2
$\begingroup$

I am solving some interviewing questions regarding gas storage optimization. I am given a gas storage facility with volume, rate of injection and withdrawal, as well as a current forward curve of gas price for the next 12 months. Obviously I should buy forward contracts for the months where prices are lowest, to max out my capacities, and sell forward contracts for the months where prices are highest. This is easy. Then the question becomes: the next day, the forward curve moved, but the basic ordering is unchanged (i.e., the cheap months are still cheap, etc..) , how do I adjust my positions of the forward contracts (long and short) in order to optimize my profit? Since I already maxed out all my capacities, any adjustments cannot change my gas flow. By no-arbitrage, I cannot generate profit by trading these contracts. Therefore I think there is no way to make changes to my contract positions to make more profit.

Am I missing something here? The question sounds like there is some adjustment to be made, otherwise it becomes a trivial question.

$\endgroup$
1
$\begingroup$

If we assume that we have no variable storage cost, than the optimal strategy in the beginning seems to be to buy as much as possible in forward contracts for the month with the cheapest forward price. Assuming you can buy enough to get through the year you'll just sell what you have until you start the cycle again next year. The next day the forward prices might have changed. If the month with previously lowest prices is still the cheapest month you can win nothing by selling or buying contracts. But imagine a situation where maybe the month next to the former cheapest month becomes the month with the lowest price. Than it would be beneficial to sell all the forward buying contracts and buy them new for the current cheapest month. Example: At the beginning you buy a forward contract for 100 units of gas in june. And you sell them over the course of the following year. The forward price for june is 10 USD per unit and the prices for all other months are higher than that. Now assume the june price drops to 9 USD but the july price drops even lower to 8 USD. Selling all your june contracts causes you a loss of 100*1 USD but by buying the july contracts you save 100*2 USD because you buy 2 USD per unit cheaper than before.

$\endgroup$
  • $\begingroup$ Thanks for the detailed explanations. I have one small related question: I think forward contracts are not tradable (or traded OTC), and futures are tradable at the exchange. Shouldn't these forward contracts be futures instead? In other words, how do I "sell" my forward contracts? $\endgroup$ – user138668 Sep 16 '16 at 3:43
  • $\begingroup$ I think you are right, future contracts would work better here. You can neutralize a forward buy with a forward sell, but since we are talking physical settlement here, that might cause logistical problems. On the other hand you might contracting forward with cash settlement and than buy the actual commodity on the spot market. I assume though, that this technicalities can be ignored for the sake of answering this stylized question. $\endgroup$ – Ami44 Sep 16 '16 at 6:15

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.