Tradeoff between Storage and Transport in Merchant Energy Trading on a Network

The operations of merchant energy trading in wholesale markets across different locations and current and future dates can be represented as a network where storage and transport trades compete for the capacity of storage and transport assets. We study the tradeoff between storage and transport trading for a network with a single storage asset and multiple transport assets, a realistic situation that we model as a Markov decision problem (MDP). Due to the intractability of computing an optimal policy of this MDP, we leverage our structural analysis of this model to modify a least squares Monte Carlo method to obtain a heuristic policy, also computing both lower and upper bounds on the market value of an optimal policy. On a realistic natural gas application, we document a substantial tradeoff between storage and transport trading. This tradeoff is difficult to manage, as sequential storage and transport trading is considerably suboptimal, especially when prioritizing transport over storage. In contrast, our joint policy is near optimal. A practicebased method based on sequentially reoptimizing a deterministic model is also near optimal, but, even after simplification, is computationally more intensive than our approach. Moreover, we highlight the operational differences between managing storage jointly with transport assets versus as a single asset. Beyond natural gas, our research has relevance for managing the merchant trading operations of other energy sources, natural resources, and other storable commodities.