Weather Derivatives Essay

1153 WordsNov 30, 20135 Pages
Overview of uses[edit] Farmers can use weather derivatives to hedge against poor harvests caused by failing rains during the growing period, excessive rain during harvesting, high winds in case of plantations or temperature variabilities in case of greenhouse crops; theme parks may want to insure against rainy weekends during peak summer seasons; and gas and power companies may use heating degree days (HDD) or cooling degree days (CDD) contracts to smooth earnings. A sports event managing company may wish to hedge the loss by entering into a weather derivative contract because if it rains the day of the sporting event, fewer tickets will be sold. Heating degree days are one of the most common types of weather derivative. Typical terms for an HDD contract could be: for the November to March period, for each day where the temperature rises above 18 degrees Celsius keep a cumulative count of the difference between 18 degrees and the average daily temperature. Depending upon whether the option is a put option or a call option, pay out a set amount per heating degree day that the actual count differs from the strike. History[edit] The first weather derivative deal was in July 1996 when Aquila Energy structured a dual-commodity hedge for Consolidated Edison Co.[1] The transaction involved ConEd's purchase of electric power from Aquila for the month of August. The price of the power was agreed to, but a weather clause was embedded into the contract. This clause stipulated that Aquila would pay ConEd a rebate if August turned out to be cooler than expected. The measurement of this was referenced to Cooling Degree Days measured at New York City's Central Park weather station. If total CDDs were from 0 to 10% below the expected 320, the company received no discount to the power price, but if total CDDs were 11 to 20% below normal, Con Ed would receive a $16,000

More about Weather Derivatives Essay

Open Document