Weather hedging seems to have worked as intended for Star Group (formerly Star Gas Partners) in the first-quarter of 2020, as higher temperatures in the United States triggered a payout under the energy providers weather derivatives arrangements.
Star Group has been using weather derivatives to hedge out the impacts of temperature variability on its bottom-line for more than a decade, with degree day triggered parametric risk transfer in derivative form now firmly part of the energy providers risk management processes.
It’s not that often the company reports a positive gain from the derivatives though, but in Q1 2020 Star Group reported a favorable change in money due from its weather hedging arrangement amounting to $13.1 million.
As part of total net quarterly income of $58.4 million, the weather derivative payout contributed a significant amount of profit during the period, helping to offset reduced demand for heating oil and propane products from homeowners.
Star Group said that it experienced lower volumes sold and positive factors experienced were more than offset by warmer temperatures during the quarter.
“Temperatures in Star’s geographic areas of operation for the fiscal 2020 second quarter were 18.2 percent warmer than during the fiscal 2019 second quarter and 21.2 percent warmer than normal, as reported by the National Oceanic and Atmospheric Administration,” the company said.
The company’s performance was “Impressive given that temperatures were 18.2 percent warmer than last year, and our weather hedge worked as anticipated – resulting in a $10.1 million credit for fiscal 2020,” Jeff Woosnam, Star Group’s President and Chief Executive Officer explained.
Speaking during the firms earnings call last week, the CEO said that the “weather hedge worked as anticipated.”
Richard Ambury, CFO, further explained, “As of December 31st 2019 we expected to pay $3 million under the weather hedge program, because at that time the weather experienced during that quarter resulted in us increasing our expense for $3 million.
“However, the warm weather experienced during the second quarter of fiscal year ’20 resulted in a reversal of the $3 million charge previously accrued, as well as recording a benefit and receivable in the amount of $10 million. This $10 million was subsequently received in April 2020.”
Companies including energy providers often buy weather risk transfer and hedges in order to protect themselves from volatility, in terms of how warmer or cooler than expected or forecast weather conditions can impact the bottom-line.
Sometimes these hedges can be in the form of insurance contracts, supported by reinsurance and capital markets, but in the energy sector they are more often in derivative or swap form and the parametric index triggers used as heating and cooling degree days.
Structured a financial instrument in this way, benefits or expenses are recorded for the weather hedge depending on the actual weather conditions for each quarter and with the impacts of weather so easily and directly correlated to revenues in these cases, the use of derivatives and swaps works well.
That’s as long as the hedge is bought at the right strike price, or parametric triggers, to ensure it is closely sensitised to the actual experience of the protection buyer.
Star Group clearly benefited from its weather hedge as the warmer than normal Q1, particularly March, weather in parts of the U.S. disrupted its supplied volumes and as a result dented its profits, for which the payout from the weather derivatives compensate to a degree.
Some insurance-linked securities (ILS) funds are active in the weather derivatives and weather risk transfer space, although these kinds of derivatives based on heating and cooling can also be entered into on exchanges such as the CME.