introduction to weather derivatives by anjelina belakovskaia weather derivatives trader head of the...
TRANSCRIPT
Introduction to Weather Derivatives
By Anjelina Belakovskaia
Weather Derivatives Trader
Head of the Weather Desk at Williams Co.
Copyright 2002 © Anjelina Belakovskaia
• Q: What are Weather Derivatives?• A: Options to buy or sell sun, rain,
snow, wind, etc… as well as swaps (exchange rights) on the above.
+ =
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Somewhere RAIN creates flood. Somewhere DROUGHT lasts for months.
Some areas are HOT. Some areas are COLD.
Copyright 2002 © Anjelina Belakovskaia
Weather Derivatives are used when:• Company’s revenue is sensitive to the
temperature, rainfall, snowfall, etc… • Weather events are non-catastrophic.• Goal is to reduce risk due to weather exposure
and decrease volatility of return.• Credit exposure has to be diversified.
Also as investment strategies:• To diversify investment portfolio.• To capture inefficiency in the weather market.
Copyright 2002 © Anjelina Belakovskaia
WHO BENEFITS? Agriculture (early frost – yield, hot summer – livestock).
Construction (work interruption, damage to materials, project risk).
Energy (mild winter – less revenue, hot summer – extreme prices).
Entertainment (no snow – ski resorts, cold and rainy – Amusement parks).
Financial Institutions (uncorrelated to stock market).
Food Industry (mild summer – soft drinks and ice cream).
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WHO BENEFITS? Heath (pollen - allergies, heavy rains - viruses).
Insurance and Reinsurance (hedging some risk).
Municipality (heavy snowfalls – budget crisis).
Retail (cool summer – T-shirts, mild winter – fur coats).
Sport (football, baseball).
Transportation (trucks, trains, barges, airplanes).
Travel (canceled trips, less demand).
Copyright 2002 © Anjelina Belakovskaia
Trading Instruments and Measure:
• Calls• Puts• Swaps• Digital options• Strangles,
Collars• Baskets• Structures
• CDD – cooling degree days
• HDD – heating degree days
• VDD – variable degree days
• TMAX – max. temperature
• TMIN – min. temperature
• Rainfall – inches of rain
• Snowfall – inches of snow
Copyright 2002 © Anjelina Belakovskaia
Weather Calculations:
• CDD = MAX ( Temp – 65, 0 )• HDD = MAX ( 65 – Temp, 0 )• Temp = Average daily temperature
= ( TMAX + TMIN ) / 2• 65 => Base temperature (chosen)• VDD => Base temperature is different or
=> TMAX, TMIN is used instead of AVG or
=> SUM ( CDD & HDD )
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Daily and Cumulative CDDs
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Days
CD
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CDD
Cumulative CDDs
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Weather Market:
• OTC, 5-6 brokers.• ICE, CME, LIFFE.• Locations: Airports (mainly).• Seasons: May-Sep, Nov-Mar, monthly,
weekly, multi-year.• Size: $1-2 MM Notional (Cap).
$ 5,000 per DD.
Copyright 2002 © Anjelina Belakovskaia
Pricing Weather Contracts:
• 10 YR Mean.• STD.
• Swap => around 10 YR Mean.• Options => about 1/3 STD from 10 YR
Mean.
• Time Series and Distribution Models.
Copyright 2002 © Anjelina Belakovskaia
Electricity Load as a function of Temperature
Electricity Load increases with temperature primarily because of the use of air-conditioning. The increase in electricity load because of falling temperatures is smaller because natural gas is used for heating alongside electricity.
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Temperature
Load
PJM Load vs. Temperature
T > 90o FT < 32o F
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Electricity Prices as a function of Temperature
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Temperature
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PJM Price vs. Temp
Electricity Prices increase dramatically as temperature rises beyond 90 degrees Fahrenheit because of supply side constraints. A corresponding increase in electricity prices is not visible when temperature falls to freezing and below.
T < 32o F T > 90o F
Electricity Price Spikes
Copyright 2002 © Anjelina Belakovskaia
Trade 1: Long power + Short CDD Calls
TRADE OUTCOMES:
Very Hot Summer
Significant gain on long electricity position due to convexity of power prices with respect to temperature. Linear loss on short CDD Options capped at $ 1 million. Net outcome is a very positive pay-off.
TRADE A: Buy July power, when temperature is expected to be above 90o F and price spikes are likely.
TRADE B: Sell Out-of-the-Money CDD calls with a cap of $ 1 million. Collect $ 300,000 premium.
Mild SummerLoss on long electricity position is partially off-set by the weather option premium. Electricity prices do not fall as quickly.
Copyright 2002 © Anjelina Belakovskaia
Trade 2: Long gas + Short Heating Degree Day weather options
TRADE OUTCOMES:
Very cold winter
Significant gain on long natural gas position due to spikes in gas prices when temperature falls. Linear loss on short HDD Options capped at $ 1 million. Net
outcome is a very positive pay-off.
Mild winter
Loss on natural gas position is partially off-set by the weather option premium.
This trade is similar to the previous trade.
TRADE A: Long natural gas contracts for settlement in Dec, Jan or Feb when temperature is expected to be below 40o F and price spikes are likely in the natural gas markets.
TRADE B: Sell Out-of-the-Money HDD calls with a strike of 1200 and a cap of $ 1 million, when 10-year average of Dec-Feb HDDs is 1100. Collect $ 300,000 premium.
Copyright 2002 © Anjelina Belakovskaia
History:
• 1996 – 1997: Aquila, Koch & Enron –
1st weather-indexed commodity transaction.
• 1999: CME.• 2001: ICE, LIFFE.• 50 % - Energy.• 25 % - Insurance, Reinsurance.• 25 % - Other.
Copyright 2002 © Anjelina Belakovskaia
WRMA Survey:
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1998 1999 2000 2001
Number of Contracts, 1998-2001
Winter
Summer
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1998 1999 2000 2001
Notional Value of Contracts (in millions), 1998-2001
Winter
Summer
1,836
2,959
2,517
4,306
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WRMA Survey:
Number of Contracts, 1998-2001
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500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
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Other
Europe
Asia
North AmericaSouthNorth AmericaEastNorth AmericaMidwestNorth AmericaWest
Notional Value (in millions), 1998-2001
0500
1,0001,5002,0002,5003,0003,5004,0004,5005,000
1998 1999 2000 2001
Other
Europe
Asia
North AmericaSouthNorth AmericaEastNorth AmericaMidwestNorth AmericaWest
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2001 – 2002 Energy Crisis:
• “post-Enron” era • Energy traders are replaced by Banks, Hedge
Funds, Reinsurance• Broader variety of sectors: Agriculture,
Construction, Entertainment, Sport, Travel and more…
• Geographical expansion to Asia, Europe & Australia.
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New weather markets:
• Storms, Hurricanes, Tornados• Droughts• Floods• Food production• Hydroelectric production• Wind farms• and more…
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New weather products:
Many fancy exotic solutions:
• “Refund for Rainy Days during Holidays” http://www.wrma.org/pdf/Medienmitteilung%20-%20CelsiusPro%20and%20AGA%20Collaboration_EN.pdf
• WindLock – Wind Power Variability Risk Hedging instrument
http://www.wrma.org/pdf/3TIER-Galileo-Hedge-Financial-Risk-Wind.pdf
Copyright 2002 © Anjelina Belakovskaia
Web sites:• http://www.wrma.org/ • http://www.cmegroup.com/trading/weather/• http://www.eurexchange.com/trading/products/WED_en.html• www.guaranteedweather.com• https://www.climetrix.com/• http://www.weatherderivs.com/• http://www.weather-risk.com/• http://www.climate.com/• http://www.galileoweather.com/• http://weatherdata.com/• http://www.willis.com/client_solutions/services/weather_risk/• http://www.wxrisk.com/
Copyright 2002 © Anjelina Belakovskaia