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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.

Suggested Citation

  • 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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    Citations

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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. 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.
    3. repec:wsi:ijtafx:v:20:y:2017:i:01:n:s0219024917500042 is not listed on IDEAS
    4. 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.
    5. Almansour, Abdullah, 2016. "Convenience yield in commodity price modeling: A regime switching approach," Energy Economics, Elsevier, vol. 53(C), pages 238-247.
    6. repec:eee:eneeco:v:67:y:2017:i:c:p:1-16 is not listed on IDEAS
    7. 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.
    8. 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.
    9. 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).
    10. 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.
    11. Mason, Charles F. & A. Wilmot, Neil, 2014. "Jump processes in natural gas markets," Energy Economics, Elsevier, vol. 46(S1), pages 69-79.
    12. 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.

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