Valuation of Natural Gas in Salt Cavern Storage Facilities

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

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

3. Natural Gas Use

4. Necessity for Storage • Other commodities • 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

5. Seasonality of Gas Prices

6. Gas In Storage

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

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

9. Underground Storage Facilities

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

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

12. 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

13. Salt Dome Cavern

14. 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.

15. Salt Deposits

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

17. Approach • Set initial parameters • 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

18. Approach • Create simulation with AWESIM • Evaluate results

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

20. 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 Model - Parameters

21. Gas prices

22. Performance • Trivial pricing • Same transactions • Equal profit

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

24. Various Patterns • Same results

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

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

27. 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

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

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

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

31. V180 vs V45 • V45 cf/y greater • V45 cost per injected cf lower

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