Exchange traded weather derivatives still struggling to gain traction

Exchange traded weather derivatives are still struggling to make headway across Europe, as demand for bourses’ contracts remains limited, suggesting a need for further sector education and innovation.

Speaking at a conference as part of Germany’s E-World trade fair, weather risk transfer experts discussed the persistent challenges and struggles facing a successful European energy market for weather derivatives.

Europe, as with the wider world, experiences seasonal changes and a variety of weather events across numerous regions, including wind events, storms, earthquakes, flooding, and so on. But despite the dynamics of the European energy market, which continues to adapt to renewable energy advances, industry experts explained that bourses such as Nasdaq and EEX have seen limited demand for solutions.

Speaking at the conference Jens Boening, Head of Weather Derivatives at EDF Trading in Britain, said, “most European utilities consider weather risk management as strategically important,” adding that “the weather derivative market is still in its infancy.”

To date, explained industry experts in an article published by Reuters today, weather derivatives are placed bilaterally between buyers (utility companies) and sellers (insurers and reinsurers), with reinsurance companies and large ILS funds dominating the sell side owing to their ability to diversify energy risk across their portfolios and structure complex, customised deals.

In addition, stiff competition and mounting sector headwinds has resulted in an availability of cheap and increasingly efficient reinsurance capacity.

At the same time, the education of potential corporate buyers of exchange traded weather derivatives has perhaps been lacking, and exchange traded solutions might do better, in some instances, were they sold to company Chief Financial Officers (CFOs) as a form of contingent capital, as opposed to targeting insurance buyers.

The Reuters article notes a lack of interest for wind power contracts launched in 2015 on bourses Nasdaq and EEX, an area Artemis discussed recently as being a billion-dollar opportunity for insurers, reinsurers, and insurance-linked securities (ILS) players.

Speaking to Reuters, Peter Reitz, Chief Executive Officer (CEO) of EEX said that he wasn’t too concerned by slow penetration rates of the bourse’s German wind power derivative launched recently. Saying that while it’s yet to witness any trades, “we just have to be patient.”

“We won’t measure success by trading volumes in the first 24 months. We aim to change thinking around how to integrate renewable power into the market,” said Reitz, speaking with Reuters.

A large number of weather derivative transactions completed by reinsurers are tailored and structured to meet complex client needs, and the inability of bourses such as Nasdaq and EEX to match this could also be hindering take-up rates.

This notion was put forward by Ralph Hungerbuehler, Senior Originator for Weather and Commodity risks at reinsurance giant Munich Re, who said; “The bourses cannot tailor their weather products as well as the over-the-counter markets. Ever for us, it is sometimes hard to gauge customers’ behaviour.”

It’s worth noting that it isn’t just in Europe that exchange traded weather derivatives are struggling to gain traction. The Chicago Mercantile Exchange (CME) has been offering such solutions for at least 15 years, but has never been able to gain any meaningful traction.

So perhaps increased education and innovation around weather derivatives is needed if exchanges in Europe and elsewhere in the world are going to be able to compete with insurers, reinsurers, and also ILS players that could look to participate in the weather derivative space in the future.

Even the most established players in weather risk transfer say they are surprised that everyone isn’t already hedging their weather risks. As such an all-pervasive risk, you would imagine that the world’s corporations and smaller enterprises would all be aware that weather affects their revenue flows and that these can be smoothed by identfying the right weather risk factors and hedging them.

With the frequency and severity of weather events expected to increase in the coming years corporates’ need to hedge against the impacts on profits as a result of the weather is expected to grow. With this in mind, bourses and re/insurers and ILS players have an opportunity to capitalise on a billion-dollar market.