A growing number of companies in Europe are sensitive to the weather, yet insurance usually only covers catastrophic events. Marcus Gibson looks at the increasing trend of managing weather risk.
Companies are coming to realise that they can buy the weather they want – rather than put up with what they get.
This is the view of Nick Mooney, director of weather risk in Europe for Enron, the energy and communications network company.
This summer, the European market in weather derivatives has really taken off as the penny has finally dropped among buyers that such deals offer real opportunities for better management of bottom-line results.
Quite suddenly, climate has become a fascinating subject to firms whose revenues are highly sensitive to weather.
And the buyers of weather derivatives, which until recently were limited in Europe to energy companies such as Scottish Hydro-Electric and Energie Noord West in the Netherlands, now include supermarkets, beer producers, vineyards, ice cream and soft drink manufacturers.
Market leaders in weather trading derivatives such as Enron, Aquila, Koch Industries and Gerling Capital, are now being inundated by enquiries.
"All are looking at ways of better managing their weather risk," says Mooney, "Especially as their success or failure in this regard is increasingly how they are valued on stock markets."
Nowadays, he says, analysts expect companies to minimise their weather risks in order to stabilise earnings and remove natural volatility.
The potential market for weather trading is enormous. Broadly, weather factors such as temperature and rainfall account for a ten per cent volatility in total earnings for UK energy producers. "That's a $1 billion-a-year (£600m) risk in the energy sector alone," says Mooney. Across Europe, the figure would be nearer $8bn (£4.8m).
Experts say weather is a key factor in influencing the fortunes of around 25% of America's $9 (£5.5) trillion economy.
Enron is currently talking to a European theme park whose gate receipts are heavily weather-dependent. In addition, film companies which do not want to insure a single day's filming – want to hedge against a prolonged period of poor light which prevents filming.
While insurance usually covers catastrophic events, derivatives cover minor deviations from historic weather patterns.
The purchaser must demonstrate a loss with an insurance claim; but pay-out on a derivative is automatic if weather data during the period being covered exceeds set boundaries.
In reality, AIG's Storm product differs little from those of derivative providers such as Enron or Koch.
One obstacle to growth has been the extremely high cost of weather data from institutions such as the Met Office, which charges three times as much as France's Meteo. Thirty years of data from only one site costs £3,000.
This situation could change following a very large response to a Met Office questionnaire intended to gauge interest in weather data.
Market leaders Enron and Gerling, however, are not having all of the market to themselves. A significant newcomer to weather trading earlier this summer was the French banking group Societe Generale.
From its London office, section head Diego Wauters says he is talking to over 30 potential clients.
The rise in interest in weather trading has been tracked at Artemis.bm, the global ART web site, which has recorded more than 40,000 hits a month from interested parties.
Artemis, almost certainly the first capital market to be born on the Web, has served to unite the Alternative Risk Transfer market since it was launched six months ago. Charles Hyde-Smith, web site development director believes 2000 will be the year when weather trading takes off in Europe.
Hyde-Smith says: "The site is being interrogated by thousands of companies looking for the right contacts. Often the biggest hurdle in any new business is to find the right people to talk to."
Artemis's personnel directories list almost every professional active in weather trading – brokers, underwriters, capital providers, lawyers and weather data providers, he says. The web site's market intelligence section lists major deals.
A lot of work needs to be done to explain the often alien terminology used in weather trading which is off-putting to newcomers, even to experienced finance directors and CEOs.
Once that terminology has been explained, and the benefits set out, assures Mooney, weather trading transactions are quite simple.
Artemis' and Enron's web sites can be found at: www.artemis.bm and www.enron.com
