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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

now. Times have certainly changed since 1996 and 1997, when there was one deal and 82 deals, respectively, according to a survey released by the Weather Risk Management Association (WRMA) in June 2001, and conducted by PriceWaterhouseCoopers (the PWC survey). By the end of the 2000 season, the total number of weather risk contracts had shot up to an amazing 1,663. ()

The trajectory of notional value-the maximum payout under a weather risk contract-has not been quite as steady an upward rise. While the October to April 1998 notional value grew at rate of 550 percent from 1997, and at a rate of 110 percent for the same period in 1999, the notional value fell for the October to April 2000 period by 19 percent. ()

Sweetnam might best sum up the current state of weather risk management when he says, "The weather market has continued to develop in positive directions on whole, but it is a market that takes two steps forward and one step back all the time it seems." Growth has not been as large as sector participants would like, nor has the growth been as spectacular as some of the hype. Still, Sweetnam says, what growth there has been is solid. He says he is still looking for this market to grow.

Others in the industry take a similar view. Tobben says the fits and starts the market is seeing is just part of the natural growth of a marketplace. "Certainly, there are ebbs and flows in the acceleration of a marketplace. I don't attribute that to an overall slow-down." The growth that the United States has seen has been primarily in terms of players and trading volume, he says. "We were hoping when we got into the market that there would be a lot more larger, structured end-user type deals coming in, non-energy related. The big utilities have this massive amount of weather risk, but they just basically take [it] as part of their doing business every day. We would have hoped, over time, that they would have been more active in looking to hedge that."

Tobben predicts that the next PWC study, expected to be released in June, will document substantial growth for the past October to April season, particularly in Europe.

Caifa, who has been in the weather risk business since 1998, when there were only six or eight players in the market, says, "[A]s someone who has been in it since then, as well as other players, our overall perspective and hope is that we would have been further along by now than we are as an industry," he says. He goes on to note that the industry has made some great strides over the last couple years. In particular, he points to the presence of over 20 active players in the market right now, an amount he says is growing.

Clemmons, who has been in the weather risk market about as long as anyone, came to Element Re in 2000 from the Enron desk, which she started. Clemmons' assessment of the industry is