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The Storage Model
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"The winter/summer spread and volatilities have collapsed. How much should I pay for storage?"
The WTM storage model will give you an accurate answer! Other models tend to make you overpay.
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Why This
Model?
The WTM natural gas storage model is designed to help traders optimally extract and hedge
both intrinsic and extrinsic values each and every day; the model is not just a valuation
model! The WTM model is the first to correctly bring together the two features that must be
incorporated into any storage model if it is to be accurate and is to give optimal daily
trading recommendations:
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The model must possess the correct methodology for capturing the complicated,
follow-on American optionality of storage, and
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It must do so on a set of realistically modeled cash and forward price movements.
No other storage model on the market can do both of these simultaneously. The Monte
Carlo simulations don't do (1),
and the tree models don't do (2).
What This
Means
simply is that your current model could be telling you to pay 30 to 50 cents over fair value for the demand charge!
WTM’s Storage Optimization Software (SOStm)
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"It’s winter, my lease ends in March, and forward prices are contango through next summer. When
should I start withdrawing?" SOS will show you how to withdraw in a way to maximize your
remaining extrinsic value!
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As discussed just above, SOS by WTM is a breakthrough natural gas storage model and is the first to marry together the two
critical features needed for storage modeling. This marriage not only provides more accurate valuations, but also allows
the model to give more metrics for optimally managing storage: thresholds on cash-to-prompt spreads for optimal injection
and withdrawal that day; superior dynamic hedges that protect extrinsic value; results that impart whether capturing
intrinsic or extrinsic is more important on a given day. See our
back testing
results for how well this "marriage" works.
No other model on the market can accurately produce these metrics, if at all. These other
models have been around for years, they haven't measurably changed over that time (only the
"marriage" of the two critical features discussed above would allow for that), they are
used primarily for compliance, and they are not used for trading. So if your needs are
primarily to meet compliance goals, the other models on the market will be adequate to do
so. And while SOS can be used for compliance, doing so as a primary purpose would be a great
waste of its potential!
The SOS model is among the easiest of the storage models to operate. And with SOS, traders can now run the model every day,
receive pertinent trading results from it, and act. Here are the metrics you get for managing storage:
Accurate storage values, both intrinsic and extrinsic, based on optimal storage trading
Threshold cash-to-prompt spreads for optimally injecting and withdrawing
Dynamic hedge positions in forward contracts that protect extrinsic, not just intrinsic
A table of results indicating which value is more important to pursue immediately, intrinsic or extrinsic, and which inventory levels have the highest optionality
Below, as an example, are some of these results as the model shows them.
The above results came from a Gulf region forward curve in early May 2011. The contract
is on one-BCF, the cycle rate is 1.5 times per year, standard commodity and fuel charges
apply, and the lease term remaining is 10 more months. The actual results show more dynamic
hedge (delta) positions to the right (all the way to the lease end month) and more results
by inventory level below (all the way to the lease's maximum capacity).
The above results show that the current inventory of 200,000 MMBtus has a remaining value,
both intrinsic and extrinsic, of $1.578 per MMBtu (of which $1.325 is intrinsic). Subtracting
out the weighted average cost of gas for that current inventory gives total performance to
date. The results also show that it is optimal to inject (+8,330) for the current inventory,
prices, volatilities and operating constraints. The model's hedging deltas are shown to the
right, too; these deltas are designed for maximum extrinsic protection.
The threshold cash-to-prompt spreads are interpreted as follows: If cash is 11.7 cents over
prompt (or less), the optimal physical trade is to buy and inject; at 21.2 cents or greater,
withdrawing and selling becomes optimal. In between, doing neither is optimal. Thus, prices,
volatilities, operational constraints, and the current inventory in this example are such
that optimal trading is heavily skewed toward injections.
The table of results by inventory is best looked at by examining the "Recommended Trade (MMBtus)" over inventory levels. All
else equal, this table typically shows injections as optimal for lower inventory levels, withdrawals as optimal for higher
inventory levels, and doing neither for mid-range levels. This pattern is a mathematically proven result in cases involving
simpler operational constraints. One can think of the levels in which no trading is done as the set of optimal inventories
to be at and trade to. The levels in this set, whether near empty, full, or something in between, indicate which value is
more important that day: intrinsic or extrinsic. So when you are in early September, you're 75 percent filled, but cash is
trading at 15 cents above prompt, SOS will indicate whether it is better to withdraw to get the 15 cents or just keep filling
to collect the rest of the winter-summer spread.
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