<B>Weather derivatives</B>

Joshua Jampol. Journalist. The Time

25 May 2003

Weather conditions affect four-fifths of the world’s economic activity. Yet there are no financial products that meet challenges posed by climate. That it, until recently.

Creation of weather derivatives began in the United States in 1997, the year El Niño wreaked havoc on coastlines and crops worldwide.

Growth of weather derivatives followed, and now many sectors and companies are using them.

Trade in weather derivatives has been championed in North America, Japan and Europe by energy suppliers, particularly power utilities. Success of their business depends on climatic fluctuations. More electricity is consumed, for example, on colder days for heating and on warmer days for air conditioning.

But they are not the only ones concerned. Weather-dependent industries are easy to spot. They include agriculture, manufacturers of summer and winter wear, and outdoor specialists in general. Influence is also heavy on the ice-cream and drinks sectors, on restaurants with outdoor dining facilities, and on open-air selling. Other industries, from construction to tourism and sports, all need to know what forecasts will be.

Weather derivatives are financial innovations based on weather data, such as rain- or snowfall, hours of sunshine, air temperature or wind speed. Since weather data are totally independent of goods or financial markets, they are different from other derivatives.

An index is created on the basis of this data and this is quoted on the stock market. The main exchanges trading weather derivatives are the Chicago Mercantile Exchange and London’s LIFFE.

According to a study by Deutsche Bank Research (Frankfurt Voice, 25 February 2003, www.dbresearch.com), the most common underlying variable in weather derivatives, in both over-the-counter and exchange trading, is the temperature. In 2001, temperature contracts made up nearly 90 percent of the total number and 96 percent of the contracted volume. Figures for rain were a mere 7 percent for number and 2 percent for volume.

The new market is showing strong growth in the U.S., Europe and Asia. Deutsche Bank quotes a PricewaterhouseCoopers report showing nearly 700 deals in the U.S. in 1998, and four times that amount by 2002. In Europe, two deals were transacted in 1998, rising to nearly 800 by 2001. Asian sales jumped from seven in 1999 to 450 in 2001. Total number of new deals worldwide climbed 43 percent in 2001, to nearly 4,000.

Deutsche Bank predicts double-digit growth for the world market in the coming years, adding that interest of insurance firms and banks will surely increase.


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