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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

risk, he says, and are looking for some sizeable transactions to help them ameliorate that. On the whole, Caifa says that Europeans are not into trading. Instead, they are looking to hedge large blocks of risk.

For Clemmons, one of the key factors to the growth of the European weather risk market is the entry of banks. In addition to the usual players such as Aquila, Element Re, and Entergy/Koch, she noted that Deutsche Bank trades in London. "I think it's an increase in the number of banks taking a look at these products as something else they can offer their customers. And there are insurance companies that are doing the same thing." In Clemmons' opinion, Europe, as well as Japan, tends to have more non-energy customer-focused deals than in the U.S., relative to the size of energy deals. "So for instance in the United Kingdom, you might see a number of restaurant transactions, or theme park transactions, that you might not see in the United States, because the U.S. market is so focused on energy."

Finding the Other Side

One of the things that could help the weather risk industry the most, ironically, is to get away from such an energy-focused clientele. It's a change that would ultimately help those energy clients, too.

Clemmons says that people in the industry are actively trying to expand beyond the energy market. These efforts are an attempt by players to provide themselves with a larger customer mix. In addition, it is also about getting a better mix of risks, she says, so that everyone isn't trying to protect themselves from warm winters. "I think the next big step for the weather market in the United States is going to be agriculture." She points to a very large agricultural rainfall deal done in Alberta recently, and some other crop coverage type of transactions put together recently in the United States, as evidence of that trend.

Skees is pushing for the weather risk industry to expand into agriculture. He says, "[t]he more that the weather traders can create a global market, the more that they will be able to find offsets, and the more liquidity that will be in the market." According to Skees, there are some specific attributes to weather risk products for agriculture that make the offsets quite interesting for the energy industry. For example, in a hot, dry summer, agriculture is a loser, while the energy industry is a winner. "That's the vision," he says, "getting two big markets together that depend on weather, but different types of weather, will improve opportunities for both. And improve pricing, liquidity, and price discovery-all the things that happen in a wonderful market."

Caifa applauds the move to diversify the industry client base. "I think now the shareholders, and possibly even the analysts, are going to be pushing for another alternative to help mitigate some of this volatility," he says. He, too, says the industry is starting to diversify amongst non-energy users, to clients like municipalities, entertainment companies, and construction companies. Construction is in many ways to