Merchant Commodity Storage Practice Revisited

Operations Research, 2015, 63, 5, 1131-1143.

Posted: 14 Jan 2015 Last revised: 4 Dec 2015

See all articles by Nicola Secomandi

Nicola Secomandi

Carnegie Mellon University - David A. Tepper School of Business

Date Written: April 1, 2015

Abstract

Commodity merchants use various heuristics to value leasing contracts on storage facilities as real options and make inventory trading decisions. Two prominent heuristics sequentially reoptimize simple models, leading to the so called rolling intrinsic (RI) policy and rolling basket of spread options (RSO) policy. Lai et al. (2010) numerically demonstrate that these two policies are nearly optimal in many realistic settings and can be used with Monte Carlo simulation to obtain fairly accurate estimates of the value of storage contracts. This paper provides a theoretical basis for the observed benefit of reoptimization with these heuristics and additional numerical evidence for the near optimal performance of the RI and RSO policies in several practical cases, but shows that the RI policy significantly outperforms the RSO policy in some of these cases. This research also proves that the RSO policy has a double basestock target structure, a known property of an optimal policy that is trivially true for the RI policy. Moreover, this work develops efficient and effective new dual bounds to assess the performance of merchant commodity storage heuristics. In particular, these bounds are immediately relevant to the developers and users of the two considered heuristics.

Suggested Citation

Secomandi, Nicola, Merchant Commodity Storage Practice Revisited (April 1, 2015). Operations Research, 2015, 63, 5, 1131-1143., Available at SSRN: https://ssrn.com/abstract=2549026 or http://dx.doi.org/10.2139/ssrn.2549026

Nicola Secomandi (Contact Author)

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

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