Optimization Techniques Applied to the Trading of Natural Gas from a Restricted Storage Facility
Ellen Fowler | August 2002
We apply operations research techniques to the trading of natural gas from a restricted storage facility. In particular, we consider a gas trading firm that has entered into a one-year contract for gas storage whose terms restrict the balance held at any time and the quantities withdrawn and injected each day. Based on price forecasts assumed to be accurate, mathematical models identify optimal trading plans each day with the objective of maximizing net trading proceeds for the year.
We conduct a two-part numerical study. First, we contrast the financial performance of a year of trades prescribed by the optimization model to the outcome according to a "naïve" strategy, which represents the strategy of a hypothetical trader unaided by such a model. Comparisons are made using perfect price information, to isolate the value of optimization, and using forecasted prices, in order to make a more practical evaluation. Second, we compare the financial outcomes of our optimal trading decisions when hedging is required and when it is not, in order to gain insight into the opportunity cost of hedging.
As expected, optimization models lead to better financial performance than naïve strategies in all instances when perfect price information is in place. When prices are forecasted and trading decisions are therefore hampered by forecast inaccuracy, the optimization model outperforms the naïve strategy on average although not in every instance. The second component of our analysis suggests that a hedging policy, while eliminating price risk, has a dramatic opportunity cost.