It has long been known that adverse weather conditions can seriously affect business revenue. Estimates suggest up to 70% of all businesses are exposed to some degree of weather risk. Up till now, the problem has been that companies have been limited to purchasing traditional insurance products to protect themselves against weather risks. This, however, only alleviates rather than solves the problem as insurance covers high risk, low probability type events and invariably only pays out once an event has happened. By contrast, weather risk management products – or weather derivatives – are financial tools that businesses can use to cover volumetric risk, and companies can then protect themselves more specifically against the weather conditions that may adversely affect revenue and thus profits. Managing weather risk has the potential to be big business as the European climate becomes more erratic.
The weather derivatives market has been around for some time, particularly in the US where it is currently worth about $9bn. Take-up has been slower in Europe for a variety of reasons, most of which are centred on data.
Data is key to the evolution of any financial market and every professional market needs an independent, recognised professional body supplying that data. Crucially, too, that professional data supplier needs to be sure it can provide the data in the format and way that the market needs in order that liquidity growth is helped as much as possible.
This means the data supplier must understand the market demands in relation to data supply. For example, derivative contracts cannot be based on sites that may be closed in the future, as this would make those financial contracts null and void. Therefore, in order to maintain market confidence that data will be available constantly and in perpetuity, the data supplier needs to establish fall-back stations to ensure this cannot happen.
Until now, no weather data supplier has worked with the weather derivative industry to solve these problems. In addition, the absence of a centralised European data supplier has slowed the evolution of the market because not only must the data be standardised and cost-effective, but also access to it needs to be easy and efficient.
In order to address these issues, a unique partnership linking the financial markets with accurate weather data was formed earlier this year. Called weatherXchange Ltd, the new project is a joint venture between the UK Meteorological Office and Umbrella Brokers Ltd, a company formed by derivatives experts aimed at developing this type of business. WeatherXchange is a result of the Met Office recognising the needs and demands of the weather risk management market, and was formed to provide cost-effective data and forecasts tailored to meet the requirements of the rapidly-evolving market in weather derivatives.
Prior to weatherXchange, the Met Office had been supplying high-quality weather data via an internet-based service, Weather Derivatives Online, for some time. This service solely covered the UK, providing companies with historical records dating from 1959 as well as information on current weather conditions. By contrast, weatherXchange offers not only weather information, but also allows professional traders, commercial companies and government bodies to access the site and obtain:
WeatherXchange has a dedicated link directly to the Met Office. All data and products are branded exclusively by the Met Office, ensuring the data is reliable, clean and available earlier than other weather resource sites on the internet. Once logged onto weatherXchange.com as a registered user, it is possible to gain instant access to a range of comprehensive data facilities, including:
Having instant access to weather data means that industry and commerce will be able to price their weather exposures more efficiently.
To obtain historical data, there is a searchable 20-year archive for the 33 locations, and data from this archive can be downloaded from the site. Five-day and monthly forecasts can also be viewed and downloaded. In addition to this text-based historical data, weatherXchange provides current graphical data direct from the Met Office.
These images can be accessed either by searching for the desired images and downloading as a single zip file or by viewing individually on the site. In addition, daily mark to market basic quality-controlled data can be sent as csv files to traders' desks.
Comprehensive information on the sites and definitions of the elements is available through the platform. Clients are no longer required to negotiate with the individual Met Services to get the information essential for their trading purposes.
Importantly, in order to improve liquidity in the weather risk management market, weatherXchange has developed a Weather Index Settlement Rate (WISR). These rates are prepared using high-quality, actual weather end-of-month summaries, compiled by the Met Office on a site-by-site basis.
This data has been put through a number of rigorous quality control processes and is made available exclusively for licensed subscribers to weatherXchange just five days after the end of each calendar month, giving the users a distinct competitive advantage when compared with the current market practice of settling 60 days after the trade date. The quality control process also ensures that the data sets are of the highest standard; the data receives human scrutiny (for UK sites) as well as further checking against local seasonal extreme values and comparison with data for the previous and following day for all European sites.
By the end of August, the website will be expanded to cover 150 locations across Europe covering all six elements of temperature, windspeed, rainfall, sunshine hours, atmospheric pressure and relative humidity. Forty-year data sets will be available for many of the key sites and most will have a minimum of 27 years-worth of information. The WISR summaries will be published for all sites five days after the end of each month and the daily mark to market will be available on the web site itself or as a csv file sent to customers.
By the end of the year, forecasts will be available across all locations out to six months. Companies will have the ability to model their own weather exposure on the site itself using a number of analytical tools plus the historical data from any of the 150 sites. This allows the growth of the market to develop without the financial constraints due to the price of data or, indeed, the price of the software tools.
Throughout this development weatherXchange will be working with the key industry practitioners in order that the market gets the data and products in the format and way it needs.
In doing all of this, weatherXchange aims to provide the market with the tools it requires for the weather derivative market to take off.
With the tendency for global weather to become increasingly unpredictable, weather risk management tools should become a fundamental part of every risk manager's strategy in order that their companies avoid the fluctuations in the profit and loss account that weather exposure can cause. Without cost-effective, centrally supplied, standardised data this will be difficult to achieve.