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Department of Business and Management Science, Norwegian School of Economics (NHH) Discussion Papers, Department of Business and Management Science, Norwegian School of Economics (NHH)

No 2008/20:
Gas Storage Valuation: Price Modelling v. Optimization Methods

Petter Bjerksund (), Gunnar Stensland () and Frank Vagstad ()

Abstract: The existence of a financial gas market motivates the analysis of gas storage as a separate asset, using the market value context for utilization and valuation. In the recent literature, gas storage is typically analysed within a framework with a simple one-factor price dynamics that is solved to optimality. We follow a different approach, where the market is represented by a forward curve with daily granularity, the price uncertainty is represented by six factors, and where we impose a simple and intuitive storage strategy that follows from repeated maximization of the intrinsic value.

Based on UK natural gas market price data, we obtain the gas storage value using our approach, and compare with results from one-factor models as well as with perfect foresight. We find that our approach captures much more of the true flexibility value than the one-factor models. Our results indicate that the appropriate framework for analyzing complex assets like gas storage is a rich representation of the price dynamics combined with a simple and intuitive decision rule.

Keywords: Energy; uncertainty; flexibility; exercise strategy; (follow links to similar papers)

JEL-Codes: Q40; (follow links to similar papers)

31 pages, October 17, 2008

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