A multiple-location model for natural gas forward curves

This thesis presents an approach for financial modelling of natural gas in which connections between locations are incorporated and the complexities of forward curves in natural gas are considered. Apart from electricity, natural gas is the most volatile commodity traded. Its price is often dependent on the weather and price shocks can be felt across several geographic locations. This modelling approach incorporates multiple risk factors that correspond to various locations. One of the objectives was to determine if the model could be used for closed-form option prices. It was suggested that an adequate model for natural gas must consider 3 statistical properties: volatility term structure, backwardation and contango, and stochastic basis. Data from gas forward prices at Chicago, NYMEX and AECO were empirically tested to better understand these 3 statistical properties at each location and to verify if the proposed model truly incorporates these properties. In addition, this study examined the time series property of the difference of two locations (the basis) and determines that these empirical properties are consistent with the model properties. Closed-form option solutions were also developed for call options of forward contracts and call options on forward basis. The options were calibrated and compared to other models. The proposed model is capable of pricing options, but the prices derived did not pass the test of economic reasonableness. However, the model was able to capture the effect of transportation as well as aspects of seasonality which is a benefit over other existing models. It was determined that modifications will be needed regarding the estimation of the convenience yields. 57 refs., 2 tabs., 7 figs., 1 append