Pricing an European gas storage facility using a continuous-time spot price model with GARCH diffusion

Stephan Schlüter and Matt Davison

No 02/2010, FAU Discussion Papers in Economics from Friedrich-Alexander University Erlangen-Nuremberg, Institute for Economics

Abstract: In this article we present both a theoretical framework and a solved example for pricing an European gas storage facility and computing the optimal strategy for its operation. As a representative price index we choose the Dutch TTF day-ahead gas price. We present statistical evidence that the volatility of this index is time-varying, so we introduce a new continuous-time model by incorporating GARCH diffusion into an Ornstein-Uhlenbeck process. Based on this price process we use dynamic programming methods to derive partial differential equations for pricing a storage facility. As an example we apply our methodology to a storage site located in Epe at the German-Dutch border. In this context we investigate the effects of multiple contract types, and perform a sensitivity analysis for all model parameters. We obtain a value surface displaying the properties of a financial straddle. Both volatility and mean reversion influence the facility value - but only around the long-run mean of the gas price. The terminal condition, which includes information about the contract provisions, is of importance if it contains e.g. penalty terms for low inventory levels. Otherwise its influence is diminishing for increasing lease periods.

Keywords: TTF gas price; GARCH diffusion; natural gas storage; dynamic computing (search for similar items in EconPapers)
JEL-codes: C31 C61 (search for similar items in EconPapers)
Date: 2010
New Economics Papers: this item is included in nep-ene and nep-eur
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:iwqwdp:022010

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