LONDON, Oct 11 (Reuters) – Financial instruments allow energy companies, hedge funds and commodity traders to bet on the weather as they seek to protect against or profit from an increasingly extreme global climate. We are strengthening the use of
On the Chicago Mercantile Exchange, average open interest in weather futures and options from January to September was 4x compared to the same period last year and 12x compared to 2019.
Open interest measures the number of outstanding futures and options contracts that have not been settled. Trading volume also quadrupled in one year.
Weather derivatives were born in the late 1990s. The market expanded, partly due to the influence of US energy company Enron, and attracted speculators looking for assets isolated from broader financial markets, but shrank after the 2007-2008 financial crisis. did.
This time around, market participants are hoping that growth will become more sustainable as concerns about climate change and energy supplies prompt companies such as major power companies to use contracts to protect themselves. ing.
“There is a general belief that extreme (weather) events are going to become more common and also more extreme,” said Peter Keavy, global head of energy and environmental products at CME Group. Ta. “That was the biggest driver of this issue.”
According to the European Union Climate Change Agency, a combination of climate change and the El Niño phenomenon will make 2023 the northern hemisphere’s hottest summer on record. This year has seen a series of extreme weather events, causing devastating floods and wildfires around the world.
Weather derivatives allow buyers to avoid the risk of weather damaging their business. Unlike insurance, where a business has to prove it has suffered a loss, payments are made based on metrics. These might track the temperature in Paris or the rainfall in New York.
In a typical deal, energy companies would buy temperature-linked contracts to hedge against the risk that natural gas sales would decline as the weather warms during the winter heating season. If the temperature during the period is warmer than average, the value of the contract will increase and you will receive a payment at closing.
Ski resort operators can avoid the risk of not getting enough snow, and music festivals can protect themselves from rain. Usually, it’s a large reinsurance company or a large hedge fund on the other side of the deal, such as billionaire US investor Kenneth Griffin’s Citadel.
“If you can measure it and put a price on it, you can basically offer a product,” said Nick Ernst, an industry veteran who was hired by broker BGC Group in July to start its weather derivatives desk.
Ernst said the Ukraine war and ensuing energy crisis, as well as U.S. and European regulations requiring companies to understand their exposure to climate change, have increased interest.
Matthew Hunt, head of UK power desk at renewable energy company Statkraft, said the Ukraine war had highlighted how fragile energy supplies were. He said the company is using derivatives that “really help” it hedge against the risk of not having enough wind power on the grid.
growing pains
This market remains small compared to other commodity-related markets. Average open interest in CME weather futures and options contracts in September was about 170,000 contracts, compared to about 10 times that of crude oil, but market participants believe 90% of the weather derivatives market is traded over-the-counter.
“Extreme weather events tend to be good marketing for the future of climate,” said Samuel Randalls, a professor of weather and climate at University College London. But he said defenses against climate change would have limited use because they would not mitigate long-term changes that would make many businesses unviable.
Education is a challenge, said David Whitehead, co-chief executive officer of Speedwell Climate, which produces many of the weather indicators that support the market. The growth of the renewable energy market has been a boon as many people are unaware of the existence of these products.
“Everyone was worried about how much oil was going to come out of the ground. Now people are concerned about how much wind and solar power is coming out,” Whitehead said.
But UCL’s Randles is skeptical about the potential for growth.
“Unless companies are convinced that this is a necessary activity, and that may be difficult, the futures market will struggle to grow beyond the reach of some companies and traders.”
Another possible limitation is the fact that investors cannot trade weather indices in the same way as oil or bonds, which are the basis of other futures markets. This means the market is not suitable for pure speculation, BGC’s Ernst said.
But market participants say hedge funds and other institutions are getting involved again. Citadel has become an increasingly important player.
Martin Malinow, founder and CEO of Parameter Climate, said these companies “think of themselves as risk warehouses, like insurance or reinsurance companies.” “This is a sign of a more functional market, with players like Citadel coming in who can play a variety of roles.”
Report by Harry Robertson.Editing: Emelia Sithole-Matarise
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