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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

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.

Suggested Citation

  • Schlüter, Stephan & Davison, Matt, 2010. "Pricing an European gas storage facility using a continuous-time spot price model with GARCH diffusion," FAU Discussion Papers in Economics 02/2010, Friedrich-Alexander University Erlangen-Nuremberg, Institute for Economics.
  • Handle: RePEc:zbw:iwqwdp:022010
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    Cited by:

    1. 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.

    More about this item

    Keywords

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

    JEL classification:

    • C31 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models; Quantile Regressions; Social Interaction Models
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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