July 11, 2019
How is Natural Gas Storage Valued?
By Jeff Bolyard, Vice President, Commodity Strategy
There are various ways in which natural gas can be stored, all of which come at some cost to the owner or user of the asset. Prior to technology advancements which brought about Liquified natural gas (LNG) and Compressed natural gas (CNG) storage into the mix, the location in which large volume storage could be developed was dependent on geology. The most common types of traditional natural gas storage are previously depleted gas wells & reservoirs, underground salt caverns formations, or aquifers; each one requiring specific geological conditions and each having its own physical characteristics and economics to operate. Although the exact amount of storage capacity in the continental U.S. isn’t known, the EIA estimates a maximum of 4.3 Trillion cubic feet of natural gas can be stored at any point in time. Each week, the EIA reports the amount of natural gas injected into or withdrawn out of storage and breaks the report down into five different regions, with ~84% of storage capability existing in the South Central, Midwest, and East regions (Exhibit A).
There are several ways in which one can calculate the value of natural gas storage. Here are the most common:
1. Intrinsic value: The most common way to value storage is to calculate the differential in price between the injected cost and the withdrawal cost, less any carrying cost of capital used to purchase the gas and hold it in storage until withdrawals occur. In the typical forward market, there is a seasonal discount to the summer (injection) season vs. the higher winter (withdrawal) season due to supply being greater than demand in the summer and demand being greater than supply in the winter. The chart below shows the last 12 months of supply vs demand and the need for natural gas storage.
As of 6/18/19, the remaining average summer NYMEX strip (July-Oct. 2019) was trading at $2.38/MMBtu while the following winter of Nov2019 to Mar2020 averaged $2.69 /MMBtu. Assuming a consistent fill the rest of the summer and a consistent withdrawal during the winter, the summer/winter spread would give us a starting point intrinsic storage value of $0.31/MMBtu.
2. Extrinsic value: Since the cost to utilize storage is typically higher than the intrinsic value example above of $0.31, most entities that own storage also include some extrinsic value calculation into the decision to own storage. Calculating the extrinsic value of any storage asset varies based on the type of storage facility, market conditions, and the capability of that storage to reach a specific market. For end users, storage provides the ability to avoiding purchasing gas during periods of high prices when their demand is higher than normal.
Storage also allows them to avoid selling excess gas into a low-price market at a loss. Calculating this potential extrinsic value is very difficult to determine and depends on a list of variables, some of which are known, while others are not. For example, salt cavern storage has high volume injection capabilities at high pressures. The result of which is a high volume and quick withdrawal capability, which can be filled up and emptied and over a period of days, allowing the storage owner to cycle (inject into and withdraw gas from the storage asset) gas many times in a single month or season, taking advantage of short term pricing opportunities while cutting the fixed cost component of owning storage in half each time the storage is cycled.
Another type of storage extensively used is depleted well storage, which has much slower injection and withdrawal limitations with minimum and maximum daily and monthly limits based on the geological limitations of the formation. This slower fill, slower withdrawal storage gives time for the gas to migrate through the geological formation when put in and taken out. Since there aren’t any walls to keep the gas in, geology ultimately determines how much can be injected and how long it can be left in the ground before it must be withdrawn prior to migrating past the point where it cannot be recovered. However, depleted well storage also provides access to storage over a much longer stretch of cold weather compared to salt dome storage.
3. Market conditions: Other factors that come into play in the valuation of storage relate to regional market conditions, often as it pertains to abnormal weather. Although rising significantly over the past 10 years, production has been on a somewhat steady rise month over month as seen in the chart above, while demand for gas is still more seasonal and exceeds supply significantly each winter, requiring withdrawal out of storage to meet peak winter demand. The market’s perception of whether there is enough inventory in storage to make it through the winter and the market’s perception of the ability to get storage full each summer prior to winter plays a huge part in the valuation of storage.
4. Storage service level (firm vs interruptible): Another component worth considering is the service level of storage or the availability of storage during peak demand (firm storage); or whether the storage asset is only available during certain periods of less demand (interruptible) will greatly impact the value as well with firm storage costs being higher than the more economical but less available interruptible version.
5. Market access: The ability to deliver stored gas into a highly priced, highly volatile market during peak demand periods has a lot more extrinsic value than deliverability to a less volatile, lower priced market. The same phrase used in valuing real estate also applies to natural gas storage, which is “location, location, location”. Although not a guarantee, the likelihood of significantly increasing the value of storage has a stronger potential with deliverability in areas of high historical price volatility. For example, with a high demand stretch from January 1st – 10th in 2018:
• Storage owners that had access to premium northeast markets avoided daily gas prices that averaged $36.65/MMBtu (vs a January 2019 average price of $4.16), while storage capable of reaching the Chicago market in January 2018 only averaged $4.79 (vs January 2019 average of $3.22).
• The Southeast market posted a $3.92 average in early 2018 (vs the January 2019 average of $3.00) while in west Texas, that region averaged $3.68/MMBtu in 2018 vs the 2019 January monthly average of $2.04.
Regional weather differences played a major role in the year on year price differences, but so did the introduction of new pipeline infrastructure and access to supply, which can also change the value of storage.
6. Storage space vs injection/withdrawal rights: Also rolled into the economics is not only how much physical storage space is available in the facility, but also how much access is allowed on any given day. In other words, the amount of space available in storage to fill is important, but equally important is the amount of gas that can be injected or withdrawn each day. 1,000,000 MMBtu of gas in storage with a 50,000 MMBtu daily injection/withdrawal limit could be less attractive to one client while the same 1,000,000 MMBtu in storage with a 100,000 MMBtu daily injection/withdrawal limit would be much more attractive to another. It all depends on how the storage is intended to be used and what risks are trying to be avoided.
In today’s complex energy environment, the ability to quantify the value and take advantage of assets like storage is a combination of known and unknown factors that depends on how one intends to use the asset and the flexibility storage can provide to an entity trying to avoid risk. Each variable that goes into calculating the potential benefit of storage comes with risk and reward and varies greatly based on known market conditions at the time, as well as unpredictable market conditions down the road being overlaid with the term commitment of owning storage. Edison Energy can help educate you with energy expertise to help you meet financial goals, mitigate unwanted risk, and protect the resiliency of your facilities.
To find out more about how to get independent, comprehensive, expert and data driven advice on your natural gas supply management, contact your Energy Manager directly at Edison Energy or send an inquiry here and our Energy Team will promptly respond.