Weather derivatives notional volumes fall by $100 million

The Weather Risk Management Association (WRMA), the international trade organisation of the weather derivatives industry, yesterday said that the notional value of weather derivatives contracts fell by $100 million from last year’s figures.

In its third annual survey, released yesterday at its conference in Miami, WRMA calculated that the global weather risk market was worth $4.2 billion for the 2002/2003 period, down from a notional value of $4.3 billion for 2001/2002.

But WRMA, which conducted the survey in association with PricewaterhouseCoopers, also found that the number of weather risk management contracts almost tripled from 11,756 contracts transacted through 2002/2003, up from 3,937 weather transactions for 2001/2002.

Weather risk management futures and options traded on the Chicago Mercantile Exchange (CME) totalled 7,239, while over-the-counter risk transfers totalled 4,517. The number of OTC contracts only grew by 14% from the 2002 survey, WRMA added, so the increase in contract numbers can be attributed to the success of the CME exchange-traded offerings.

The CME has been particularly successful in the past year due to the influx of hedge funds that trade its weather contracts speculatively and due to increasing worries about counterparty credit risk between energy companies, which are still battling against post-Enron rating downgrades. Energy companies are the largest users of weather derivatives, and pioneered the market’s development until many US firms such as Aquila and Dynegy exited the market due to credit issues.

WRMA reported that the European market recorded a total of 1,480 contracts this year, compared with 765 contracts measured in the 2001/2002 survey – an increase of more than 90%. In Asia, 815 contracts were completed – an increase of nearly 85% – compared with 445 contracts in the 2001/2002 survey. Both markets are almost entirely OTC. The North American market noted a 20% decline over the previous year's 2,712 contracts to 2,217, meaning North American OTC contract activity fell significantly.

This year, WRMA has reverted to its 2000/2001 view of stressing contract number growth size over notional volume growth. In the 2000/2001 survey, WRMA claimed that period’s decline in notional values from 1999/2000 figures – down 14.8% to $2.5 billion – was less important than the increase in the number of contracts. In the 2001/2002 survey, it appeared to stress the 72% notional increase over the 43% contract growth, and has this year reverted back to stressing contracts' growth size over notional volume increase.

Last week, inter-dealer broker Icap told RiskNews’ sister publication EPRM that it had exited the European weather derivatives market because “the markets for these products are not developing at a large enough rate to warrant commitment". Icap joins a number of other companies that have fled weather hedging over the past 18 months, including banks BNP Paribas and Intesa BCI.

This year’s survey did find that the variety of weather products has shifted from purely temperature-related products. While temperature-related protection continues to be the most prevalent contract type, comprising more than 85% of all contracts compared with nearly 90% in last year’s survey, there were substantial increases in the use of rain-related and wind-related contracts. In the 2002/2003 survey, rain-related contracts account for 8.6% of the market compared with 6.9% in 2001/2002, wind for 1.6% compared with 0.3% and snow for 2.1% compared with 2.2%.

WRMA did not release information regarding the number of companies that took part in this year’s survey. Last year 20 companies submitted figures out of a total of 70 WRMA members.