In the past, companies in most industries accepted weather as an inevitable element of nature and simply absorbed the financial burden of volatile climate patterns. This all changed in 1997, when utility companies in the US – companies whose fortunes are intimately tied to the weather – began to purchase derivative contracts to protect their revenues from the effects of warmer-than-normal weather. This uncommon practice became known as weather risk management. Four years later, weather risk management has grown from a little-known niche sector to a $7.5bn international industry of brokers, traders, consultants, insurers and government agencies that have taken a keen interest in participating in the most innovative segment of risk management today. This global industry has provided financial stability for end-users not only in the utility and energy sectors, but also in the fields of entertainment, agriculture, retail, transportation, food and beverage.
The Weather Risk Management Association (WRMA), formed in 1999, is the only trade association dedicated to serving and promoting this industry. Our internationally based membership covers Europe, North America and Asia, and is comprised of more than 70 member companies, many of whom are the leading producers in this market. Our principal goal is to demonstrate that financial weather products are marketable and economically productive assets that will enhance the financial portfolio of any business. WRMA is also devoted to developing industry standards of methodology and contracts, addressing critical issues that affect the industry (such as easy and inexpensive access to historic weather data, which is a key factor in developing effective financial weather products), and facilitating the growth of a strong and vibrant weather trading market.
WRMA recently completed a comprehensive survey of the industry in conjunction with PricewaterhouseCoopers. One of the key developments tracked was the tremendous growth of the number of contracts executed since the winter of 1997, when 82 contracts were executed for a total notional value of $169,410. By comparison, in the winter season of 2000, 1,633 contracts were completed for a total value of $1.8m. The survey also revealed that the industry has diversified. In the winter of 1997, every transaction took place in North America and protected only against warmer-than-normal temperatures. However, in the winter of 2000, weather contracts protected companies in North America, Asia, Australia, Europe and other countries around the world. In addition, the types of protection have moved toward shielding company profits from the effects of rain, snow, wind, sweltering and freezing temperatures. These figures prove that the weather risk management industry has shown remarkable development in a very short time.
The question now for many companies isn't whether to purchase a financial weather product but what form it will take. Utility and energy companies have traditionally purchased derivatives, which are index-based and were the first type of contract traded in the early days of the industry. But insurance is beginning to gain appeal with companies in other sectors, many of them not experienced in risk management. The insurance arm of the weather risk management industry is still in its fledgling stage but as the market diversifies and as the recent historically large contracts have shown, it has remarkable promise.
But how exactly can companies use these products? As stated before, energy and utility companies have typically used weather products to protect their volume-related revenues against unpredictable weather patterns. This was typically done to protect against warm winters, but has evolved to also include cool summers and too little or too much precipitation. The consumer entertainment industry – prime examples being ski resorts and theme parks – uses weather products to offset the effects of a mild winter, recouping revenue lost due to too many rainy days. Agribusiness uses weather products to protect against losses from crops' exposure to harsh weather. Beverage companies use it to protect against downturns in sales that are the result of cooler – than – normal summers. Retailers such as coat makers use it when the winter season is warmer than expected, causing customers to purchase less of their product. And the transportation industry faces a range of threats from weather including heavy snowfall that makes roads, railroad tracks and runways impassable; freezing temperatures that cause ice to accumulate; and too little rainfall, which creates hardships for businesses that utilize barges.
Though the weather risk management industry has grown rapidly over the last few years, its continuing success depends on the ability of providers and end-users to operate with increased precision in terms of analysing their exposure to weather and crafting the best solutions to protect against it. No two companies' needs are exactly the same and the nuances of their geographic locations are always unique – some have easy access to data, others do not. In addition, the demand for well-trained meteorologists has reached an all-time high. Our industry requires professionals equipped to interpret weather data, understand the dynamics of weather and take an active role in developing deals that are customised to the needs of end-users. It is WRMA's job to help facilitate this process and ensure that providers, end-users and all the players in between are properly educated on developments in the industry and have access to the tools they need to help it grow.