Gas storage valuation using a multifactor price process

Abstract

In this paper we discuss an extension to the spot approach, a popular valuation method for gas storage facilities. The least-squares Monte Carlo (LSMC) method, which is the basis for the spot approach, allows for multifactor price processes. Such price processes can capture the actual price behavior present in energy markets more realistically.We demonstrate the application of multifactorLSMCto gas storage valuation.We study the impact of using multifactor price processes on different aspects of the valuation, such as convergence, average storage value and distribution of storage values in a numerical example. We find a counterexample to the idea that an increase in market volatility leads to an increase in storage value.We also find a counterexample to the idea that the natural hedging strategy of the spot approach is no hedging. As simple static financial hedge can reduce the inherent risk of the spot approach. Finally, we study the impact of model error on the price process.