Gas storage valuation in incomplete markets

Natural gas storage valuation is an important problem in energy trading, yet most valuation approaches are based on heuristics or ignore that gas markets are incomplete. We propose an exact valuation model for incomplete gas markets based on multistage stochastic programming. Market incompleteness structurally changes the problem of storage valuation and asset backed trading and the resulting model requires analysis of a combined control problem of storage operation and futures trading that takes risk preferences into account. As the problem is subject to the curse of dimensionality, we reduce the stochastic process to a scenario lattice and solve the resulting problem using stochastic dual dynamic programming. We show that the intrinsic value of storage corresponds to the value under perfect risk aversion and that the rolling intrinsic value, which is popular among practitioners and has been found to be near-optimal when markets are complete, is an inconsistent price rule in incomplete markets. Our results inform managerial decisions on risk management and asset pricing for natural gas highlighting the importance of explicitly modeling risk preferences.