Natural gas storage valuation, optimization, market and credit risk management

Abstract

This paper presents a method for optimizing, pricing and hedging gas storage facilities and leasing contracts in the presence of counter-party credit risk (CCR). A reduced factor, time-independent and Markovian representation of the forward curve is developed that explains 99% of the curve dynamics and incorporates implied volatility seasonality. A system of partial differential equations for valuation and optimization is derived. The resulting PDEs are solved using a specialized implementation of the radial basis function (RBF) technique. The combination of the time-independent, Markovian, framework facilitates the optimization of high-deliverability storage contracts. In addition, as a by-product of the RBF-PDE solution process, a series of analytic RBF expansions for the value of the gas storage contract is produced. These expansions can be differentiated analytically at virtually no cost to obtain hedging statistics. These expansions can also facilitate the millions of individual contract valuations required to price and hedge CCR.