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The Perils of Ignoring Mother Nature

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

how people view currency hedging or interest rate hedging today. "No bank or financial company would be caught without doing some interest rate managing, or currency fluctuation management, if they're in international countries," he observes. Caifa also points out that even the interest rate market is relatively young, about 20 years old. Weather is possibly an even bigger risk than the interest rate environment.

Lynda Clemmons, president and chief operating officer of Element Re, a subsidiary of XL Capital, says she still regularly has the "Weather risk? What are you talking about?" kinds of conversations with potential clients. "There's a whole world out there that needs to be educated, and you can't hit them all in the first few years. It's just not going to happen, especially at the rate of change that you've seen going on in the energy business," she observes.

Retail deregulation may help push that educational process along. As companies move to deregulate, Clemmons says, it doesn't make sense to pass along unhedged risk costs. "Typically, you're passing that on in a 12-month lag, so it's the weather that happened last year. So you'd be passing that on-if you had retail customers, who had the ability to switch from you to someone else, you would be passing on potentially to a new customer a charge from the previous year, based on weather. That might not make you competitive," she says wryly.

Meanwhile, to keep customers consistently in the market, Sweetnam says that liquidity and transparency must improve. "People have a sense that [hedging is] expensive-and it's not-but you can't really know that until you have the liquidity and transparency," he points out. While there is plenty of healthy competition to ensure weather products are not expensive, "the perception when you're talking to one seller after another, is that it can be [expensive]. When people get comfortable about the value of what a hedge is bringing them, then we'll see more industry activity."

Interestingly, businesses outside the United States often seem to have a finer grasp of the value of weather hedging. Clemmons says, "When I spent some time in Sydney, there were already a lot of people that had the education about the marketplace, and were just looking for somebody to fill their needs."

Tobben, too, says that markets such as Asia seem to have a more sophisticated knowledge of weather risk. In particular, he says, Japan seems to have a very clear understanding of how weather affects their business.

"I'm not just talking utilities-retail companies, department stores, theme parks, restaurants-they know how weather impacts their business," he says. Such knowledge gives those companies a strong base from which to help go purchase products to protect their risk. "We here in the states have not had that knowledge so widely understood nor researched as much," Tobben says.

Another reason, he says, for the lack of education, has been Wall Street's failure to hold companies accountable for weather-related downturns in revenues. And he questions that stance. "Why is that? If they [utilities] can structure a program, or take the