A methodology for the gridding and upscaling of geological systems characterized by channeling is presented. The overall approach entails the use of a flow-based gridding procedure for the generation of variably refined grids capable of resolving the channel geometry, a specialized full-tensor upscaling method to capture the effects of permeability connectivity, and the use of a flux-continuous finite volume method applicable to full tensor permeability fields and non-orthogonal grids. The gridding and upscaling procedures are described in detail and then applied to several two-dimensional systems. Significant improvement in the accuracy of the coarse scale models, relative to that obtained using uniform Cartesian coarse scale models, is achieved in all cases. It is shown that, for some systems, improvement results from the use of the flow-based grid, while in other cases the improvement is mainly due to the new upscaling method.