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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

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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  • Zhuliang Chen & Peter Forsyth, 2010. "Implications of a regime-switching model on natural gas storage valuation and optimal operation," Quantitative Finance, Taylor & Francis Journals, vol. 10(2), pages 159-176.
    • Handle: RePEc:taf:quantf:v:10:y:2010:i:2:p:159-176
    DOI: 10.1080/14697680802374791
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    References listed on IDEAS

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    1. Cartea, Álvaro & Williams, Thomas, 2008. "UK gas markets: The market price of risk and applications to multiple interruptible supply contracts," Energy Economics, Elsevier, vol. 30(3), pages 829-846, May.
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    3. de Jong, C.M., 2005. "The Nature of Power Spikes: a regime-switch approach," ERIM Report Series Research in Management ERS-2005-052-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
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    Citations

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    Cited by:

    1. Anton A. Shardin & Michaela Szolgyenyi, 2016. "Optimal Control of an Energy Storage Facility Under a Changing Economic Environment and Partial Information," Papers 1602.04662, arXiv.org, revised Apr 2016.
    2. Almansour, Abdullah, 2016. "Convenience yield in commodity price modeling: A regime switching approach," Energy Economics, Elsevier, vol. 53(C), pages 238-247.
    3. Margaret Insley, 2013. "On the timing of non-renewable resource extraction with regime switching prices: an optimal stochastic control approach," Working Papers 1302, University of Waterloo, Department of Economics, revised Aug 2013.
    4. Mason, Charles F. & A. Wilmot, Neil, 2014. "Jump processes in natural gas markets," Energy Economics, Elsevier, vol. 46(S1), pages 69-79.
    5. Abdullah Almansour and Margaret Insley, 2016. "The Impact of Stochastic Extraction Cost on the Value of an Exhaustible Resource: An Application to the Alberta Oil Sands," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2).
    6. Insley, Margaret, 2017. "Resource extraction with a carbon tax and regime switching prices: Exercising your options," Energy Economics, Elsevier, vol. 67(C), pages 1-16.
    7. Nemat Safarov & Colin Atkinson, 2016. "Natural gas-fired power plants valuation and optimisation under Levy copulas and regime-switching," Papers 1607.01207, arXiv.org, revised Jul 2016.
    8. Hanfeld, Marc & Schlüter, Stephan, 2016. "Operating a swing option on today's gas markets: How least squares Monte Carlo works and why it is beneficial," FAU Discussion Papers in Economics 10/2016, Friedrich-Alexander University Erlangen-Nuremberg, Institute for Economics.
    9. 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.
    10. Margaret Insley & Yichun Huang, 2020. "The economics of water conservation regulations under uncertainty: An application to Alberta's Lower Athabasca River Region," Working Papers 2003, University of Waterloo, Department of Economics, revised Jul 2020.
    11. Reus, Lorenzo & Munoz, Francisco D. & Moreno, Rodrigo, 2018. "Retail consumers and risk in centralized energy auctions for indexed long-term contracts in Chile," Energy Policy, Elsevier, vol. 114(C), pages 566-577.
    12. Nemat Safarov & Colin Atkinson, 2017. "Natural Gas-Fired Power Plants Valuation And Optimization Under Lévy Copulas And Regime Switching," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 20(01), pages 1-38, February.
    13. Bastian Felix, 2012. "Gas Storage Valuation: A Comparative Simulation Study," EWL Working Papers 1201, University of Duisburg-Essen, Chair for Management Science and Energy Economics, revised Apr 2014.
    14. Mason, Charles F. & Wilmot, Neil A., 2020. "Jumps in the convenience yield of crude oil," Resource and Energy Economics, Elsevier, vol. 60(C).
    15. Jang, Bong-Gyu & Tae, Hyeon-Wuk, 2018. "Option pricing under regime switching: Integration over simplexes method," Finance Research Letters, Elsevier, vol. 24(C), pages 301-312.
    16. Lin, Boqiang & Wesseh, Presley K., 2013. "What causes price volatility and regime shifts in the natural gas market," Energy, Elsevier, vol. 55(C), pages 553-563.
    17. Anton A. Shardin & Michaela Szölgyenyi, 2016. "Optimal Control Of An Energy Storage Facility Under A Changing Economic Environment And Partial Information," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 19(04), pages 1-27, June.
    18. Niu, Shilei & Insley, Margaret, 2016. "An options pricing approach to ramping rate restrictions at hydro power plants," Journal of Economic Dynamics and Control, Elsevier, vol. 63(C), pages 25-52.

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