At one time, most natural gas was sold under long term contracts. However, reneging on take or pay contracts by pipelines poisoned the environment. It may well be that the demise of long term gas contracts stimulated the emergence of gas futures and options because these derivative contracts have extra enforcement arrangements like daily mark to market settlements. Forms of Flexibility Another way to hedge market risk, is to build physical flexibility into the operations. For example, refinery investment over and above simple distillation permits successful operation in a wider range of market conditions.
Vertical integration is another example.
Refiners with an upstream production affiliate, have a kind of assured supply with price guarantees for a defined time period. The producing subsidiary is a ready supplier, especially in difficult market conditions, compared with nonaffiliated producers. As such, it is reasonable for the internal transfer price to reflect the options premium. Moreover, vertical integration reduces the problem of contract reneging. These are powerful considerations.