The weather risk market demonstrated its diversity and growth at the recent Weather Risk Management Association (WRMA) 12th Annual European Meeting in Dusseldorf, Germany. Over ninety weather risk professionals from six continents and seventeen countries attended, demonstrating continuing global interest in weather risk hedging and making it the most diverse WRMA event yet.
The meeting was kicked off by a provocative keynote talk from Dr. Mojib Latif, Germany’s leading expert on climate change from the Leibniz Institute of Marine Sciences at the University of Kiel (IFM-GEOMAR). Dr. Latif shared his views on the impacts of climate change from the growing emissions of greenhouse gases, including the overall trending of global warming. Following his presentation, attendees addressed their concerns with the “Climate Gate” scandal and overall skepticism behind the science used to back his claims. Dr. Latif then posed the question to the attendees, “If you got on a plane and were notified it had a 10% chance of crashing, would you still get on the plane?” He then noted that science was not 100%, but could show enough certainty on which to base future decision making.
“Severe weather has major societal and economic impacts in Europe and worldwide,” said Dr. Erik Andersson, Head of the Meteorological Division of the European Centre for Medium Range Weather Forecasts (ECMWF), who led the meeting’s afternoon forecasting session. “Advance warnings are vital to mitigate the effects of these events,” he said, noting that strong winds, heavy precipitation, heat waves, and cold spells are the dominant factors in economic losses. ECMWF is constantly working to improve its models and is introducing products that are specifically tailored for severe and extreme weather.
How energy companies manage weather risk
Energy companies continue to be major players in the weather risk market with a growing number of companies taking advantage of the benefits of weather risk management products. Representatives from EDF Trading, RWE Supply and Trading and E.ON Energy Trading SE gathered to further explore this relationship on an international and local German level.
“Most major energy utilities consider weather risk management as strategically important,” said Jens Boening, Head of Weather Derivatives for EDF Trading. “Weather is unpredictable and very volatile, which implies huge risks and uncertainties for weather-dependent industries,” Boening said. Both natural gas demand and electricity demand are very temperature-dependent. Because of this, many European utilities employ weather derivatives to “mitigate the negative impact of adverse weather conditions,” he said.
Energy and commodity markets are already using complex weather derivative structures to offset risk, said Eric Stein, Head of Weather Analysis and Trading of RWE Supply and Trading. Precipitation, sunshine hours, wind, and temperature are all factors in weather risk exposure. “Weather exposure and sensitivity is amplified or damped by structural and social impacts,” Stein said. Recent examples are a grid shutting down wind power due to network congestion, lack of cross-border capacity, and an unexpected change of focus such as Germany exiting its nuclear program.
Companies that wish to hedge weather exposure need to follow four steps in the designing of a weather risk product, said Richard Betts, Senior Structured Trader of Weather Derivatives, from E.ON Energy Trading SE. The steps are to identify risk, quantify risk, structure a contract that pays when adverse weather occurs, and execute the contract to manage the risk. For its part, E.ON chooses to trade weather since trading weather improves and maintains the company’s credit rating and earnings.
Renewables’ weather risk must be managed
Intermittent power sources such as solar and wind will continue to grow substantially over the next few years. That growth is spurring the hedging of weather risk. In the case of an offshore wind farm, weather impacts the wind farm during construction as well as operation, said Michael Lewis, Managing Director Europe, E.ON Climate and Renewables. Strong winds and high waves can delay deployment of construction ships and prevent access to the structure under construction and have high impact on accessibility once operational. “To further reduce exposure to weather risk, more innovative approaches are required,” said Lewis. While “managing a portfolio across regions and continents helps to mitigate weather risk exposure, nevertheless, the impact of weather conditions in the construction and operating phase is still significant.” Lewis said.
Weather risk management tools are being used with success not just in Europe and North America, but also in Latin America. Colbún, the second largest utility in Chile, has been using weather risk management tools since 2009, said Mario Amaro. The innovative hybrid insurance product that Colbún employed in 2009 allowed the company to hedge its weather and fuel price risks, benefiting the bottom line. ead of
Rounding out the meeting was the Introduction to Weather Market Basics workshop, which outlined the various components needed to operate a weather risk desk for hedging; an update on derivatives legislation in the European Union and the US provided by Clifford Chance’s Claude Brown; a discussion about how volcanic activity impacts forecasting and weather by Simon Blockley of Royal Holloway, University of London; and a global overview of weather risk tools for agriculture by Salah Dhouib of Liberty Syndicates.