Scandinavian Working Papers in Economics

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

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

Petter Bjerksund (), Gunnar Stensland () and Frank Vagstad ()
Additional contact information
Petter Bjerksund: Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway
Gunnar Stensland: Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway
Frank Vagstad: Viz Risk Management, Postal: Viz Risk Management Services AS, P.B 6216, NO-5893 Bergen, Norway

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

JEL-codes: Q40

31 pages, October 17, 2008

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