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Implications of a regime-switching model on natural gas storage valuation and optimal operation

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  • Zhuliang Chen
  • Peter Forsyth
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    Abstract

    In this paper, we propose a one-factor regime-switching model for the risk adjusted natural gas spot price and study the implications of the model on the valuation and optimal operation of natural gas storage facilities. We calibrate the model parameters to both market futures and options on futures. Calibration results indicate that the regime-switching model is a better fit to market data compared to a one-factor mean-reverting model similar to those used by other authors to value gas storage. We extend a semi-Lagrangian timestepping scheme from Chen and Forsyth (2007) to solve the gas storage pricing problem, essentially a stochastic control problem, and conduct a convergence analysis of the scheme. Numerical results also indicate that the regime-switching model can generate operational strategies for gas storage facilities that reflect the existence of multiple regimes in the market as well as the regime shifts due to various exogenous events.

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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal Quantitative Finance.

    Volume (Year): 10 (2010)
    Issue (Month): 2 ()
    Pages: 159-176

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    Handle: RePEc:taf:quantf:v:10:y:2010:i:2:p:159-176

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    Related research

    Keywords: Gas storage; Regime switching; Stochastic control;

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    Cited by:
    1. Date, Paresh & Mamon, Rogemar & Tenyakov, Anton, 2013. "Filtering and forecasting commodity futures prices under an HMM framework," Energy Economics, Elsevier, vol. 40(C), pages 1001-1013.
    2. Abdullah Almansour & Margaret Insley, 2013. "The impact of stochastic extraction cost on the value of an exhaustible resource: An application to the Alberta oil sands," Working Papers 1303, University of Waterloo, Department of Economics, revised Jun 2013.

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