Energy markets still the primary users of weather risk management tools

by Artemis on May 27, 2011

At the recent Weather Risk Management Association’s (WRMA) 13th annual meeting held in Houston, Texas earlier this month participants on a panel about power and natural gas agreed that the energy markets continue to be the primary users of weather hedging and weather risk management tools.

The energy markets including power producers, distributors, alternative energy sectors such as wind power and major end users of energy all have earnings and costs which are strongly correlated to variations in the weather. As a result much of the weather risk management market has evolved around products created to address their needs, such as heating degree day and cooling degree day derivatives and hedges. However the panel did discuss instances where the correlation breaks down such as last year when the correlation between weather and natural gas was adversely affected by an oversupply of gas in Europe.

The French energy industry continues to be one of the strongest users of weather derivatives where the WRMA say the main market drivers are nuclear, hydro and temperature (with cold temperatures being a primary driver for weather hedging). “If electricity demand is very high, there’s a need to buy power in the market” said Jens Boening of EDF Trading. “Setting up the hedge is critical. You don’t want it to go wrong, so structure it properly,” said Direct Energy’s Kevin Krcil.

The wind power industry and particularly wind power generation is a sector which is receiving a lot of attention in the weather risk market right now. A new weather hedging product for the wind power industry was announced last week by renewable energy risk analysis firm 3TIERĀ® and Galileo Weather Risk Management which we covered the announcement of here. “As wind power develops the need for weather hedges will continue to grow, particularly for new products. Spikes in wind-based generation show the need for hourly weather derivatives,” said Krcil. “Better wind forecasting is also needed since it’s difficult to plan more than a couple of days out.”

The energy sector is likely to continue to lead the way in the use of sophisticated weather hedging tools and weather derivatives as there is such a strong correlation between weather and power use and the sector is financially quite sophisticated. However the weather market is growing, as evidenced by the results of the WRMA annual survey which you can read more about here. The tools and techniques used to hedge weather risk by the power sector do serve to provide a proving ground for products which can be translated to other sectors as well so the continued use by energy companies can help the weather market to innovate and expand in the future.

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