Risk Management

Weathering the Storm?

Global climate change could alter business models. One answer may be "weather hedging."
Stephen TaubApril 29, 2008

Among all the other havoc that global climate change is expected to wreak, it also could take a toll on corporations’ business models.

At least, that is the finding of a survey conducted by Storm Exchange, a firm that makes money helping companies cope with weather-related risk, and CME Group, a derivatives exchange that offers weather-hedging financial products.

In the study, 82 percent of 205 senior finance and risk managers at companies in weather-sensitive industries said weather volatility will require changes to their businesses over the long term. The industries included energy, agriculture, retail, construction, and outdoor entertainment.

Thirty-eight percent of the respondents said their exposure to risks stemming from weather volatility could be “significant,” and 21 percent said it could be “severe” (21 percent).

In addition, 34 percent said weather has become more volatile in recent years; the number jumps to 43 percent in the energy and agriculture sectors.

One way finance executives could mitigate the future costs is to hedge their exposure.

According to the survey, just 10 percent had used weather options or futures to hedge that exposure. However, of those who said their companies have used weather hedging tools, 86 percent said they found them useful.

It has been proven that one cannot forecast the weather beyond a few days with enough accuracy to support sound commercial decisions. However, some companies do experience operating results that correlate with temperature and other weather statistics. This makes possible financial products based on weather outcomes that can be used to transfer weather risk to others in a better position to manage it. Many insurance companies, commercial banks, investment banks, large energy companies, and trading companies are willing to underwrite weather hedges in the form of custom OTC contracts that settle on weather statistics.

Apparently, promoting the virtues of weather hedging is the overwhelming motivation for conducting this survey.

“This survey shows that not only will managing weather risk become increasingly significant, but also that hedging tools such as futures and options on weather that are now available are extremely important,” said Felix Carabello, director of alternative investments at CME Group. “We hope this survey will help businesses understand the value of hedging weather risk, and also that the market has resources available to them to manage their exposure.”