Public Utilities Reports

PUR Guide 2012 Fully Updated Version

Available NOW!
PUR Guide

This comprehensive self-study certification course is designed to teach the novice or pro everything they need to understand and succeed in every phase of the public utilities business.

Order Now

The Perils of Ignoring Mother Nature

Experts say utilities' inconsistent approach to weather risk is costing them dearly.
Fortnightly Magazine - May 15 2002

people from the ultimate question of what can you stand as an industry, he says. The real question for the farmers and for the energy industry is how much risk can you stand, and what kinds of events will lead to bankruptcy, according to Skees.

Some companies that offer weather risk products, such as Element Re and Swiss Re, say they have not seen the so-called in-and-out of the market phenomenon displayed by utilities. Yet in addition to Sweetnam, Aquila's Brian Tobben, vice president for weather products, says that his company also has clients who hedge one year and decide not to hedge the next.

Of course, Mother Nature may provide the necessary education about hedging weather risk, though the lesson may be harsh. "[I]f you look at the utilities, and you look at the last five years, there have been some utilities that have suffered tremendously due to mild winters. This winter is a perfect example. I think if anything, just climatic volatility is going to move them to hedge more and more," Tobben says. He points out that for a utility, throughput of commodity, whether power or natural gas, is the heart of how they make money. "The funny thing about weather is over time it normalizes, but one year to the next it can be quite volatile, and certainly, five or six years ago, no one looking at the historical data up to that point probably figured the next four to five years were going to be warm, and if you had a couple [of warm winters], you'd figure the next year is going to be cold, we don't need to worry about it. Then, boom, another warm winter, it's definitely going to start affecting your operations."

Many companies are currently dealing with the fact that four out of the last five winters were mild, so that they really have no margin for error in the next year. Companies are forced to do something to re-evaluate how they manage their company, and their operations, and that will force them to take a strong look at putting some hedging in place. "We're seeing more and more utilities desiring to take a comprehensive approach to risk management, not only commodity price, but also their volumetric risk," Tobben says.

Frank Caifa, associate director at Swiss Re, says he has started "getting the requests we were hoping to see two to three years ago, and the end-users are starting to come in." He says that trend started in the Midwest a few years ago, when a handful of companies did some hedging. "Now, four or five have done hedging, simply because no one wants to be left exposed to an unhedged balance sheet simply because their competition is hedged. And that's the thing that as an industry we're striving to continue to educate the marketplace."

In part, Caifa says, the issue is critical mass. Another big piece of the puzzle is educating the marketplace. He said that eventually there will be no reason for this risk class to be any different than from