Short-term LNG imports over the last ten years (103 m3 liq) (Source: GIIGNL)

Figure 2: Number of commissioned LNG trains between 1995 and 2005 (Source: Gaz de France) In 2005, the international trade accounted for 310*106 m3 in liquid form: it rose by 22.3*106m3, or 7.8%, a higher growth rate compared to 2004 figures. Spot and short-term imports represented 13%1 of the LNG trade, which figured an increase in the spot imported quantities by 19.5% between 2004 and 2005 and by 11.2% in the number of traded cargoes.

Spot and short-term Volume in 10 m LNG

6 3

2004 33.5 313

2005 40 348

Number of Cargoes

Table 1: Spot and short-term imports in 2004 and 2005 - (Source: GIIGNL) But it doesnt mean that the total amount of this 40*106 m3LNG spot quantities were traded under arbitrage deals.

1.1.2

Arbitrage operations in 2005

At this stage it is important to tell arbitrage from other spot operations. Arbitrage is the free choice to send a cargo to one market rather than to another one, the final decision being based purely on
1

Source: GIIGNL (The LNG industry in 2005).

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price in most cases, or taking into account other more marginal criteria like political pressure (e.g. in Winter 2005/2006 in the UK). Spot operations can be arbitrage but can also be dedicated to supply only the usual market route (like excess cargoes which are frequently sold by a producer to its main long-term customer(s) thus avoiding any scheduling and commercial difficulty). For instance, a large part of spot and short-term transactions in 2005 were cargoes sold under long-term contract and sold again by the long-term customer to another market. The rise in the spot market share may mainly be attributed to the Egyptian exports to Spain and the United States (around one third of the spot cargoes number increase are due to the sole Gaz de France Egyptian contract). The table below presents spot and short-term LNG quantities received in 2005 by the importing countries from the exporting countries. The green color indicates the existence of at least one long or medium-term contract between the considered producing and importing countries which makes the short-term or spot trade a mere complement of long-term contract, without any indication that an arbitrage was considered or even possible. The pink color highlights the quantities, which were sold to an importer who isnt a regular customer, and therefore have a high probability of being an arbitrage2. According to this counting method, the real arbitrage quantities are around 13.4*106 m3LNG, or around 116 cargoes, which represents only the third of spot and short-term LNG quantities, and 4.3% of total LNG quantities.

Figure 3: Spot and Short-term LNG quantities received in 2005 by the importing countries from the exporting countries (103 m3 liq) Considering importing continents, the three pie charts below shows that the Atlantic basin is more active on the spot market (with 75% market share) than Asia, unlike on the LNG long-term market, and may even attract around 84% of the arbitrage business.

Arbitrage quantities between Algeria and Spain have been taken equal to 1 300*10 m 3 3 Arbitrage quantities have been taken equal to 1 049*10 m LNG.

3 LNG

; between Egypt and USA

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LNG Share by Importing Continent

LNG spot Share by Importing Continent Europe 32%

Europe 25%

Asia 25%

Asia 65%

Americas 10%

Americas 43%

Potential "Real Arbitrage" by Importing Continent Asia 16% Europe 36%

Americas 48%

Figure 4: LNG importing market share by continent (long-term and spot market, spot market and potential real arbitrage) 1.1.3 Some examples of arbitrage done by Gaz de France

Gaz de France does arbitrages at a modest scale (in volume) but in an innovative way. In 2005, the major operation (considering the quantities) consisted in a Sale and Purchase Agreement with BG concluded in June 05 regarding 2 cargoes per month over 18 months to be delivered in North America until December 2006 (Lake Charles Elba Island). In this transaction, financial derivatives provided by our subsidiary Gaselys3 helped Gaz de France to obtain maximal value and limited risk from diversions and in fact some of these cargoes we finally unloaded in Europe. One of these cargoes, resold by BG to Gazprom, was in fact the first Russian LNG cargo sent to the US. Another deal was concluded late 2005 between MED LNG & Gas and Gazprom: one cargo initially allotted to France was diverted for Gazprom to Cove Point (US), Gazprom delivering at the same time additional pipe gas to Gaz de France to balance Gaz de France portfolio. In 2006 another deal between Gaz de France and Gazprom was concluded: one cargo was sold to Gazprom Marketing and Trading and resold to BP in April 2006 at Isle of Grain. In addition several cargoes were sold to Petronet and Gaz de France managed to send some cargoes to the Far East.
Although spot market has been increased for several years it doesnt mean the end of long-term contract sovereignty, which will remain the reference, since the LNG industry is a highly capital-intensive business. The real question is is spot market share growth, and particularly the arbitrage growth, sustainable? The answer depends both on limiting factors and of course on the money you can get out of this business. We will look first at the limiting factors that have to be overcome.

The Gaz de France / Socit Gnrale Trading JV

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1.2 Limiting factors

Outside the price issue, there are different categories of limiting factors that may be gathered for instance in 5 different groups: the cargoes availability, the assets availability and compatibility, technical and scheduling constraints, regulatory and contractual limitations. 1.2.1 Cargoes availability

In a world where financing and building new liquefaction plants still requires long-term contracts (even if it is said that Sakhalin II FID was made before LT SPA were signed and if big players could theoretically afford to build new trains without long-term contracts), divertible cargoes are available in limited cases: On buyers side, cargos availability will normally result from a temporary oversupply on its market due to mild weather, reduced demand compared to prevision, etc like in Spain in April 2006. But in that case, arbitrage may be fruitful only if that oversupply were limited to a specific area otherwise there would be no margin to capture. Another crucial parameter on buyers side is that flexibility of gas supply for power production has been overestimated. On sellers side, there seems to be more opportunities to practice spot operations either in partnership with a downstream player who can offer a privileged access to its market or directly on a liquid market. These excess cargoes may result either from commissioning and ramp-up periods or from excess production due to temporary favourable thermal effects, safety margin in basic design, debottlenecking, or from scheduling mismatch between starting of commercial production and sales and purchases agreements. More marginally, some producers may also dedicate limited quantities to arbitrage or spot operations provided they are able to finance their project without selling 100% of nameplate production. We can assume that, in the future, there will be more cargoes available especially because of debottlenecking of existing plants. But it doesnt necessarily imply a growth of arbitrage operations to the extent that most of the players will still supply their firm market first.

1.2.2

Shipping availability

Regarding the ships availability, there has been no shortage until fourth quarter of 2005, but difficulties have appeared after that date. According to Poten & Partners, 36 vessels were chartered under short-term contracts in 2005. In 2006, the use of ships as temporary storage capacity (i.e. temporal arbitrage instead of geographical arbitrage) was a new feature of the LNG industry and did reduce significantly the number of available ships.

Figure 5: Existing Fleet (Poten & Partners September 2006) In the long run, there is no sign that shipping capacity will grow more quickly than LNG production although Poten & Partner estimate that the number of additional ships may be equal to 165 until 2011 (See Figure 6 below). In fact, because new long-term trading routes become longer than ever, shipping capacity for diversion could remain tight. For instance, diversions from the Atlantic basin to Asia are very ship time-consuming.

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Figure 6: Expected fleet growth (Poten & Partners September 2006) / Number of liquefaction Trains by year-end Making rough assumptions based on GIIGNL 2005 annual report (see 2005 data in table below), CERA, CEDIGAZ LNG production previsions and so on, it appears that the Liquefaction capacity / Fleet Ratio may get worse as it may raise by 30% between 2005 and 2010.

2005
World LNG Tanker Fleet LNG production (in mtpa) Capacity/Fleet Ratio (in mtpa/ship) Ratio Increase 2005/2010 (in %) 191 142 0,74

2010
374 360 0,96 30%

2010*
374 380 1,02 37%

Table 2: LNG Tankers and Liquefaction plants production as of 2005 (Source: GIIGNL) and potential scenarios for 2010 (CERA, CEDIGAZ, ) On the other hand, increase of ship size (126 000 m3LNG in 2005 in average Source GIIGNL) has to be taken into account, but it may be not enough to balance the first trend, to the extent that enhancing the average capacity of world LNG tanker fleet in 2010 to 150 000 m3LNG for instance would be equivalent to 20% rise, as a result the equivalent ratio Liquefaction capacity/ship capacity may decrease by 10%. Moreover marine routes becoming longer make worse the ships availability in 2010. In 2005, the number of nautical miles sailed was 16.44 * 106 (that is to say 86 000 nautical miles per ship4 per year or around 7 200 nautical miles per ship per month in average), up from 15.91 * 106 in 2004, that is to say a 3.33% annual rise. Assuming the same annual increase until 2010, it makes a total rise of 18% in 2010. As a result, the shipping capacity might become scarcer than today probably by more than 25%. 1.2.3 Regasification availability

Regarding regasification capacity, some excess capacities seem to be planned on both sides of the Atlantic (Figure 7). But it doesnt mean that the capacity will be available at the most valuable time for this market. Spot capacities are available in Europe but currently rather limited, either in regulation-exempted terminal.

World LNG tanker fleet consisted of 191 vessels at the end of 2005 (source: GIIGNL The LNG industry)

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Figure 7: Atlantic Regasification and Supply Source: Suez To be able to deliver arbitrage cargoes to the US market, either you book a firm capacity dedicated to arbitrage which is expensive (typically 0.90 USD/MBTU if diversion occurs for one in two cargoes) or you enter into Margin-sharing agreements with primary capacity owners in the US. Moreover access to downstream network has to be booked as well if you want to sell your gas at a liquid hub, and as a result a partnership with a local player seems more appropriate to guaranty the access to North American market. The optimum has to be found in the balance of profit and risk (either you choose to lock the access to the market through fixed costs or you make the gamble to be able to manage your arbitrage with variable costs only and to find the berthing slot when you need it). 1.2.4 Technical and scheduling constraints

But berthing slots is not the only issue, which has to be considered in case of physical arbitrage, the whole scheduling is also a big one with offtake constraints at liquefaction plants and shipping duration compatibility. Moreover, ship/terminal compatibility has to be checked case by case and will become even more complicated with Qflex and Qmax ships. Another major issue to be addressed in North America, like in the UK, is gas quality. In Continental Europe, LNG interchangeability is already largely possible, especially in Spain, France and Belgium and will improve (see below) as soon as the use of EASEE-gas recommended practices will be implemented (2010), allowing shippers to deliver almost any LNG to any entry point in continental Europe. In the UK and in the US, gas specifications issue will be limited for regular flows by Qatari (and others) decision to produce lean or rich LNG qualities, but will remain a major constraint for arbitrage.

Figure 8: LNG interchangeability in Europe

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The last main technical issue to consider is authorization and vetting process. For instance, two months are required to get a ship approved by local authorities for delivery in Tokyo. Moreover although a ship may have been allowed once by the terminal operator to deliver one cargo, it doesnt mean that, 3 years after, the same ship will be able to restart deliveries without going through a new vetting process. 1.2.5 Regulatory policy, contractual limitations

In Europe, regulatory policy and Use It Or Lose It (UIOLI) rules may act as a brake on the transatlantic arbitrage. Even in a supposedly fully liberalized market like in the UK, the regulator or the politicians may intervene in shipper deliveries scheduling and threaten to deprive them of their allotted slots (as in winter 2005/2006), in case they dont deliver gas during shortage periods and divert cargoes towards more valuable markets. More generally, UIOLI rules prevent traders doing last-minute diversion according to last-minute price signals since the primary capacity owner (who has paid for firm capacity) must announce well in advance if he will use a berthing slot or not. Moreover LNG storage services rules in Spain may also be a constraint and even prevent sometimes like in April 2006 a ship from delivering its whole cargo at the scheduled slot, and slot cancellations like in April 2006 are even worse, leaving the traders in complete uncertainty: if big players will always find a solution both in physical and commercial terms, smaller players could be exposed to huge losses is such cases. And, of course, contractual limitations can be numerous: obligation for the shipper to supply its dedicated market without any possibility of diversion, DES contracts or FOB contracts with restrictions The main contractual issues are: the right to divert cargoes and the kind of profit sharing mechanism, and the Force Majeure risk hedging. As a result, only a diversified portfolio with LNG and pipeline gas as well, long and short-term contracts, from different sources allows you to play efficiently in the game.

After having looked into the reality of spot arbitrage and addressed its limiting factors, we are going to assess the value of transatlantic arbitrage.

2. The Value of Arbitrage

2.1 General consideration
Arbitrage is a topic that presently causes a lot of ink to flow: lots of people speak about it, but very few are really doing it, and even fewer doing it at a significant scale or looking at it and assessing its value in the medium or long-term. Trying to assess the value of arbitrage is made difficult by the fact that two different manners to do physical arbitrage coexist. The first one consists in selling cargoes to a player who has the regasification capacity and the downstream market, but a margin sharing mechanism has to be defined and the risk of Force Majeure has to be hedged. The second amounts to booking excess regasification capacities on the other side of the Atlantic Basin that gives shipper total independence from other traders and opportunity to capture the whole margin. Nevertheless the option value has to be higher than the total of the costs of the excess capacity (typically 0.35 USD/MMBTU in the Golf of Mexico or 0.5 USD/MMBTU taking into account transportation costs to the nearest hub) and shipping differential (around 0.5 USD/MMBTU). An alternative to the physical arbitrage may be the financial arbitrage, which consists in buying financial options on the market and striking them to the extent that it brings you more value than the gas price on your main market. The main difference between these strategies is their duration: firm booking capacity will be typically done for 20 years when the lack of visibility on NBP and Nymex market, where the

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liquidity of this kind of financial products is limited to 3 to 5 years, will limit financial arbitrage to the same duration.
The purpose of this second section is thus to look at historical value of physical arbitrage before trying to assess the future value of both financial and physical arbitrage. Main assumptions of the study are first presented hereafter, and then the value of physical arbitrage in the recent past is assessed before comparing future value of physical arbitrage with financial arbitrage.

2.2 Main assumptions

Although NBP represents only a small part of the European market (Source IEA: UK markets represents 18.5 % of the EU25 total gas consumption and some quantities among this 18.5% are not NBP-indexed), transatlantic arbitrage is considered hereafter under NBP-Nymex spread. Concretely, one cargo per month (around 3.16*106 MMBTU) originally dedicated to the NBPindexed market will be considered for a potential arbitrage diversion to Nymex-indexed market on the other side of the Atlantic. It is assumed that firm regasification capacities are booked on European Atlantic side while north American regasification capacities could either be subscribed on a long-term basis or used on a spot term basis: two options have to be evaluated since the final result depends on costs aspects and risk hedging strategies. In both cases, fixed or variable regasification fee is worth 0.5 MMBTU. In addition, a shipping differential has to be included either as a fixed cost or as a variable cost. For both strategies it is taken equal to 0.5 USD/MMBTU (the journey to Europe is supposed to be the shortest one, for instance for LNG coming through Gibraltar straight). This approach leads to four scenarios of costs sharing: 1. all costs are fixed: the shipper affords itself a total flexibility to the extent that he can divert a cargo as soon as Nymex-NBP spread is at least higher than 0 USD/MMBTU. But for each potentially arbitrated cargo the shipper has to pay 1 USD/MMBTU, whether there is arbitrage or not. Annual fixed costs in this scenario are 38 MUSD per year. 2. shipping costs are fixed and regasification variable: you pay each month 0.5 USD for each MMBTU and 0.5 USD/MMBTU in addition in case arbitrage occurs, it means as soon as the spread is higher than the variable costs, that is to say 0.5 USD/MMBTU in that case. Annual fixed costs in this scenario amount to 19 MUSD per year. 3. shipping costs are variable and regasification fixed: same margin scenario as in case 2 but without consideration of schedule and feasibility issues (it can be punctually more difficult to book a slot at a regasification terminal than to charter a ship on the short-term market and vice versa) 4. all costs are variable: the mathematic value of the margin is in theory optimized to the extent that you pay only the regasification and shipping services when you need it, i.e. when Nymex-NBP spread is higher that 1 USD/MMBTU. But it supposes that there always exists an available oversupply of regasification capacity at the right time and place, and non-committed ships. These three margin scenarios (scenario 2 and 3 are equivalent from the costs structure point of view) will be used hereafter in the assessment of past and future physical arbitrage value. But it has to be noted that by deciding to arbitrate as soon as Nymex-NBP spread is higher than variable costs, we make a very simplistic view. In practice, because of scheduling hurdles and costs, transaction costs, and so on, nobody would care to divert a cargo for less than 0.2 USD/MMBTU (or even 0.5 for some players) net margin.

2.3 Arbitrage Value in the recent past

2.3.1 Global past value over 101 months

Nymex-NBP differential in the recent past is well known. The chart below recalls the historical average month-ahead Nymex and NBP prices and the resulting Nymex-NBP monthly average spread is in red. The green straight curve represents the cost of cargoes diversion from NBP to Nymex, as result there is a positive value for arbitrage in scenario 4 when the red bars are higher than the green curve.

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Figure 9: Past average month-ahead values of Nymex, NBP, and Nymex-NBP spread Monthly averages of month-ahead daily quotations give an acceptable vision of what the value of arbitrage was from the point of view of a shipper wondering if he should divert a cargo next month. However it would mean that some additional margin that may be taken from daily Nymex and NBP month-ahead volatilities would not be considered. In fact, it is difficult to capture the whole margin to the extent that only a crystal ball can predict the highest spread value of the month. As a result it is helpful to consider average and highest month-ahead spread to have a good idea of margin range. Using the methodology described in paragraph 2.2, there were according to each scenario between 43 and 82 out of 101 arbitrage deal opportunities based on monthly average of month-ahead spread between January 1999 and October 2006 (included) and between 65 and 89 out of 101 arbitrage opportunities based on monthly maximum of month-ahead spread. The table 3 below presents the corresponding margins:

Scenario

Costs sharing (in USD/MMBTU)

Potential past arbitrage Potential past arbitrage Potential past arbitrage Net profit based on monthly Net profit based on monthly Net profit based on likely average of month-ahead maximum of month-ahead case spread spread
in in in Number of Number of Number of USD/MMBTU USD/MMBTU USD/MMBTU arbitrage arbitrage arbitrage for each in for each in for each in opportunities opportunities opportunities MMBTU MUSD MMBTU MUSD MMBTU MUSD over 101 over 101 over 101 effectively effectively effectively months months months diverted diverted diverted

2-3

Fixed Costs : Variable Costs : Fixed Costs : Variable Costs : Fixed Costs : Variable Costs :

0 1 0,5 0,5 1 0

USD/MMBTU

43
USD/MMBTU USD/MMBTU

1.11

150
x2

57
+ 5%

0.88

158

65

1.59

332

65
USD/MMBTU USD/MMBTU

0.35

72

77

0.38
+ 28%

92

84

1.09

290

82
USD/MMBTU

0.12

30 x 2 89

0.17
+ 53%

46

89

0.95

267

Table 3: Potential past arbitrage net profit (or loss) between 1999 and October 2006 based on both average and maximum month-ahead spread [Nymex NBP] for 4 scenarios and for one cargo per month. Assuming that shippers crystal ball has been working well in the past, their maximal historical margin would have been equal to a range of 267 and 332 MUSD over 101 months (that is to say 8 years and 5 months), that is to say an average of around 32 and 39 MUSD per year. Regarding past average value of arbitrage, it could have allowed players to earn between 30 MUSD in scenario 1 and 150 MUSD in scenario 4, for one cargo per month over almost 8 years: Nymex-

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NBP historical differential has been sufficient to balance the medium-term regasification and shipping booking costs for all 4 scenarios over past 8 years. But while scenarios had a significant influence in proportion on arbitrage value based on monthly average of month-ahead spread (since the margin can be doubled or quadrupled), it was not the case regarding monthly maximum of month-ahead spread, to the extent that fixed costs were a trifle compared to the spread. In fact, considering a medium arbitrage valorization method, taking first into account monthly average value and second the monthly historical maximum with a capped income, gives a more realistic view of historical arbitrage value that may have been captured by well experienced players. The results presented in the middle of table is equivalent to the potential past arbitrage net profit based on average spread with an additional value which has been defined as follows: in case arbitrage doesnt occur with monthly average spread, monthly maximum spread is then compared to variable costs plus a threshold that has been arbitrarily fixed at 0.20 USD/MMBTU. When [maximal spread variable costs > 0.20] is true, then the monthly net profit is equal to the minimum of [maximal spread variable costs fixed costs] and 0.20; in case it is false, it is equal to the fixed costs. This method reflects with more finesse the ability for a player to capture the spread volatility, as a result, the corresponding net profit is more realistic: at the end, it is, in relative, not very far away from the net profit based on monthly average of month-ahead spread. In proportion this approach shows that in scenario 1 (variable costs are equal to 0 USD/MMBTU) you increases your net margin by 53%. 2.3.2 A high volatile market

However considering a global potential value over recent 8 years is a rough approximation, to the extent that both average value and volatility varied in a large extent, making the value of arbitrage more attractive in 2005 than in 2002 (or 1999). In recent past, volatility and average price have globally followed the same trend on each market (see figures below). More largely, both markets had the same bullish or bearish trend in average, excepted in 2005 when volatility on NBP became suddenly very high at the end of the year.

Figure 10: Volatility trend on NBP and Nymex markets in recent past

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Figure 11: Average Price Trend on NBP and Nymex markets in recent past (in USD/MMBTU)

Scenario 4 (fixed annual costs equal to 0 MUSD)

Scenario 3-2 (fixed annual costs equal to 19 MUSD)

Scenario 1 (fixed annual costs equal to 38 MUSD)

Potential past arbitrage Potential past arbitrage Potential past arbitrage Net profit based on monthly Number of Net profit based on Net profit based on Number of Number of average of month-ahead monthly average of monthly average of arbitrage arbitrage arbitrage spread opportunities month-ahead spread opportunities month-ahead spread opportunities (in USD) (in USD) (in USD)

1999 2000 2001 2002 2003 2004 2005 01/06 10/06 Total 01/99 10/06

486 461 12 164 934 9 306 445 2 751 569 45 354 146 30 157 537 49 877 957 0 150 099 049

1 5 4 3 10 10 10 0 43

-13 404 532 919 421 -3 325 000 -11 125 258 41 323 701 26 952 676 46 068 963 -15 028 584 72 381 385

9 10 4 7 11 12 11 1 65

-17 447 128 -1 368 278 -12 950 988 -17 197 245 39 202 064 25 993 438 42 911 102 -29 126 931 30 016 035

13 14 6 11 12 13 11 2 82

Table 4: Potential past arbitrage net profit (or loss) between 1999 and October 2006 par year, based on average month-ahead spread [Nymex NBP] and scenarios for one cargo per month. The closer volatility and average price value on both market, at the same time, were, the lower was the value of arbitrage: in 2002 (as it was the case in 1999), volatility and average prices value were very close on NBP and Nymex, reducing the value of arbitrage, contrary to 2005, when volatility and average price reach their highest historical values giving a high value of arbitrage (see table above). Despite the fact that for the first time in 2005 annual average gas price value on NBP has become higher than Nymex, the value of arbitrage was at its utmost, making obvious the preponderant impact of volatility in the value of arbitrage. The main conclusion you can get from past values is that you need to have good financial backing if you try your luck in transatlantic arbitrage. The challenge is thus not only to be able to predict or anticipate future average values and particularly volatilities but to have an appropriate portfolio that can allow you to limit your risks. Net profit potential is not likely to be the same in the future as it is closely linked to several fundamentals like gas price and gas competitiveness with alternative energy sources, gas demand (especially regarding gas fired power plant), Despite lack of visibility in fundamentals trends and without consideration of particular portfolios, next sections are dedicated to an attempt to assess the future arbitrage value: the first one is based on the physical approach, the second one is considered from a financial point of view.

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2.4 Physical Arbitrage Value according to future markets

In this section, the potential future value of physical arbitrage is assessed through two variants of software called VIAGGEO that has been developed by the Research Division of Gaz de France. Both of them give an arbitrage value assessment using numerical Monte Carlo method. As a result, the arbitrage value based on historical and forward prices has been evaluated as of October 2006 and a sensitivity analysis on prices fundamental parameters (average value, average trend, seasonal spread, seasonal phase displacement and daily volatility) has been led. General considerations and main assumptions presented above do apply to this section, as well. However, to limit the vast scope of the study only scenario 1 and 3 have been considered hereafter in the sensitivity analysis (variable shipping costs / fixed regasification) to the extent that it gives central results and seems more realistic in practice from Gaz de France point of view as a shipper. 2.4.1 Arbitrage value based on historical value and forward prices

The chart below presents the month-ahead average previsions assessed by VIAGGEO version 1. The calculated curves are based on historical and forward prices as of October 2006 and have been assessed thanks to an algorithm developed by the Research Division of Gaz de France. Although the volatility is not presented on the chart, it is included in the assessment of the potential arbitrage margin.

Figure 12: VIAGGEO month ahead average prices for NBP (red curve in USD/MMBTU and Nymex (black curve in USD/MMBTU) projection for each month over one year as of October 2006

The potential future margins (as of October 2006) between 1/11/2006 and 1/11/2007 are given by the charts below, whether an arbitrage business is put in place (WITH arbitrage) or not (WITHOUT arbitrage): each possible margin (expressed in MUSD) is linked to its probability of occurrence. In fact, each bar represents the probability (in 1/1000) calculated by a Monte Carlo numeric method of realizing a margin expressed in MUSD, as a result the probability distribution looks like a Gaussian distribution, whose average value is presented on the right of the chart and the potential margin value at a risk level of 5% is represented through a red dotted line (each drawing lot gives a margin and the aggregation of 1 000 drawing lots gives the global probability for each margin).

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Figure 13: Potential margin WITH and WITHOUT transatlantic arbitrage as of October 2006 VIAGGEO simulations with fixed regasification costs on both sides of the Atlantic (abscissa: margin in USD ordinate: frequency in 1/1000) At a first glance, the arbitrage brings additional value whether you consider North American regasification costs as fixed or variable, to the extent that the average margin differential is equal (see table below) to 106 MUSD (with fixed costs scenario 1) and 113 MUSD (with variable costs scenario 3). Looking more in depth, arbitrage can be viewed over the considered period as a stop loss, because of the negative value of the margin (-20 MUSD) at a risk level of 5% without arbitrage, while it is largely positive (at least 85 MUSD) with arbitrage. To make the understanding of the reader easier, the risk level and its associated margin transcribes in fact the probability to obtain a margin at least equal to the one presented: for instance a 5% risk level, that gives a associated margin X, means that, in 95 times out of 100, the margin will be higher than X.

Fixed regasification costs on both side (Scenario 1) WITHOUT transatlantic arbitrage (in MUSD) WITH transatlantic arbitrage (in MUSD) Margin differential

Variable regasification costs on North America side (Scenario 3) WITHOUT WITH transatlantic transatlantic Margin arbitrage (in arbitrage (in differential MUSD) MUSD)

Average Margin
5% risk level 20% risk level 50% risk level 80% risk level 95 % risk level 100 % risk level

205
-20 27 113 313 754 3888

311
85 138 242 414 776 3871

106
105 111 129 101 22 -17

205
-20 27 113 313 754 3888

318
88 143 248 421 793 3888

113
108 116 135 108 39 0

equivalent Table 5: Potential Margin assessed by VIAGGEO (in MUSD) as of 30/11/2006 for one cargo per month over one year [1/11/2006 1/11/2007] More generally, as of October 2006, transatlantic arbitrage seems to be profitable to a large extent (see additional margin charts below) over the next 12 months. But it doesnt mean that it will remain true in the long run. To assess the value of arbitrage, great assumptions have to be made and a sensitivity study to be led, what is undertaken in the next section.

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Figure 14:Probabilistic assessment of potential additional values due to transatlantic arbitrage in MUSD: each possible additional value due to arbitrage compared to the base case all to NBP has been given a probability by VIAGGEO calculation model (abscissa: additional margin in USD ordinate: frequency per thousand) 2.4.2 Sensitivity analysis

NBP and Nymex prices can be described under 5 parameters that are the following: average value, average trend, two components for the seasonality, which are spread and phase displacement, and the volatility. As a result, the formula below may be a good transcription of past month ahead prices on Nymex and NBP markets and is likely to remain an acceptable representation for future prices.
2 2 P(t , M + 1) = at + b + c1 sin + c 2 cos + d (chance) 12 12
with: a b c1 and c2 d (chance) M+1 t Price average trend Average price spread and phase displacement volatility Random function Month ahead (month when the delivery occurs) One day of the month before gas delivery: time at which decision to divert the cargo to Nymex has to be taken regarding the month ahead Nymex-NBP spread

R-software5 computed all regression coefficients associated to historical prices on both markets over different periods starting from one year to 7 years (time limits are 1999 and 2005) and according to the formula presented above. The underlying regression errors are never worse than 10-15, as a result the mathematic representation seems to agree with real prices trend. The charts below give two examples of the computed results: the black curve is the graphic representation of the formula completed with computed coefficients of the considered period and with a volatility equal to zero to make the reading easier; the red curve represents the real historical prices. At a first glance, the similarity between the two curves seems good, what is confirmed by a p-value less than 2.2*10-16 in both presented cases.

R is a free software environment for statistical computing and graphics. For further information please look at http://www.r-project.org/

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Figure 15: NBP price curve between 1999 and 2004 (left) and in 2005 (right) Once the regression for each past year and over longer periods is done, VIAGGEO V2 comes into play. This derived software from VIAGGEO V1 is user-definable as a result the main inputs are a, b, c1, c2 and d, allowing thus the user to lead a real sensitivity analysis. The determination of past value for this parameters is very useful in fact to give more sight regarding future trends forecasts and so helps to fix a base case which is equivalent to a central scenario around which each parameter can be modified. As a result more information regarding the impact of each ones on the arbitrage value can be comprehended. The central scenario has be chosen as the following: arithmetical average of maximum and minimum values over 7 years (1999 2005) for a, b, c1 and c2, and geometrical average of maximum and minimum values for the volatility d over the same period. In fact, the volatility average geometrical value is lower than the arithmetical average value, especially for NBP. But it seems more realistic to start with a medium volatility for the central scenario to the extent that recent volatility on NBP might not remain at so high a level as in winter 2005/2006 in the long run.

Figure 16: NBP and Nymex central scenario curve with volatility equal to zero The central scenario gives quite the same average margin potential whether you consider the possibility of arbitrage or not, but the value at 5% risk is lower (see red straight on charts below) in the case in which arbitrage may occur. This effect is due to fixed regasification costs for all the presented analysis results.

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Figure 17: Potential margin WITH and WITHOUT transatlantic arbitrage (abscissa: margin in USD ordinate: frequency) with central scenario Around 100 simulations were done with volatility higher than zero. As a result, the following main principles can be remembered: From a general point of view, if it is true that fixed costs capacities on North American side may be a dead loss, they are also a insurance against potential NBP market reversal: more than an opportunity of capturing an additional margin, it represents a perfect illustration of risk hedging strategy. Although this point was quite obvious, it appears more clearly over the different simulations as a good hedging strategy. This observation appears very clearly in the average price sensitivity analysis. The straight curve, whose equation is done by a * t + b , gives the prices annual average trend. As a result, using central scenario with a and b equal to either minimum or maximal values on both markets between 1999 and 2005 is equivalent to looking at the impact of 365 + b ) on the value of arbitrage (16 annual average prices (given by around a * 2 different combinations). Such combinations give a range of arbitrage values based on known past a and b values, whose limits are given by the combination [min;min] and [max;max] on both markets. It is useful to notice that these two combinations dont represent real former prices since a and b were not at their highest or minimal values for each market at the same time and may not agree with rational values. Moving apart unrealistic average annual prices (annual average prices are not likely to be negative), there is, in almost all cases, an arbitrage value in a range of 20 MUSD 340 MUSD per year; however there is a very limited potential loss equal to 9 MUSD (that is to say less than fixed costs) for the case NBP high and Nymex low. Seasonality and phase displacement have a lower impact on arbitrage, to the extent that average price and volatility are the main issues. In fact, unlike NBP, Nymex has not a strongly marked seasonality, as a result Nymex summer historical prices have been often higher than summer NBP prices in the past. Influence of volatility: using equivalent average value on NBP and Nymex (not central scenario) and applying lowest and highest volatilities that have ever been between 1999 and 2005 (4 different combinations) shows that in all cases there is a positive value of arbitrage. Of course, the value reaches is highest point with volatility highest value on both Nymex and NBP and its minimum with volatility minimum values on both markets. Comparing more in depth the resulting values of arbitrage, it appears that the case highest-highest gives 14% more average value than minimum-minimum case but 25%

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more value at 5% risk. Doubling two maximal volatilities gives a value of arbitrage 45% higher than in max-max combination; this effect is stronger for the value at 5% risk level that is enhanced by 60%. In a nutshell, the more volatility increases on both markets, the more value of arbitrage raises and the more the margin is secured, since the value at 5% risk increases.

2.4.3

Main lessons

Regarding the past and the next 12 months after October 2006, Atlantic physical arbitrage is valuable. The sensitivity analysis shows in fact that, before being an opportunity of capturing a potential additional margin, physical arbitrage represents a good hedging strategy in the long run. Besides, the more volatility increases on both markets, the higher the value of arbitrage is and the more the margin is secured, since the value at 5% risk increases. However Achilles heel of physical arbitrage is the mismatch between the feasibility of locking forward prices at Nymex or NBP over more than 3-4 years or pricing a spread option over the same duration and the normal duration of tolling agreements for firm regasification capacity (typically 20 years). The visibility in case of a financial arbitrage is not better but the commitment duration can be shorter (typically 3 years at the most), as a result it remains to demonstrate whether financial arbitrage is economic or not, or even more economic than physical arbitrage

2.5 Financial Arbitrage Value according to future markets

In this paragraph the issue of financial arbitrage is addressed and then compared to a physical arbitrage at current future prices. The simplest way to realize financial arbitrage consists in buying call options6, whose underlying asset is the Nymex-NBP-spread, for a quantity equal to one cargo per month, at a strike value of 0, 0.50 or 1 USD/MMBTU and using them when the spread is higher than the strike. Because liquidity of such financial products is limited to 4-5 years, it is not realistic to compare physical and financial arbitrage, as durations are not the same; but it gives a good idea of the competitiveness of these two different strategies on the medium term. After this short digression, lets precise the area of the study: all call options prices expressed in USD/MMBTU as of October 2006 and as of December 2006. The Nymex-NBP spread and the call options value have been monetized for 3 different strike values over around 5 years (59 months), although the liquidity of this financial market is very limited after 3 years. The three different strike values are in fact equivalent to the three different variable costs structures presented in the physical arbitrage section: 0 USD/MMBTU (scenario 1), 0.5 USD/MMBTU (scenario 2 and 3) or 1 USD/MMBTU (scenario 4). As of October 2006, Nymex-NBP forward spread values between February 2007 and December 2011 have a medium value of 0.83 USD/MMBTU and are never higher than 1 USD/MMBTU (the minimum is equal to 4.2 USD/MMBTU and the maximum is equal to 0.70 USD/MMBTU: see chart 18 presenting the evolution of Nymex-NBP spread, call options price -intrinsic and time value- for two7 strikes - 0 and 0.5 USD/MMBTU), as a result physical and financial arbitrage never occur in scenario 4 and the value of arbitrage is never positive.

In order to make the understanding of this part easier, a small reminder of the call concept is presented in appendix 2 The option with a 1 USD/MMBTU strike has a intrinsic value equal to 0 USD/MMBTU during the 5 considered years, as a result there is no differential between Option time value and option value.

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Physical Arbitrage
As of October 2006
Scenario 4 Fixed Costs : 0 USD/MMBTU Variable Costs : 1 USD/MMBTU Scenario 3-2 Fixed Costs : 0.5 USD/MMBTU Variable Costs : 0.5 USD/MMBTU Scenario 1 Fixed Costs : 1 USD/MMBTU Variable Costs : 0 USD/MMBTU

Financial Arbitrage
Scenario 4 Strike = 1 USD /MMBTU Scenario 3-2 Strike = 0.5 USD /MMBTU Scenario 1 Strike = 0 USD /MMBTU

Number of months when Option Intrinsic Value > variable costs for physical arbitrage or strike in case of financial arbitrage Total Fixed costs (in MUSD) Income (in MUSD) Net profit (/loss) (in MUSD)
8

13

13

0 0 0

-93 1.5 -92

-186 18 -168

-227 0 -227

-258 1.5 -257

-293 18 -275

Table 6: Physical and financial arbitrage total net profit (or loss) for one cargo par month between February 2007 and December 2011 as of October 2006. However the same valorisation ( Nymex-NBP forward spread values between February 2007 and December 2011) as of December 2006, gives other margin perspectives with a medium value of 0.033 USD/MMBTU and with 9 months when the month-ahead spread is higher than 1 USD/MMBTU (the minimum is equal to 1.80 USD/MMBTU and the maximum is equal to 1.53 USD/MMBTU ; see chart 19); as a result physical and financial arbitrage occur at least 9 times in each scenario, making the value of arbitrage positive in scenario 4, while it remains negative for all other scenarios (but with higher relative values than as of October 2006). For both valuations, regarding total amount of fixed costs, the global trend is the same, either you consider financial or physical arbitrage: the lower your strike level is, the higher option is worth, making scenario 1 largely less competitive than the others. As a result incomes are never high enough to balance the costs, except in scenario 4 of physical arbitrage as of December 2006, where the costs are equal to zero and the incomes are positive. The fact that financial arbitrage is negative for all scenarios, at present time, is not surprising, since the maturities of the considered call options are very remote, making time option value the main component of the option price.

Physical Arbitrage
As of December 2006
Scenario 4 Fixed Costs : 0 USD/MMBTU Variable Costs : 1 USD/MMBTU Scenario 3-2 Fixed Costs : 0.5 USD/MMBTU Variable Costs : 0.5 USD/MMBTU Scenario 1 Fixed Costs : 1 USD/MMBTU Variable Costs : 0 USD/MMBTU

Financial Arbitrage
Scenario 4 Strike = 1 USD /MMBTU Scenario 3-2 Strike = 0.5 USD /MMBTU Scenario 1 Strike = 0 USD /MMBTU

Number of months when Option Intrinsic Value > variable costs for physical arbitrage or strike in case of financial arbitrage Total Fixed costs (in MUSD) Income (in MUSD) Net profit (/loss) (in MUSD)

18

28

18

28

0 9.6 9.6

-93 30 -63

-186 66 -121

-241 9.6 -232

-277 30 -246

-316 66 -250

Table 7:Physical and financial arbitrage total net profit (or loss) for one cargo par month between February 2007 and December 2011 as of December 2006.

This term represents the value of arbitrage.

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Comparing both valuations, the value of physical and financial arbitrage is globally higher in December 2006 than in October 2007, although it remains negative in 5 out of 6 cases (costs, incomes and net profits/losses are presented in table 8). This improvement (it remains negative values) is due to incomes increase, except for scenario 4 of the financial arbitrage, to the extent that new income sources dont manage to balance the increase of options costs (see white characters on red background in table 8 for costs increase). Of course, in case you had bought all options on October 2006, the conclusions would have been more favourable to the extent that you would have both improved your incomes and avoided the increase of options value.

Physical Arbitrage
As of October 2006 and December 2006
Number of additional months comparing December to october valuation when Option Intrinsic Value > variable costs for physical arbitrage or strike in case of financial arbitrage Total Fixed costs differential (in MUSD) Income Differential (in MUSD) Net profit (/loss) differential (in MUSD)
Scenario 4 Fixed Costs : 0 USD/MMBTU Variable Costs : 1 USD/MMBTU Scenario 3-2 Fixed Costs : 0.5 USD/MMBTU Variable Costs : 0.5 USD/MMBTU Scenario 1 Fixed Costs : 1 USD/MMBTU Variable Costs : 0 USD/MMBTU

Financial Arbitrage
Scenario 4 Strike = 1 USD /MMBTU Scenario 3-2 Strike = 0.5 USD /MMBTU Scenario 1 Strike = 0 USD /MMBTU

13

15

13

15

0 9.6 9.6

0 28.5 28.5

0 48 48

-14 9.6 -4.4

-19 28.5 9.5

-23 48 25

Table 8: Physical and financial arbitrage total net profit (or loss) differential between October 2006 and December 2006 valuation, for one cargo per month between February 2007 and December 2011. This quick change in the situation regarding income sources can be quite surprising at first glance, although part of it can be easily explained, when we look at both intrinsic and time value of financial options. The time value of an option is an anticipation of an increase in intrinsic value, and decreases when the intrinsic value actually increases. The comparison of the two valuations as of December 2006 and as of October 2006 illustrates the greater confidence markets players have in December in a positive Nymex-NBP spread. And this confidence seems to be highly volatile during months when the time value is peaking, such as November 2006, explaining thus a part of the gap of expected incomes over the 5 coming years between valuations made just before and just after November 2006. More generally, time value of options as of October 2006 has peaking values, for each coming year, in April and November, where it reaches its top level (see charts 18 below). In fact, it is not surprising, since historical and by VIAGGEO V1 forecasted Nymex and NBP month ahead prices (as of October 2006) are crossing in April and November, making thus during such months volatility the main source of potential value for arbitrage : the probability of capturing an arbitrage value by transformation of the time value into higher intrinsic value thanks to volatility appears as high in April and November.

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Figure 18: Nymex-NBP Spread, Call Options price, intrinsic and time value as of October 2006 for a strike equal to 0 USD/MMBTU on the top and 0.5 USD/MMBTU on the bottom (all prices are expressed in USD/MMBTU) The valuation as of December 2006 confirms the existence of peaking time values, although they have moved in the first semester from April to March, November remaining the reference for the second semester. The forward Nymex-NBP spread amplitude as of December 2006 is reduced compared to its value two months earlier, and the average value has been enhanced, as it appears in the incomes increase.

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Figure 19: Nymex-NBP Spread, Call Options price, intrinsic and time value as of December 2006 for a strike equal to 0 USD/MMBTU on the top and 0.5 USD/MMBTU on the bottom (all prices are expressed in USD/MMBTU)

The first conclusion you can draw from this comparison is that if you want to have the option to capture each month the Nymex-NBP spread, and if you have a flow of LNG you are able to divert, then buying capacity on the other side of the Atlantic is a cheaper way to do it than buying call options. This shouldnt be a surprise: it simply means that having a divertible LNG flow and capacity on both sides of the Atlantic is a position which gives you an option value, and you can monetize this optionality by selling the corresponding call options to somebody else. In other terms, it means that such a physical and contractual position has a global value of around 40 MUSD per year (this figure represents the annual average financial arbitrage price / physical arbitrage cost differential over 5 years) in addition to its intrinsic value discussed in chapter 2.4. However, as far as pure financial strategies are concerned, buying a call option each month whatever the intrinsic value is and waiting until its maturity to exercise it or no would be very rough. Financial products are assets that can be monetize and optimised both at the beginning of the hedging period (in buying only a certain quantity of options on pre-defined months when the likelihood to strike them may be higher or the time value is likely to transform in higher intrinsic value) and all along the option lifetime by selling and buying other financial products. Time value is in fact the key of financial arbitrage. For instance, the simple fact of buying call options as of October 2006 and over 59 months, gives you a margin potential of 14 MUSD in scenario 4, 19 MUSD in scenario 3 and 2, and 23 MUSD in scenario 1 (look at table 8 above) by the resale of all options in December 2006 but it doesnt solve the issue of your gas portfolio management. The main conclusion thus remains that physical arbitrage seams to be cheaper than financial arbitrage for the same duration on the medium-term. Although physical arbitrage is more rigid, the choice for physical arbitrage or financial products depends on players positions and on the confidence they have in future markets trends as well. But a prudent and well-advised player may not put all eggs in one basket and physical arbitrage can be hedged and optimised thanks to other financial products acting, for instance, as stop loss.

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MAIN CONCLUSIONS
Transatlantic arbitrage is a topic for discussion in any and every conference on LNG. Some players forecast a very quick development for this kind of trade, when others, amongst which is Gaz de France, consider that the technical and contractual difficulties encountered when trying to divert a cargo, as well as the need for long-term contracts to secure financing of new liquefaction plant, will keep such arbitrage at a marginal rate within the global LNG trade. The first result of our work on arbitrage is to demonstrate that such arbitrage amounted in 2005 for less than 4.5% of total LNG trade. The second was to state that despite progress in some areas (like EASEE-Gas specifications in Europe), numerous technical difficulties remains on the way of players trying to divert a cargo and that even measures supposed to facilitate arbitrage (like UIOLI rules in Europe) could in fact impede it (by making availability of a slot uncertain for the primary capacity holder, often in a better position than a trader to have access to spot market, wanting to make last-minute decision). The third one is to show that, under reasonable assumptions regarding price and regasification capacity costs, the value brought to a player who has a normal flow of LNG going to Europe and decides each month to send or not a cargo to the USA according to price signal would have been significantly positive in average during the past seven years, although highly volatile, even with various strategies regarding costs. The fourth conclusion is that under reasonable assumptions on the future price and volatility, on taking into account the future prices for the next year, playing arbitrage across the Atlantic is not only a profitable but also a good risk-hedging strategy (minimizing the probability of low profit or loss). This becomes even more important if price volatility increases. Finally our fifth outcome is that it is possible to simulate through financial derivative (using for instance call options) the equivalent of the real option that is physical across Atlantic arbitrage, but only for a limited period of time. The fact that the cost of such a strategy seems higher than the cost of the real option (represented by regasification capacity for instance) simply means that time-value embedded in physical arbitrage capacity is higher than the cost of the capacity and is revealed in the price of financial derivatives. But it doesnt mean that financial options are less attractive for a player to hedge his position in general : a prudent and well-advised player may complement, hedge or optimise its physical arbitrage capacity by financial products acting as stop loss mechanism, for instance. To summarize : the lessons of the past are that there is money to be done by arbitrage over the Atlantic for players able to deal with all the technicalities involved with cargo diversion. For the future, taking into account the large fixed costs involved with an independent arbitrage strategy, and the high sensitivity of the profitability to the average Nymex-NBP spread and volatility, such a strategy is recommended for large players with significant LNG flows, and will even act as a riskhedging method, but is very risky for smaller players.

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APPENDIX 1 : Short presentation of VIAGGEO software

The Research Division of Gaz de France has developed two versions of VIAGGEO. Both them give an arbitrage assessment thanks to numerical Monte Carlo method. The first VIAGGEO version integrates historical and forward prices and, as a result, works out, thanks to a specific algorithm, future average months-ahead prices on both markets and their associated volatilities. The second one is more untypical because it is user-definable. The main 5 inputs (equivalent to prices fundamentals) that defined prices evolution over a year are the following: average value, average trend, two components for the seasonality (spread and phase displacement) and the volatility. This second version allows us to perform a sensitivity analysis and so helps us to estimate the arbitrage value in different future market trend. The philosophy can be illustrated as follows: the cargo is sent to the market that gives at the end the highest margin. For each simulation, 1 000 drawing lots are done, resulting margin in a histogram.

1M 1M > F$ if F F (t ) -C (t$ ) - C$

)(

) )( )

Europe

One Cargo per month

1M 1M if F (t ) - C < F$ (t$ ) - C$

US t t = t +1AS t$ = t +1AS $

Time

Margin = Max

1M(t ((F

1M(t ) - C ) ) - C ), (F$ $ $

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APPENDIX 2 : Call option principle

In order to make the understanding of this part easier, a small reminder of the call concept is presented hereafter: a call option is a financial contract between two parties, the buyer and the seller of this type of option. The buyer of the option has the right, but not the obligation to buy an agreed quantity of a particular commodity from the seller of the option at a certain time (the expiration date) for a certain price (the strike price). The seller (or "writer") is obligated to sell the commodity or financial instrument, should the buyer so decide. The buyer pays a fee (called a premium) for this right. Call options are most profitable for the buyer when the underlying instrument is moving up, making the price of the underlying instrument closer to the strike price. When the price of the underlying instrument surpasses the strike price, the option is said to be "in the money."

Figure 20: Call option principle

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