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Pricing an European gas storage facility using a continuous-time spot price model with GARCH diffusion

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  • Schlüter, Stephan
  • Davison, Matt
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    Abstract

    In this article we present both a theoretical framework and a solved example for pricing an European gas storage facility and computing the optimal strategy for its operation. As a representative price index we choose the Dutch TTF day-ahead gas price. We present statistical evidence that the volatility of this index is time-varying, so we introduce a new continuous-time model by incorporating GARCH diffusion into an Ornstein-Uhlenbeck process. Based on this price process we use dynamic programming methods to derive partial differential equations for pricing a storage facility. As an example we apply our methodology to a storage site located in Epe at the German-Dutch border. In this context we investigate the effects of multiple contract types, and perform a sensitivity analysis for all model parameters. We obtain a value surface displaying the properties of a financial straddle. Both volatility and mean reversion influence the facility value - but only around the long-run mean of the gas price. The terminal condition, which includes information about the contract provisions, is of importance if it contains e.g. penalty terms for low inventory levels. Otherwise its influence is diminishing for increasing lease periods. --

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    Bibliographic Info

    Paper provided by Friedrich-Alexander-Universität Erlangen-Nürnberg, Institut für Wirtschaftspolitik und Quantitative Wirtschaftsforschung (IWQW) in its series IWQW Discussion Paper Series with number 02/2010.

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    Date of creation: 2010
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    Handle: RePEc:zbw:iwqwdp:022010

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    Web page: http://www.iwqw.rw.uni-erlangen.de/
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    Related research

    Keywords: TTF gas price; GARCH diffusion; natural gas storage; dynamic computing;

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