With a 4th edition, the book “Managing Energy Price Risk” is one of the best-sellers in energy finance. Published by Risk Books in London and edited by Vince Kaminski, the first edition was published in 2004. Cyriel de Jong was one of the contributors, with chapters about gas storage and emission trading. After more than a decade with moderate changes in the second and third edition, it was time to renew the book more thoroughly. Cyriel de Jong from KYOS has completely rewritten his chapter on gas storage pricing and hedging, which provides an excellent description of the best-practice trading and valuation strategies for gas storage.
Storage plays a vital role in competitive natural-gas markets, because the average variability in the consumption of natural gas is much greater than the average variability in production. Historically, natural-gas storage has been used for two key functions. First, it provides local distribution companies with adequate supply during periods of heavy demand by supplementing pipeline capacity and serving as backup supply in case of an interruption in wellhead production. Second, storage enables greater system efficiency: instead of satisfying winter demand by adding new production facilities, the industry can maintain production at a much more constant level throughout the year. Finally, during periods of significant changes in supply or demand, storage ensures pipeline integrity is maintained.
As part of the liberalisation process in many countries the natural-gas storage service has been unbundled from the sales and transportation services, meaning that storage is increasingly offered as a distinct, separately charged service. In combination with the development of active spot and futures markets, it becomes possible to adjust trading decisions to price conditions. In other words, buyers and sellers of natural gas have the possibility to use storage capacity to take advantage of the volatility in prices.