Hedging Weather and Climate Risk
Presented to the Global Interdependence Center
June 18, 2008
introduction and overview
Introduction
Climate and Weather Risk
Weather Risk Management
Weather Derivatives and the Weather Markets
Storm Exchange/CME Benchmark Study Summary Results
Questions
storm exchange, inc. overview
Storm Exchange, Inc. (“Storm”) is a financial services company focused exclusively on weather related risk.
We provide clients with: ―
analysis necessary to identify the financial impact of adverse weather on income and expenses
―
financial capacity to offset the loss due to weather
―
ability to accelerate demand for seasonal goods and services
weather is one of the most important drivers of human activity
33% of GDP $4 Trillion
exposed to weather
U.S. Commerce Dept.
economic impact factoids noaa economic analysis
10% of GDP DIRECTLY impacted by weather
4.5% of the variation (volatility) in mean state economic output is explained by weather alone ―
ranges from 21% (agriculture) to 1.4% wholesale trade
―
fire/casualty insurance largest weather related variability: $51B
climate and weather risk
Source: The New York Times June 16, 2008
climate change a real issue Global Warming
Increasing Volatility
Northern Hemisphere
Rain Delay Index
1000 Year Observed: Data from thermometers (red) and from tree rings, corals, ice cores and historical records (blue)
Historical Volatility: Accumulated June/July Rain Days 1976-2007
25 0.5
20
0.0
15
-.05 10 -1.0 5
-1.0 1000
1200
1400
1600
1800
2000
Departures in Temperature (ÂşC) From the 1961 to 1990 Average
1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
# of days with > .1� of precipitation
2007
international panel on climate change (IPCC) Some of the Predicted long-term trends: ― VIRTUALLY CERTAIN: warmer and fewer cold days … warmer and more frequent hot days and nights ― VERY LIKELY: increased frequency of heavy precipitation events in some areas ― VERY LIKELY: increased frequency of heat waves Net/Net: increasingly volatile and increasing impactful climate/weather events are VERY LIKELY Weather Risk: a big/expensive problem; VERY LIKELY will be getting bigger and (potentially) more expensive Source: Climate Change 2007: Synthesis Report Summary for Policy Makers International Panel on Climate Change (IPCC).
•Hear the latest assessment of Storm scientists and analysts on how recent flooding will impact the corn, soy and other crops.
Recent Stories from StormWire (www.stormexchange.com)
end-user weather risk exposure scenarios
weather risk a manageable problem Three components: 1. Understanding value at risk 2. Operational management (managing the knowable)
― Real-time ― Tactical ― Seasonal ― Very long-lead (decades) Scenario Planning 3. Financial management (hedging the unknowable) ― Weather Derivative Hedging Solutions
weather risk measurable volatility
Increased heat stress = decreased corn production Increased Heat
weather risk predictable volatility Barron’s, May 19, 2008
• “Storm Exchange … is predicting corn yields this year will fall 7% below trend and plunge 14% from last year’s record harvest.”
NY Times, June 16, 2008
weather derivatives Companies use derivatives to manage uncertainty Weather risk management solutions are a form of financial protection designed to reduce revenue volatility caused by changes in temperature, precipitation or wind
‒ protection is triggered based on government (NOAA) weather data ‒ no proof of loss necessary. Applicable payments typically made within 3 days of end of period. ‒ protection can be tailored for a specific location or multiple locations ‒ financially guaranteed, then syndicated in global weather market
crop yield how it works Planting
Growing
Late April/Early May
June-July
Maturity/Harvest
Yield
Sept/Oct
typical yield
normal amount of rain fall
crop yield how it works Planting
Growing
Late April/Early May
June-July
Call option payout on too much rain
Maturity/Harvest
Yield
Sept/Oct
typical yield
$$$ normal amount of rain fall
crop yield how it works Planting
Growing
Late April/Early May
June-July
Put option payout on too little rain
Maturity/Harvest
Yield
Sept/Oct
typical yield
$$$ normal amount of rain fall
2008 So Far
10.2 Inches
1993 Comparison 3.4 Inches Blue Shaded Area = Normal Range
2008 So Far 10.2 Inches Theoretical Payout (Strike Point): 6 Inches
Blue Shaded Area = Normal Range
hypothetical hedge des moines flood hedge City of Des Moines conducts an analysis to determine costs associated with heavy rain in June Determines that every inch over 6 inches leads to flooding that results in up to $20M in unbudgeted costs
Puts in place a weather option that is structured to pay out $5M for every inch of rain accumulated above 6 inches during the month of June Limit is set at $20M (10 inches) based on the historical rainfall records back to 1950. 2008: option already triggered based on rainfall to date; $20M paid out within 5 days of the end of June. No claims process or proof of loss.
weather will be one of the big financial markets of this century $440 Trillion Derivatives
Weather-based OTC
$45.2 Billion
$8.4 Billion
$0
1972
2007
2005
2006
weather will be one of the big financial markets of this century
$200
Billion
Weather-based OTC
$45.2 Billion
2% Transportation 4% Construction 5% Retail
$8.4 Billion
7% Agriculture 13% Other 69% Energy
2005
2006
2011
summary thoughts Climate and weather a significant driver of economic volatility and uncertainty Climate change potentially increasing both the volatility and economic impact of the weather Comprehensive weather risk management efforts – both in the private and public sector – key to pragmatically dealing with the problem Use of weather derivative products likely to significantly grow in use as new originators come into the market and data/basis risk issues are resolved
contact
Paul Walsh Chief Strategy Office Storm Exchange, Inc.
paul.walsh@stormexchange.com 646.237.5370