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Merchant Commodity Storage Practice Revisited

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  • Nicola Secomandi

    (Tepper School of Business, Carnegie Mellon University, Pittsburgh, Pennsylvania 15213)

Abstract

Commodity merchants use various heuristics to value leasing contracts on storage facilities as real options and make inventory trading decisions. Two prominent heuristics sequentially reoptimize simple models, leading to the so-called rolling intrinsic (RI) policy and rolling basket of spread options (RSO) policy. The extant literature numerically demonstrates that these two policies are nearly optimal in many realistic settings and can be used with Monte Carlo simulation to obtain fairly accurate estimates of the value of storage contracts. This paper provides a theoretical basis for the observed benefit of reoptimization with these heuristics and additional numerical evidence for the near optimal performance of the RI and RSO policies in several practical cases, but shows that the RI policy significantly outperforms the RSO policy in some of these cases. This research also proves that the RSO policy has a double basestock target structure, a known property of an optimal policy that is trivially true for the RI policy. Moreover, this work develops efficient and effective dual bounds to assess the performance of merchant commodity storage heuristics. In particular, these bounds are immediately relevant to the developers and users of the two considered heuristics.

Suggested Citation

  • Nicola Secomandi, 2015. "Merchant Commodity Storage Practice Revisited," Operations Research, INFORMS, vol. 63(5), pages 1131-1143, October.
    • Handle: RePEc:inm:oropre:v:63:y:2015:i:5:p:1131-1143
    DOI: 10.1287/opre.2015.1407
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Jiao Wang & Lima Zhao & Arnd Huchzermeier, 2021. "Operations‐Finance Interface in Risk Management: Research Evolution and Opportunities," Production and Operations Management, Production and Operations Management Society, vol. 30(2), pages 355-389, February.
    2. Cruise, James R. & Flatley, Lisa & Zachary, Stan, 2018. "Impact of storage competition on energy markets," European Journal of Operational Research, Elsevier, vol. 269(3), pages 998-1012.
    3. Anna Maria Gambaro & Nicola Secomandi, 2021. "A Discussion of Non‐Gaussian Price Processes for Energy and Commodity Operations," Production and Operations Management, Production and Operations Management Society, vol. 30(1), pages 47-67, January.
    4. James Cruise & Lisa Flatley & Richard Gibbens & Stan Zachary, 2019. "Control of Energy Storage with Market Impact: Lagrangian Approach and Horizons," Operations Research, INFORMS, vol. 67(1), pages 1-9, January.
    5. Löhndorf, Nils & Wozabal, David, 2021. "Gas storage valuation in incomplete markets," European Journal of Operational Research, Elsevier, vol. 288(1), pages 318-330.
    6. Adam Diamant, 2021. "Dynamic multistage scheduling for patient-centered care plans," Health Care Management Science, Springer, vol. 24(4), pages 827-844, December.
    7. Alessio Trivella & Danial Mohseni-Taheri & Selvaprabu Nadarajah, 2023. "Meeting Corporate Renewable Power Targets," Management Science, INFORMS, vol. 69(1), pages 491-512, January.
    8. Secomandi, Nicola, 2016. "A tutorial on portfolio-based control algorithms for merchant energy trading operations," Journal of Commodity Markets, Elsevier, vol. 4(1), pages 1-13.
    9. Yangfang (Helen) Zhou & Alan Scheller‐Wolf & Nicola Secomandi & Stephen Smith, 2019. "Managing Wind‐Based Electricity Generation in the Presence of Storage and Transmission Capacity," Production and Operations Management, Production and Operations Management Society, vol. 28(4), pages 970-989, April.
    10. Nadarajah, Selvaprabu & Secomandi, Nicola, 2023. "A review of the operations literature on real options in energy," European Journal of Operational Research, Elsevier, vol. 309(2), pages 469-487.
    11. Christian Mandl & Selvaprabu Nadarajah & Stefan Minner & Srinagesh Gavirneni, 2022. "Data‐driven storage operations: Cross‐commodity backtest and structured policies," Production and Operations Management, Production and Operations Management Society, vol. 31(6), pages 2438-2456, June.
    12. Alessio Trivella & Selvaprabu Nadarajah & Stein-Erik Fleten & Denis Mazieres & David Pisinger, 2021. "Managing Shutdown Decisions in Merchant Commodity and Energy Production: A Social Commerce Perspective," Manufacturing & Service Operations Management, INFORMS, vol. 23(2), pages 311-330, March.

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