Abstract: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.

A review of numerical algorithms for the analysis of viscous flows with moving interfaces is presented. The review is supplemented with a discussion of methods that have been introduced in the context of other classes of free boundary problems, but which can be generalized to viscous flows with moving interfaces. The available algorithms can be classified as Eulerian, Lagrangian, and mixed, ie, Eulerian-Lagrangian. Eulerian algorithms consist of fixed grid methods, adaptive grid methods, mapping methods, and special methods. Lagrangian algorithms consist of strictly Lagrangian methods, Lagrangian methods with rezoning, free Lagrangian methods and particle methods. Mixed methods rely on both Lagrangian and Eulerian concepts. The review consists of a description of the present state-of-the-art of each group of algorithms and their applications to a variety of problems. The existing methods are effective in dealing with small to medium interface deformations. For problems with medium to large deformations the methods produce results that are reasonable from a physical viewpoint; however, their accuracy is difficult to ascertain.

We present an algorithm for the valuation and optimal operation of hydroelectric and thermal power generators in deregulated electricity markets. Real options theory is used to derive nonlinear partial-integro-differential equations (PIDEs) for the valuation and optimal operating strategies of both types of 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 electricity markets. Particular attention is paid to the operational characteristics of real power generators. For thermal power plants, these characteristics include variable start-up times and costs, control response time lags, minimum generating levels, nonlinear output functions, and structural limitations on ramp rates. For hydroelectric units, head effects and environmental constraints are addressed. We illustrate the models with numerical examples of a pump storage facility and a thermal power plant. This PIDE framework can achieve high levels of computational speed and accuracy while incorporating a wide range of spot price dynamics and operational characteristics.

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