Complexity of weather deals set to grow

Trades in the growing weather risk market are likely to include a greater number of complex cross-commodity products as end-user sophistication increases, according to Valter Stoiani, manager for trading at Houston-based Enron Global Markets' weather group.

Speaking at Risk magazine’s Alternative Risk Strategies conference in New York on Friday, Stoiani said the weather risk market has seen a widening of the types of transactions conducted in the past 18 months beyond traditional temperature-only deals to those linked to rainfall and power load risk management.

He said deals such as that struck by the Sacramento Municipal Utility District (Smud) earlier this year could become more common. Smud, a hydro generator in the western US, agreed to buy a precipitation put option with a payout linked to the price of natural gas on the US benchmark Henry Hub. In the event that annual rainfall in the utility’s area falls below 42.5 inches a year, Smud will receive 18,000 times the Henry Hub gas price for each one-tenth of an inch below the strike.

"I believe we will see more linked deals of this sort, not just involving rainfall and natural gas but, for example, heating degree day/natural gas and contracts linking temperature and corn prices in the Midwest [US]," Stoiani said.

Stoiani points to non-energy deals, such as snowmobile manufacturers buying protection against low snowfall and construction companies entering into rainfall related hedges to protect themselves against work time lost to rain, as evidence that companies outside the energy sector are starting to wake up to the need for weather risk management.

But the market is likely to remain dominated by temperature-related deals for the time being. "The market for rainfall is not yet liquid... and so this is still handled largely by the insurance market," he said. "The most efficient way to manage this kind of risk is to delta-hedge on a daily basis, but this can be very complex and requires a liquid commodity."