Warm winter highlights weather hedging winners

The warmer than average winter, which has been responsible for a number of reports of losses to weather exposed businesses and a growing interest in weather derivatives and weather risk management tools, also reveals some of the weather hedging winners who had protection in place against the unseasonably warm weather. A good example of this has come to light in Just Energy Group’s recent financial results.

Just Energy Group is primarily involved in the sale of gas and electricity to residential and commercial customers and specialises in offering fixed price and price-protected contracts, as many energy firms do now. The warmer than average winter caused a sharp decline in gas consumption across some of the key markets Just Energy serves and they reported an average heating degree day increase of 15% in the fourth quarter of 2011.

Despite this sharp decline in consumption Just Energy were able to report margin in line with their forecasts and one factor that helped was a weather hedge they had set up for the winter season.

Just Energy’s management invested in weather index options prior to the onset of winter. Just Energy reported that these weather derivatives helped their bottom line by contributing $13m in margin that they would have otherwise lost due to the warm temperatures.

Executive Chair Rebecca MacDonald stated, “Many of shareholders look to Just Energy as an important source of steady predictable income. This will not change. While the past year saw unfavourable weather conditions for our operating results, we were able to meet our guidance and continued to pay our $1.24 dividend. Our payout ratio on Adjusted EBITDA declined for the third straight year reaching 62%, down from 66% in fiscal 2011 and 78% in fiscal 2010”.

The financial report details their weather derivatives purchase for the recent quarters:

Just Energy entered into weather index derivatives for the period from November 1, 2011 through to March 31, 2012 with the intention of reducing gross margin fluctuations from extreme weather. The maximum payout cap on the options was $15 million. The weather during the third quarter was approximately 10% to 15% warmer than normal and accounted for approximately $9 million of the total option payout. For the fourth quarter, weather remained approximately 10% to 15% warmer for January and February, absorbing the remainder of the payout cap, but then the weather was approximately 38% warmer than normal in the month of March. The impact from the record warm winter was lost gross margin of approximately $28 million, offset by the $15 million payout from the weather index derivative.

Just Energy said that they have also entered into weather derivatives contracts for the third and fourth quarters of 2012 to help them reduce extreme weather induced fluctuation in their gross margins. They’ve invested $2m in purchasing options for which there is a maximum possible payout of $15m.