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Derivatives

Weather business sizzles in the summer heat Add to ...

Beverly Archibald has been in the weather business for more than 20 years, but never has she seen a summer like this.

Ms. Archibald runs Edmonton-based True North Weather Consulting Inc., which provides specialized forecasts for dozens of companies, mainly in the oil and gas sector, to help them plan various projects. Much of her work involves predicting conditions that lead to forest fires. The hot, dry weather across much of Canada this summer has kept Ms. Archibald scrambling.

“We haven’t been this busy in 25 years,” she said. “We’ve had a scorcher.”

Some shrewd investors have benefited from the heat wave as well. Traders who have been using weather derivatives to bet on rising temperatures have cashed in: A key weather contract on the CME has jumped more than 60 per cent in the past month because of the heat, and is now trading 50-per-cent higher than its 10-year average.

The contract is called the Chicago Cooling Degree Day Futures. It is derived from temperature changes above or below 65 F. During summer, when temperatures are above 65, the value of the contract rises (it is measured in a unit called “cooling degree days”).

On June 3, the contract was trading at 268 cooling degree days. It jumped sharply in recent days and hit 450 on Thursday. Each point is equal to $20 (U.S.), meaning the value of the contract has increased by $3,640.

The main users of CME weather contracts are utility companies, said Jeff Hodgson of Chicago Weather Brokerage LLC. For example, a utility might want to protect itself against an excessively cool summer by taking the opposite position on a weather contract. If the temperature drops, the utility makes less money on the sale of its electricity, because demand for air conditioning is low, but it will make a profit on the futures contract.

“We are just exploding,” said Mr. Hodgson, whose firm helps clients hedge against temperature and other weather events, including rain and snow. When asked whether some people stand to make big money from the heat wave, he replied: “Absolutely.”

The CME contract is just one type of weather derivative. There are many more that trade over the counter, or privately between two parties, and the number is growing. According to the Washington-based Weather Risk Management Association, weather derivatives are an $11-billion business and the number of products jumped by 30 per cent last year.

Weather consulting and hedging have become a big business, with companies from Goldman Sachs Group Inc. and JPMorgan Chase & Co. to FedEx Corp. and United Parcel Service Inc. hiring meteorologists to keep track of weather. Others, including big retailers like Wal-Mart Stores Inc., hire private firms to supply weather information, devise hedging programs or arrange weather insurance.

The demand has led to a booming business in weather consulting.

Last year, researchers at the University of California at San Diego created an online weather system, called EarthRisk Technologies, that crunches more than 50 years of data to offer forecasts to customers. Another U.S. weather company, WeatherBill Inc., recently launched a service that constantly analyzes data to provide farmers with insurance against extreme weather.

New York-based Galileo Weather Risk Management Advisers LLC offers a range of products. “We sell weather protection and we generally sell it in the form that most people request it, which is derivatives,” said chief executive officer Martin Malinow.

Among the most frequent customers are manufacturers who have special electricity contracts with utilities called “interruptables.” Under those contracts, the manufacturer receives a discount on electricity, but agrees to some type of power cut if the supplier needs to divert supplies to other customers during times of extreme demand, such as during a heat wave.

“There are ways to hedge yourself if you are a factory,” Mr. Malinow said. “If the power company calls on a really hot day and says, ‘Shut down, stop making widgets for the next day,’ you could actually buy a weather derivative from somebody like ourselves. And you could get [compensated] to pay you back what you expect to lose in production.”

For now, most of the action in the weather business is outside Canada. Ms. Archibald of True North said drumming up business in Canada isn’t easy because Canadian companies seem content with Environment Canada forecasts, which she said do not provide detailed longer term information. “There is a reluctance here and I don’t know why,” she said.

Mr. Malinow agreed; he said he sells billions of contracts in the United States, Europe and Australia, but few in Canada. “I scratch my head a lot and wonder why Canadian companies are not more interested in products like this,” he said. “Because they are certainly exposed to these types of risk.”

 

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