Weather Derivatives - Weather Derivative Solutions

What Are Weather Derivatives?

Weather Derivatives (also known as “certificates”, “options”, or “guarantees”) are financial contracts that reduce the risk of weather-related losses.

First, the buyer requests a customized structure that pays relative to their weather risk. Then the seller offers a price that reflects the chance of the structure paying the buyer.

If the defined weather condition occurs, then the weather derivative pays the buyer. However, the seller profits from selling the contract if the weather does not occur. And therefore, the seller becomes the bearer of the risk as the contract makes up for the buyer’s losses due to the weather.

Example

Summer Season Ice Cream Sales

An ice cream parlor suffers from lower sales as a result of cooler summers.

Therefore, it decides to buy a weather derivative to compensate for cooler summer conditions.

On one hand, if it is a cooler summer, the weather derivative payout will replace the lost revenue from less sales.

On the other hand, the parlor benefits from increased sales from a warmer summer. Any losses due to the weather derivative are limited to its cost.

How Do They Work?

Weather derivatives cover for any measurable, third-party weather observation index. The index source must be agreed upon by the buyer and seller.

Example indices include rainfall accumulation or the number of “heat” days.

Unlike indemnity insurance, these contracts usually pay based on a linear model.

If triggered, the seller pays for each index unit away from a specified reference point (or “strike”). Call structures pay for each unit above the strike. And, puts pay for each unit below. Most structures are capped at a payout limit.

Thus, weather derivatives do not need a file claiming process for settlement.

The buyer receives a payout per unit of Weather Index below an agreed Strike (Put Strike), subject to a Maximum Payout.

The buyer receives a payout per unit of Weather Index (Call Strike) in excess of an agreed Strike, subject to a Maximum Payout.

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Attractions
Construction
Energy
Food
Hospitality

Outdoor Attractions & Events

Outdoor amusement and event revenue is especially exposed to the weather.

On one hand, rainy days cause parks to close and cancel events.

On the other hand, temperatures that are too hot or cold can affect merchandise and concessions revenue.

Construction

Project delays mean huge penalties in construction.

Concrete mixtures do not set below a certain temperature. Thus, all work involving cement drying cannot proceed.

Roofing cannot take place during rainy days.

Energy

Temperature affects gas and electricity usage.

Air conditioning requires more energy to heat or cool indoors the more hot or cold it is outdoors.

Additionally, solar panels produce less energy when it is cloudy or if covered in snow.

Also, wind turbines cannot produce energy without the wind.

Food & Water

Governments must secure food and water during catastrophic weather events.

Temperatures that are too hot or cold can also affect a restaurant’s menu item sales. Examples include ice cream, hot chocolate, as well as soup.

By the same token, grocery stores similarly price produce based on supply and demand. Lower prices rely on perfect growing weather to maximize supply.

Access to Clean Water Sanitation Featured Image & Wx Risk Global Vision

Food & Water

A wide range of hospitality companies have significant weather risk.

For instance, Emergency shelters open on days with freezing temperatures or precipitation. They run over budget when they are open for more days than planned.

Or, ski resorts must spend money to create snow when there is less than usual.

Beach resorts also incur more expenses when there are more rain days.

Attractions: Outdoor Attractions & Events

Outdoor amusement and event revenue is especially exposed to the weather.

On one hand, rainy days cause parks to close and cancel events.

On the other hand, temperatures that are too hot or cold can affect merchandise and concessions revenue.
Construction: Construction

Project delays mean huge penalties in construction.

Concrete mixtures do not set below a certain temperature. Thus, all work involving cement drying cannot proceed.

Roofing cannot take place during rainy days.
Energy: Energy

Temperature affects gas and electricity usage.

Air conditioning requires more energy to heat or cool indoors the more hot or cold it is outdoors.

Additionally, solar panels produce less energy when it is cloudy or if covered in snow.

Also, wind turbines cannot produce energy without the wind.
Food: Food & Water

Governments must secure food and water during catastrophic weather events.

Temperatures that are too hot or cold can also affect a restaurant’s menu item sales. Examples include ice cream, hot chocolate, as well as soup.

By the same token, grocery stores similarly price produce based on supply and demand. Lower prices rely on perfect growing weather to maximize supply.
Hospitality: Food & Water

A wide range of hospitality companies have significant weather risk.

For instance, Emergency shelters open on days with freezing temperatures or precipitation. They run over budget when they are open for more days than planned.

Or, ski resorts must spend money to create snow when there is less than usual.

Beach resorts also incur more expenses when there are more rain days.

Who Typically Buys Them?

Eligible Contract Participant (“ECP”) are eligible to buy these products.

An ECP is an entity that meets the government criteria based on their purpose to hedge risk or their net worth.

Basic Process Timeline

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