Saturday, July 23, 2011

Derivatives: Weather business sizzles in the summer heat

A move I missed.
From The Globe and Mail:
Beverly Archibald has been in the weather business for more than 20 years, but never has she seen a summer like this.

Ms. Archibald runs Edmonton-based True North Weather Consulting Inc., which provides specialized forecasts for dozens of companies, mainly in the oil and gas sector, to help them plan various projects. Much of her work involves predicting conditions that lead to forest fires. The hot, dry weather across much of Canada this summer has kept Ms. Archibald scrambling.

“We haven’t been this busy in 25 years,” she said. “We’ve had a scorcher.”

Some shrewd investors have benefited from the heat wave as well. Traders who have been using weather derivatives to bet on rising temperatures have cashed in: A key weather contract on the CME has jumped more than 60 per cent in the past month because of the heat, and is now trading 50-per-cent higher than its 10-year average.

The contract is called the Chicago Cooling Degree Day Futures. It is derived from temperature changes above or below 65 F. During summer, when temperatures are above 65, the value of the contract rises (it is measured in a unit called “cooling degree days”).

On June 3, the contract was trading at 268 cooling degree days. It jumped sharply in recent days and hit 450 on Thursday. Each point is equal to $20 (U.S.), meaning the value of the contract has increased by $3,640.
The main users of CME weather contracts are utility companies, said Jeff Hodgson of Chicago Weather Brokerage LLC. For example, a utility might want to protect itself against an excessively cool summer by taking the opposite position on a weather contract. If the temperature drops, the utility makes less money on the sale of its electricity, because demand for air conditioning is low, but it will make a profit on the futures contract....MORE
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