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Gas Storage Valuation: A Comparative Simulation Study

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  • Bastian Felix

    () (Chair for Management Sciences and Energy Economics, University of Duisburg-Essen)

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    Abstract

    The purpose of this paper is the comparative analysis of four natural gas storage valuation approaches. In competitive natural gas markets the optimal valuation and operation of natural gas storages is a key task for natural gas companies operating storages. Within this paper, four spot based valuation approaches are analyzed regarding computational time and accuracy. In particular, explicit and implicit finite differences, multinomial recombining trees, and Least Squares Monte Carlo Simulation are compared. These approaches are applied to the valuation of a gas storage facility considering three different underlying price processes. Major characteristics of historical natural gas prices are: seasonality, mean reversion and jumps. Therefore, we consider a mean reversion process as underlying price process. In a first step, we extend this mean reversion process to a mean reversion jump diffusion process, to account for jumps, occurring in historical gas spot price time series. Moreover, we consider a more general price process accounting for mean reversion as well as seasonal patterns as observed in the historical time series. Besides the analysis of the numerical results, the benefits and drawbacks of the methodologies are discussed.

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    File URL: http://www.wiwi.uni-due.de/fileadmin/fileupload/BWL-ENERGIE/Arbeitspapiere/RePEc/pdf/wp1201_GasStorageValuationAComparativeSimulationStudy_19Jun12_BF_EWL_workingpaper.pdf
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    Bibliographic Info

    Paper provided by University of Duisburg-Essen, Chair for Management Science and Energy Economics in its series EWL Working Papers with number 1201.

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    Length: 25 pages
    Date of creation: Jun 2012
    Date of revision: Jun 2012
    Handle: RePEc:dui:wpaper:1201

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    Keywords: natural gas valuation; limited liquidity;

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    References

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    1. Kjarstad, Jan & Johnsson, F., 2007. "Prospects of the European gas market," Energy Policy, Elsevier, vol. 35(2), pages 869-888, February.
    2. Cartea, Álvaro & Figueroa, Marcelo G., 2005. "Pricing in electricity markets : a mean reverting jump diffusion model with seasonality," Open Access publications from Universidad Carlos III de Madrid info:hdl:10016/12199, Universidad Carlos III de Madrid.
    3. Das, Sanjiv R., 2002. "The surprise element: jumps in interest rates," Journal of Econometrics, Elsevier, vol. 106(1), pages 27-65, January.
    4. Felix, Bastian Joachim & Weber, Christoph, 2012. "Gas storage valuation applying numerically constructed recombining trees," European Journal of Operational Research, Elsevier, vol. 216(1), pages 178-187.
    5. Geske, Robert & Shastri, Kuldeep, 1985. "Valuation by Approximation: A Comparison of Alternative Option Valuation Techniques," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(01), pages 45-71, March.
    6. Rafal Weron, 2006. "Modeling and Forecasting Electricity Loads and Prices: A Statistical Approach," HSC Books, Hugo Steinhaus Center, Wroclaw University of Technology, number hsbook0601.
    7. Byers, Joe Wayne, 2006. "Commodity storage valuation: A linear optimization based on traded instruments," Energy Economics, Elsevier, vol. 28(3), pages 275-287, May.
    8. Nicola Secomandi, 2010. "Optimal Commodity Trading with a Capacitated Storage Asset," Management Science, INFORMS, vol. 56(3), pages 449-467, March.
    9. Rene Carmona & Michael Ludkovski, 2010. "Valuation of energy storage: an optimal switching approach," Quantitative Finance, Taylor and Francis Journals, vol. 10(4), pages 359-374.
    10. Schwartz, Eduardo S, 1997. " The Stochastic Behavior of Commodity Prices: Implications for Valuation and Hedging," Journal of Finance, American Finance Association, vol. 52(3), pages 923-73, July.
    11. Brennan, Michael J. & Schwartz, Eduardo S., 1978. "Finite Difference Methods and Jump Processes Arising in the Pricing of Contingent Claims: A Synthesis," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 13(03), pages 461-474, September.
    12. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," University of California at Los Angeles, Anderson Graduate School of Management qt43n1k4jb, Anderson Graduate School of Management, UCLA.
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