Abstract
This paper focuses on the valuation and hedging of gas storage facilities, using a spot-based valuation framework coupled with a financial hedging strategy implemented with futures contracts. The contributions of this paper are two-fold. Firstly, we propose a model that unifies the dynamics of the futures curve and spot price, and accounts for the main stylized facts of the US natural gas market such as seasonality and the presence of price spikes in the spot market. Secondly, we evaluate the associated model risk, and show not only that the valuation is strongly dependent upon the dynamics of the spot price, but more importantly that the hedging strategy commonly used in the industry leaves the storage operator with significant residual price risk.
Highlights
Natural Gas (NG) storage units are used to reconcile the variable seasonal demand for gas with the more constant rate of natural gas production
We provide a model of the dynamics of the NG market, that incorporates all the features relevant for the evaluation of options embedded in a storage unit
We introduce a new modeling framework that unifies the dynamics of the futures curve and spot price, and is consistent with the two stylized facts that are essential to the gas storage valuation problem: price seasonality and spot price spikes
Summary
Natural Gas (NG) storage units are used to reconcile the variable seasonal demand for gas with the more constant rate of natural gas production. These gas storage facilities are mainly owned by distribution companies which use them for system supply regulation, and for reducing the risk of shortages. The idea was to project an optimal schedule of injections and withdrawals, using the term structure of future prices, and compute the corresponding discounted cash flow, which provided a lower bound to the storage value. The storage manager observed the futures curve at the beginning of the storage contract and bought/sold futures contracts, thereby determining once and for all the complete schedule of injection and withdrawals; essentially, this lead to buying cheap summer futures and selling expensive winter futures and the corresponding storage value greatly depended upon the summer-winter spread
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