An Improved Basket of Spread Options Heuristic for Merchant Energy Storage

Practitioners use the basket of spread options (BSO) heuristic to model merchant energy storage as a portfolio of spread options and spot/forward sales. This method solves a linear program to obtain the composition of this portfolio and its associated BSO policy. Sequential reoptimization of this model yields the rolling BSO (RBSO) policy. It is known that although this policy performs well, typically dominating the BSO policy and often being near optimal, it can struggle when storage is fast. To attempt to obtain an improved RBSO policy, especially for fast storage, this paper proposes a BSO heuristic that modifies the objective function of the BSO linear program based on exchange option prices and a tunable parameter. On a set of known natural gas storage instances, limited optimization of this weight leads to improved RBSO policies. The observed improvement is modest on average but substantial when the original RBSO policies perform poorly, which occurs on some fast storage instances. Moreover, fixing this parameter to 0.6 gives RBSO policies that virtually match the performance of the best considered RBSO policies. The proposed BSO heuristic is thus as easy to use in practice as the original BSO heuristic