Our third in this series of interviews with leading industry figures features Marty Malinow of Galileo Weather Risk Management Advisors LLC. Marty has been involved in the weather risk management marketplace for twelve years and in capital markets for twenty years. Before co-founding Galileo Weather he was co-founder of XL Weather & Energy and headed up their global weather business. Marty has also served as President of the Weather Risk Management Association from 2008 to 2010 so we’re delighted to have this insight from such a key figure in the weather risk market.
How do you think the weather hedging market is fairing currently?
The weather market is growing steadily in the area that is most vital to its future – end-user risk. Trading and speculative volumes on the CME fluctuate based more on available hedge fund capital dedicated to commodities but generally, once an end-user, always an end-user.
What changes have you seen over the last few years (types of deals, customers etc)?
We have seen a large increase in penetration to the traditional energy sector – gas and power – where companies are looking for operational hedges against fluctuating supply and demand based on weather and its correlation to commodity prices. We have also seen new interest in agriculture, construction and renewable energy.
How do you see the market developing?
For the foreseeable future, I think market activity will still be bifurcated into two fairly distinct areas – illiquid highly structured deals and standardized exchange-traded deals, with the former leading the market in end-user innovation and adding value to the overall space.
Where do you see the weather hedging market going in terms of innovation? What innovations excite you?
We see large growth in weather-contingent commodity products where the payout of a weather event is linked to a specific commodity index. While these originated in the energy space, these products are applicable to other industries for example agriculture. We also see great promise in “first order” hedging products – ones that are indexed to the specific risk faced instead of to the weather driving that risk. A good example is a product triggered on daily energy demand, which is highly correlated to the weather but also sensitive to other factors such as the prevailing economic environment. Another would be yield products that settle on a transparent index of agricultural yield.
Any fears for the markets future?
My only concern is that the recent trend toward increased regulation – which produced the Dodd-Frank bill – could place limits on the financial market’s ability to innovate and transact value-added products like weather derivatives. For example, legislating that the majority of derivatives must trade on a recognized exchange is not only illogical but threatens products like customized weather derivatives that don’t fit neatly onto a platform like this. At the end of the day, companies will find a way to buy risk management products that are vital to their business and the question is really more one of friction.
Are you seeing any trends emerging as the market matures?
I think that for the first time since the inception of the market, access and cost of financing are beginning to play a role in the motivation to hedge. While the majority of risks transferred over the first dozen or so years of the market were motivated by operational risks, over the next decade, this will begin to even out with financing risks. This is especially true in high-growth industries like renewable energy, where there will be a strong demand for capital in an environment where there is now more rigor in underwriting debt and managing the risk profile of financings more closely.
Tell us about your business model. Do you target specific industries exposed to weather risk?
Galileo is one of the largest portfolio managers of weather risk in the world, currently focusing on large, customized end-user deals. We see ourselves as being in the business of helping end-users manage large, complex weather-driven problems and sell our products off of a highly-rated platform. We have spent the majority of our time over the past five years since we created Galileo working with energy companies around the world but do see our customer composition beginning to evolve to other industries like agriculture and construction.
Can you tell us a bit more about Galileo’s products and why you feel they work for your customers?
Galileo’s products are customized in the sense that we rarely sell the same structure twice unless it is with a repeat customer. Unlike standardized degree-day products that trade on the CME, our products often have highly-shaped payouts based on customer-specific weather and commodity price triggers. We sell products globally and try to gain a deep understanding of our customer’s underlying business to better build a value-added hedging product.
Weather risk deals are down on previous years, do you think the market has stagnated or rather volumes are more hidden than before as it is mostly exchange traded?
Weather volumes are down on the exchange but not in the OTC market, where a steady progression has been afoot the past 12 years. Also, the WRMA survey has been less effective in sizing the market the past few years as it has grown not only globally but also through (re)insurance products and our guess is that many new players and their volumes are not included in the survey.
Do you have any thoughts on what the next big thing in weather risk transfer could be?
I would say agriculture, renewable energy and securitization of weather risk, with the goal of the latter of providing capital market investors with tradable securities in a new, non-correlated asset class.
Any final words for the Artemis.bm audience?
People ask me a lot about “climate change” and its impact on the weather business and frankly, I think it’s a very hard question to answer. In general, I find it interesting that scientists can make deterministic predictions regarding the future of our climate over the timeframe of decades. As a risk-taker in weather, we are doing similar analysis albeit on a shorter timeframe and have a good sense of what’s involved. In general, there is so much modeling uncertainty – on top of natural climate variability – that we tend to think about the world in probability ranges and not specific point values. This allows us to make prudent financial decisions for our business where the stakes are in the hundreds of millions…one would think there would be more credence given to this approach when the stakes are potentially in the trillions of dollars.
Many thanks to Marty for his time and this great insight into the weather risk market. We hope our readers are enjoying this series of interviews as much as we are.
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