Above average temperatures to continue across U.S., good news for some weather derivatives traders

by Artemis on July 27, 2011

We wrote last week that some weather traders are taking advantage of the recent heat wave across the U.S. to profit from making the right choices with their weather derivative contract purchases. The high temperatures caused some weather derivative contract prices to soar on the Chicago Mercantile Exchange (CME) allowing traders to cash in.

Now weather forecaster Weather Services International (WSI) have published a report showing that they expect the warmer than average temperatures trend to continue through the rest of the summer and transition into a very warm autumn. They expect the summer period of August-October to feature significantly above average temperatures across all of the U.S. apart from some Pacific Coast states and Florida.

“The summer heat has been more impressive and widespread than anticipated so far,” said WSI Chief Meteorologist Dr. Todd Crawford. “The extreme drought across the southern Plains has resulted in record heat in that part of the country. The drought has also acted to anchor the heat across much of the eastern two-thirds of the country, while the West has remained relatively cool, so far. We don’t foresee a significant change in pattern for the remainder of the summer, although the focus of the heat may shift slightly farther to the west in August. As we progress into fall, the pattern will generally be driven by the northern Pacific Ocean signal, which strongly argues for very warm temperatures across much of the eastern two-thirds of the US, especially in the north-central and northeastern states.”

WSI predict that for the August-October period there will be 587 population-weighted cooling-degree days, much higher than the 1971-2000 average of 498 but slightly lower than last years 603. For weather derivatives traders each cooling-degree day point above average can be worth as much as $20 per contract held meaning some will profit this year. Other users of weather derivatives such as power companies are likely to profit more than normal from their weather hedging activities, which (in the case of power generation) they may use to cover the risk of higher than normal temperatures meaning greater than normal electricity consumption for air conditioning, or lower than normal consumption for heating. In this way weather derivatives can act as a hedge or type of insurance cover.

WSI predict that regional U.S. temperatures will be as follows for August, September and October:

Northeast – Warmer than normal
Southeast – Warmer than normal, except Florida
N Central – Warmer than normal
S Central – Warmer than normal
Northwest – Cooler than normal
Southwest – Warmer than normal, except coastal CA

Read the full details from WSI here.

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Dr. Ibriham Weather August 7, 2011 at 6:15 am

I bet WSI ends up with egg on their face for August. All they are doing is kind of like persistence of June July (JJ) with all their regions of “Warmer than normal”. That appears bogus for August (A) for some of those regions like N Central and Northeast (where big metro areas with big energy demands reside). The anomalously hot weather pattern has now changed rapidly and its only first few days of August. Seasonable to slightly cooler than normal is predicted by weather models for most of August for those places that WSI was confident about (like Northeast U.S.). This blog post by Artemis is rather strange, why would energy traders care much about the north hemisphere Autumn? Come on Artemis, do your homework! August is part of the JJA (June July August) period. Seasonal JJA temperature options hedgers who were freaked out in July with all the headlines “scary hot worry a lot” can now breath a sigh of relief because August for several major CME locations like NYC, Boston, Minneapolis, Chicago, will have seasonal normal and cooler than normal to the chagrin of WSI! The mention in this blog of August – Setpember – October (ASO) is a quasi red herring for those who trade seasonal CDDs (most volume is in JJA not ASO). Yes, for the monthly traders they could have been in the “scary hot” territory of July but now its a new month and a new weather pattern. Hint for those interested in hurricanes: almost all hurricane forecasters are also over predicting their landfall-making predictions!

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