Renewables expected to drive demand for weather derivatives

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Panel forecasts sunny outlook for weather derivatives

Renewable energy generators will become an increasingly important source of business for firms involved in trading and hedging weather risk, said speakers at the annual meeting of the Weather Risk Management Association (WRMA) in London on September 19.

During an afternoon panel on weather risk management, market participants cited a number of reasons why the market for weather derivatives might be expected to grow over the coming years. While many renewable generators had previously been shielded from market forces by heavy subsidies, the scaling back of these payments could leave firms with a greater need for weather risk management tools, they said.

“We anticipate seeing more inquiries coming through in the next year to three years from not just new, but also existing operating assets that previously haven't needed low-wind protection because very ample subsidies had effectively de-risked their project,” said Julian Roberts, London-based executive director at reinsurer Willis. “But as those margins begin to shrink, the entity becomes more exposed to low-wind risk than from the outset, so I think we'll see a rise in the demand or at least more interest in de-risking wind projects.”

Feed-in tariffs, which guarantee renewable generators a high price for their power, have fuelled increases in wind and solar capacity in many European countries, but have also contributed to costlier energy bills. Italy and Spain are among countries that have been paring back these subsidies, while Germany is also expected to reform its Renewable Energy Sources Act following its recent general election.

Muted volatility and lower liquidity across European energy markets have been a headache for many market participants, but weather risk specialists speaking at the WRMA event said it might provide them an opportunity to take a bigger role. The lack of volatility meant there were fewer speculative or proprietary traders active in the market, so utilities and other generators would increasingly have a hard time laying off their risk in conventional energy markets, said Ralph Renner, London-based director of European origination at Endurance Global Weather, the weather risk management arm of Bermuda-based reinsurer Endurance.

We anticipate seeing more inquiries coming through in the next year to three years from not just new, but also existing operating assets

“A few years ago, you had a lot of speculative players in the middle of this [market] that had positions that they would happily trade out of… But if you don't have these guys, the market suddenly comes up with very little volume and you can't put anything in place.”

That was good for weather risk management specialists, added Renner. “We think there will be an increase from within our industry to provide products to the energy space."

Products such as quanto swaps, which involve weather conditions being used as a trigger to a commodity price payout referencing electricity or natural gas, for example, are already popular with utilities. However, the market had the potential to grow further, said Renner. Other weather risk products panellists expected to flourish included derivatives based on regional wind and solar indexes that allowed buyers to manage their risk for periods of peak demand, revenue protection products for wind and hydropower producers, and options that protected against extreme weather events.

Earlier this month, Bill Windle, Houston-based managing director of RenRe Energy Advisors, the weather risk management arm of Bermuda-based reinsurer Renaissance Re, told Energy Risk the firm intended to focus on providing hedging tools for renewable generators, once its acquisition by reinsurer Munich Re was completed.

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