Gas storage valuation and optimization

Abstract

In this paper we review the pricing and optimization of natural gas storage in competitive natural gas markets. Over the past decade valuation approaches have been suggested. Of those approaches, the most general ones are based on Monte Carlo price simulations, allowing the evaluation of different market trading strategies and different assumptions about the underlying price process. In a simulation exercise we first demonstrate that the impact of parameter (e.g. volatility) uncertainty on storage value is relatively limited. Inevitably, different market parameters lead to different storage values, but the trading strategy is relatively robust for a reasonably wide range of market parameters. Parameter uncertainty is also evaluated in a large-scale backtest of different storage trading strategies. The backtest of three different virtual gas storage types in the UK market provides a unique insight in how spot optimization combined with forward hedging would have fared over the past 17 years. On average, the estimated storage value is realized with a combination of spot optimization and dynamic delta hedging in the forward market. Dynamic intrinsic hedging of the spot exposures works relatively well too, but less so than delta hedging.