Natural gas storage valuation and optimization: A real options application

In this article, we present an algorithm for the valuation and optimal operation of natural gas storage facilities. Real options theory is used to derive nonlinear partial-integro-differential equations (PIDEs), the solution of which give both valuation and optimal operating strategies for these facilities. The equations are designed to incorporate a wide class of spot price models that can exhibit the same time-dependent, mean-reverting dynamics, and price spikes as those observed in most energy markets. Particular attention is paid to the operational characteristics of real storage units. These characteristics include working gas capacities, variable deliverability and injection rates, and cycling limitations. We illustrate the model with a numerical example of a salt cavern storage facility that clearly shows how a gas storage facility is like a financial straddle with both put and call properties. Depending on the amount of gas in storage the relative influence of the put and call components vary.