Valuation of Natural Gas in Salt Cavern Storage Facilities Michael Bond Hank Grant PhD

Natural Gas Consumption 1997-2007: 23 Trillion Cubic Feet/Year All US Production 4.6 Tcf Imported Pipeline (Canada & Mexico) Liquid Natural Gas

Natural Gas Use

Necessity for Storage Other commodities Natural Gas production is seasonal consumption is relatively level Natural Gas production is relatively level Short term consumption is seasonal Residential – Winter Power generation – Summer (lesser) Investment opportunity

Seasonality of Gas Prices

Gas In Storage

Types of Gas Storage Above Ground Liquid NG Containers Local distributors To meet local daytime peak usage

Types of Gas Storage Underground Depleted gas reservoir Aquifer Salt Cavern *Mines *Natural caves/caverns * Minor usage

Underground Storage Facilities

Depleted Reservoir Most common Depleted gas field 1 Turnover/year 24-36 months construction time Structural considerations – Any area with natural gas field

Aquifer Very high cushion gas requirement 1 turnover/year irrecoverable 1 turnover/year Wherever aquifers exist Most expensive

Salt Cavern Constructed in salt dome Higher Pressure Least cushion gas Turnover 4-5/year Longest to construct 36-48 months Gulf Coast, Great Lakes area

Salt Dome Cavern

The Lille Torup gas storage facility has seven gigantic cavities (200-300m by 50-75m) called caverns at a depth of 1.2 and 1.5 km in a large subterranean salt dome.

Salt Deposits

Compare Salt Cavern with Reservoir Type Examine operational differences Is there a financial advantage?

Approach Set initial parameters For a period of 1 year Gas on hand Cash on hand For a period of 1 year Generate daily decision to buy, hold or sell Stochastic Estimate future decisions Adjust if necessary Gas cannot exceed capacity Cannot sell gas not on hand Calculate change in gas and cash

Approach Create simulation with AWESIM Evaluate results

Model - Assumptions No holding costs No injecting/withdrawal costs Static injection/withdrawal rates Monthly Price changes

Model - Parameters Injection time 45 days (V45) Volume=V Inject rate= R Price = P Cost = C Injection time 180 days (V180) Volume = 4V Inject Rate = R/4

Gas prices

Performance Trivial pricing Same transactions Equal profit

Simple Single Peak Pattern Most common pattern Winter demand V180- 6 months inj then 6 months w/d Same profit

Various Patterns Same results

Initial results Given equal states Equal profits Intuitive Transaction activity (volume) Knowledge of future prices Equal profits Intuitive

Future Prices Difficult to predict the future Forecast Methods Based on historical Random Variation Mean Reverting Mean Reverting with Spikes

Real Options Theory Consider Financial Instruments Options – to buy or sell stock Potential Business opportunities = Buy Options Ex: Undeveloped Gas Reserve Commodities in storage = Buy or Call Options

Black-Scholes - Evaluating options Current Cost (Spot) Future Price (Strike) Volatility of prices Risk free interest rate (US T-Bills) Time (years) Normal Distribution

V180 Injection Pattern Injection season 180 days Withdrawal Season Low demand Lower prices Summer Withdrawal Season Higher Residential Demand Higher prices Winter

Sensitivity to Volatility Shorter cycle time Take advantage of short-term price spikes

V180 vs V45 V45 cf/y greater V45 cost per injected cf lower

Summary Continuing to investigate Quantify Salt Cavern advantage Single Cavern Facility vs Multi-Cavern