Water Hyacinth and Biogas Production

Possible Hedging Strategy against Natural Gas Prices

Fluctuations
Universit degli Studi di Siena Financial Engineering Project
Giulio Francesca
07/06/2015

Index
Introduction ............................................................................................................... 3

Energy Production and Costs ..................................................................................... 4

Investment Strategy ................................................................................................... 6

Modelling Gas prices and Monte Carlo simulations ................................................... 7

Introduction
The aim of this document is to make profitable the activity of removal of the infesting water plant, the
Water Hyacinth (also known as Eichornia Crassipes), from lake basins in tropical countries. Very often such
countries are not able to find the financial resources needed to remove this weed, and accept therefore the
consequences of the infestation of the Water Hyacinth.
Coming from the Amazon, Water Hyacinth (from now on, WH) has rapidly spread over several countries of
Latin America, Africa, south-east Asia and Pacific area. Its high reproductive rate is due mostly to the
absence of natural enemies of this plant and to the accumulation of fertilizers and chemicals in water
bodies near urban or industrial settlements.
The damages of the infestation of WH affect mostly harbors, fish fauna and hydroelectric power plant. The
removal of this weed could also appear useless: WH presents a very high speed of reproduction and the
once a sweeping operation is done, the problem could arise again in a brief period.
Table 1. Main Water Bodies Infested by Water Hyacinth in Developing Countries
______________________________________________________________________________
Region: Latin America and the Caribbean
Bolivia San Jacinto dam, Tarija.
Colombia In lagoons outside of Amazonia.
Cuba Commercial dams in Western and Central part of the country.
Mexico Lakes Chapala and Guadalupe, the Santiago River and several
other dams in the centre and south of the country.
Region: Africa (including northern part of the continent)
Angola Kwanza River and related irrigation network.
Benin So and Oum rivers, Lake Nokoue.
Burundi Kagera River.
Egypt Nile River and related irrigation network, and Northern lakes.
Ghana Tano Lagoon and Accra/Tema water areas.
Ivory Coast Tano Lagoon, Como River, Ono Lake.
Kenya Lakes Victoria and Naivasha.
Malawi Zambesi and Lower Shire Rivers, Lake Malawi.
Mali Niger River.
Niger Ibid.
Nigeria Ibid.
Rwanda Kagera River.
Sudan Nile River.
Tanzania Lake Victoria, Pangani, Kagera and Sigi Rivers.
Uganda Lakes Victoria, Kyoga and Kwania.
Zaire Congo River, Lake Albert.
Zimbabwe Lake Chivero and Manyame River.
Region: Southeast Asia.
There are various countries in this region facing problems of water hyacinth infestations, these are southern part of China, Thailand,
Vietnam, Laos and Indonesia.

WH can be removed mainly in three ways: chemical, physical and biological. To explain the problems
related to each of these techniques is out of the scope of this document, but it is fundamental to observe
how such ways of eliminating the problem fails both in an economic and environmental point of view. For
instance, the chemical removal requires facilities and equipment to apply chemical products and very often
there can be environmental constraints to the usage of such products.
Therefore, a solution could be to not waste the removed plants, but instead use it as an input in the
production of biogas. In this way, it is possible to combine the benefit of removing this weed from water
bodies, gaining at the same time a source of clean energy.

Energy Production and Costs

The yield per hectare of WH can reach, in the most favorable weather conditions, 100 t/ha/year (100 tons
per hectare per year). The yearly production per hectare in California has been estimated to be equal to 88
tons, which is well over the one of other species as showed in the following table:
Species
Brassica
Casuarina equisetifolia

Dry Mass
(t/ha/year)
3-10
8.3

Cichorium intybus

5.5-7.9

Colocasi esculenta

9-19

Cynodon dactylon

23.5-24.6

Daucus carota
Eichornia crassipes
Elodea

2.5-5.5
30-88
3

Eucalyptus

5.6-20

Helianthus tuberosus

2.2-9.5

Hydrilia
Hydrocotyle umbellata

15
20-58

Ipomoea batatas

7-23

Manihot esculenta

2-17

Melaleuca quinquenervia

28.5

Paspalum notatum

22.4

Pennisetum sp. (Napier)

57.3

Pinus clausa

9.0

Pinus elliottii

9.4

Saccharum

32-54

Sorghum

16-37

Typha sp.

20-40

Notice that all this species are not taken randomly, but they represents possible competitors of WH in the
production of Bioethanol (the result of the fermentation of carbohydrates produced in crops).
From an hectare of Eichornia Crassipes it is possible to obtain more than 70.000 m3 of biogas (70% of this
being methane). A kg of dry mass yields between 260 and 370 liters of biogas with a calorific power of
22,000 kJ/m3 ( about 60% of that of pure methane). In India, from a ton of dry mass of WH it has been
produced 50 liters of ethanol. The fermentation of a ton produces on average 750 m3 of gas (633 KJ), 51.6%
of methane, 25.4% of hydrogen, 22.1% CO2 and 1.2% oxygen.
The cost of producing biogas from the fermentation of WH is affected, as the production of natural gas, by
several factors. However, the high rate of reproduction of Eichornia Crassipes is such that we can omit
issues regarding contingencies related to this input: that is, since this particular plant is able to reproduce
itself easily and it is also highly weather resistant, it is assumed, in what follows, that the production of
biogas through WH is constant over time. The average price for biogas is on average 5 USD/MMBtu ( 5 $
per one million British thermal unit), which is well over current natural gas prices. Yet, the price of biogas
can be depurated of some components, as:
1 Emission price premium : fossil natural gas emission of CO2 coming from the extraction of this gas are
higher than those coming from the production of biogas. Nowadays, many countries legislate on the level
of emissions of CO2, requiring specific standards. Companies will then willing to pay more for a source of
energy that is compliant with regulatory constraints.
2 Arable land constraints : biogas producers usually have to face restrictions on the soil they can use for
their production. In-fact, biogas production from general crops (maize, sugarcane, ) subtracts arable land
that could be exploited for the seeding of food crops. Biogas producers will have to raise their price if they
are not willing to accept to lose profits. Notice that this represent a problem for Brazil; in this country,
which is the biggest producer of energy from biomass, the land used for food production has been strongly
replaced by crops devoted to biogas production, generating imbalances in the food industry.
This two point turn out to be not so relevant when we assume that the biomass used in the production of
the gas comes from Eichornia Crassipes: this plant is widely spread in countries that usually dont have
strict environmental laws and therefore, companies that need gas are not really concern about CO2
emissions and will not pay any premium for biogas. At the same time, WH does not subtract arable land
since it grows in places that cant be used for food crops. Take, for instance, the region of lake Victoria in
front of the city of Kisumu, Kenya:

The highlighted area in the picture shows the extension of Eichornia Crassipes. This infestation represent a
big problem for several reason, most of them related to waterway transport and fishing activities but also
to healthcare, since such infested water basins are often incubators for different diseases. It is clear, in this
situation, how the question linked to CO2 emissions and restricted arable land are of second order with
respect to the problems listed above; moreover, arable land is not at all an issue, since, as is it possible to
see in the picture above (and as the name suggests), Water Hyacinth grows in the water.
For these reason we can subtract both these premiums (on average 0.5 USD/MMBtu for emission premium
and 1.5 USD/MMBtu for arable land premium) from the estimated price for the biogas, yielding a clean
price of 3 USD/MMBtu. Given that the current price of natural gas I equal to 2.64 USD/MMBtu, how can we
take profit from the difference between those prices?

Investment Strategy
Take again as an example the bay of Kisume in Kenya. Kenyan government could decide to install a digester
plant and collect WH to produce biogas. Obviously, we are taking for granted that the government has the
amount needed to start such a project and that the gas that will be produced can be sold to foreign
government and so that it can be easily transported (which is not so common due to the lack of pipelines).
Once the plant is able to produce the biogas, Kenya would decide whether to keep this gas or sell it to
foreign countries. This countries are willing to buy the gas only to the extent that the price for it is less than
the natural gas price they can find on the markets. However, we can assume that neighbor countries will
always buy biogas from Kenya since the cost of importing gas from Europe or other places will be always
higher due to transportation costs.
Therefore, Kenyan government could find a counterparty that is interested in exchange natural gas with
biogas; in particular they could buy from the counterparty the right to sell to him a certain amount of
biogas, receiving in return the same amount of natural gas (i.e. Kenya should buy a put option with strike
equal to the cost of production of biogas and natural gas price as underlying). By this way, when biogas

price is over natural gas price, Kenyan government will exercise the option, take the profit from the
difference between prices and, at the same time, satisfy the internal demand for gas.
In the hypothesis in which biogas prices is under natural gas prices, Kenyan government will lose the
premium paid to buy the option and dont exercise it. Instead, it could sell a portion of the biogas to
neighbor countries (that are always glad to buy it locally rather than importing it from other places in the
world), leaving another portion for internal requirements.
There would be also the possibility to sell it to non-neighbor countries that face emission constraints if, for
example, these constraints raise the price of natural gas over the sum of biogas price plus the
implementation cost of pipelines. That is, Kenya would find profitable to sell the biogas to such countries
only if the biogas price, plus the periodical amortization of the new pipelines, are less than what these
importing countries should pay for normal natural gas (taking into account emission constraints cost).

Modelling Gas prices and Monte Carlo simulations

Several models have been implemented to study gas prices. There are simple models, which depends only
on one stochastic factor and models that refer to different stochastic factors. The most simple, but
probably the most reliable models, are based on one factor only; in particular, in such models, it is assumed
that the gas prices follow a Ornstein Uhlenbeck process. Therefore, the model could be written as:
= ( ) +
Where S represents the price of natural gas, the speed of mean reversion and the long term mean.
Given this model, we can simulate the equation above by Monte Carlo method and obtain the value of the
gas prices at a certain date in the future. Moreover, we can use this simulated value to investigate whether
a put option with underlying K, corresponding to the production price of biogas from WH, will be exercised
or not.
Using a K equal to 3 USD/MMBtu, starting from a value of the natural gas prices of 2.64 USD/MMBtu,
setting a maturity of 1 year and for 10000 simulations, we obtain a value for such a contract of 0.65 USD.
However, as the maturity widens, the output can change a lot: if we set as expiration date 20 years, the
price rises to 0.87 dollars while if the contract is set on 40 years, the price of this put option collapses to
0.37 dollars. The differences between prices for different maturities for this put option depends on the
variability of gas prices; this variability would be higher if we took into account more than one factor
(considering seasonality effects for example). Notice that we could also design the price of biogas K, as a
stochastic process since also biomasses are influenced by weather conditions and many other factors.
Anyway we have also already noticed that Eichornia Crassipes is not much influenced by these factors and,
in any case, its growth is less affected by exogenous elements if compared with other sources of energy.
The model could be extended including the so-called convenience yield : this factor represents the
benefit from directly holding gas (rather than having a derivative contract on it) during irregular market
movements. The model, introduced by Gibson and Schwartz in 1990, is composed by two stochastic
processes: the spot price of natural gas is assumed to follow a Brownian motion (where we add the
convenience yield to the drift term), while follows a mean reverting process. Formally:
= ( ) +

 = ( ) +
Notice that the convenience yield can assume both positive and negative values. As assumes higher and
positive values, natural gas prices will fall down; this will increase the payoff of the put option as the
difference between K and S widens ( producing an increase also in the price of this contract ). On the other
hand, when is very small, the payoff between biogas price and natural gas will be narrower until the
point it becomes negative, inducing Kenyan government to not exercise the put option and deliver the
biogas production to other uses ( internal demand or neighbor markets ).

More complicated models take into account seasonality term. In general, we observe high gas prices in
winter and lower gas prices in summer months:

And, also in this case, the seasonal component will modify the choice of whether exercise or not the option.