Valuation of Natural Gas in Salt Cavern Storage

Facilities

Michael BondHank 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

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 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

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

Average Prices 2005-2007

0.00

2.00

4.00

6.00

8.00

10.00

1 2 3 4 5 6 7 8 9 10 11 12

Month

$/M

MB

TU Wellhead

CityGate

Performance

Trivial pricing Same transactions Equal profit

Trivial

0.00

0.50

1.00

1.50

2.00

2.50

1 2 3 4 5 6 7 8 9 10 11 12

Month

$/M

MB

TU

Wellhead

CityGate

Simple Single Peak Pattern

Most common pattern

Winter demand V180- 6 months inj

then 6 months w/d Same profit

Simple Single Peak Pattern

0.001.002.003.004.005.006.007.008.009.00

1 2 3 4 5 6 7 8 9 10 11 12

Month

$/MMC

F

Wellhead

CityGate

Various Patterns

Same results Multi Peak Pattern

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

1 2 3 4 5 6 7 8 9 10 11 12

Month$/

MM

CF

Wellhead

CityGate

Initial results

Given equal states 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 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

Single Peak with Variation

0.001.002.003.004.005.006.007.008.009.00

1 2 3 4 5 6 7 8 9 10 11 12

Month

$/MMb

tu

Wellhead

CityGate

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