Temperature, Price and Profit: Managing Weather Risk

Fortnightly Magazine - September 1 1998
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THE SUMMER OF 1996 OPENED COOLER THAN normal in June and July, cutting electric sales. When prices for natural gas did not fall as expected, as a counterbalance Consolidated Edison Co. of New York entered a combined gas-conversion and weather-heading transaction with power marketer Aquila Energy, giving Con Ed some measure of protection against further revenue shortfalls in August.

The deal was designed to run four days a week throughout the month (Tuesday through Friday) and to provide a guarantee of total cooling degree-days in New York City, with no apparent direct cash outlay from Aquila. If the variance between actual cooling degree-days and the forecast fell 10 percent below specified parameters, Con Ed would win a discount from Aquila, presumably on power the utility purchased from the marketer. Any returns due the utility from the marketer would come in increments of 50 cents per megawatt-hour; Aquila capped the utility's entitlement at $1.50 per megawatt-hour.

"It was a no-lose situation from my perspective," says Ken Bekman, Con Edison's wholesale power director. "It was an opportunity to generate some savings. The product ... was a good deal. It worked and we were happy with the results."

In the case in point, the parties took counter positions in weather. The utility sought protection against weather risk - the uncertainty in earnings and cash flow due to weather volatility - by entering into a weather-based hedge. The energy company took a weather position plus offered a client a desired weather risk management product.

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