Wind, rain or shine, be in control

Posted by admin on February 16, 2011

“Financial statements are awash with comments blaming the weather for poor performance. In the past, statements such as these were accepted as part of doing business, however, blaming poor results on weather is no longer an excuse accepted by stakeholders.” Bill Windle, WRMA president, Sheraton Krakow, 16/09/10

The 11th Weather Risk Management Association (WRMA) AGM took place in the historic city of Krakow, Poland, from 15-17 September 2010. Hosted and co-organised by Consus, the meeting offered a valuable opportunity for WRMA members and representatives of related industry sectors to come together and asses the role weather risk management has to play within the global economic cycle.

With the impact of the volcanic eruption in Iceland still at the forefront of business minds, the proceedings commenced with a presentation by tephrachronologist Dr. Simon Blockley from Royal Holloway, University of London. Whilst weather risk deals primarily in more commonplace seasonal variances, an extreme event such as the recent eruption of Eyjafjallajökull provided a stark reminder of how specific market sectors can be laid to ruin by natural occurrences.

Why be exposed to risk?
Managing a company and the risks it is exposed to, induces varying levels of boardroom caution that create a foundation for old habits, and a wariness of embracing new practices. Stuart Brown of Swiss RE focussed on this wariness when it comes to the shortage of companies protecting themselves against weather risk.“ Companies protect themselves against price risk, and property damage risk, and something falling on somebody and being sued risk. What’s so special about weather risk that people want to keep it?!” he asked. Addressing attendees from the energy sector Brown asserted, “When your demand is driven by the weather, (then) weather protection, equals demand protection”.

This was a major question being asked at the 11th WRMA AGM: Why aren’t more companies protecting themselves against weather risk?

In his opening speech WRMA president Bill Windle investigated how across a range of trading platforms, banks and fund managers will seek to mitigate against all kinds risks within the currency markets but leave themselves open to weather risk exposure. “Managers, economists, politicians…pay close attention to the monetary policy, but are we sure that a 25 basis point drop of the repo rate by the ECB has a bigger effect on the economy than a 1°C change of the average temperature over a certain period?”, he asked.

Windle sought to outline how the weather is volatile, and that the risk it poses to market demands cannot be eliminated, “But we can financially manage its impacts,” he explained. Companies need protection against the volumetric risk caused by the weather. The temperature in the winter will determine how much natural gas an energy company sells, the level of rainfall throughout the summer will influence the gate receipts at Euro Disney. “One can buy its desired weather,” Windle continued, “If you want it to be cold during the winter financially, products are available, to financially ensure that it is cold.”

All about liquidity
Director of the weather risk management department at Consus Juliusz Pres sought in his address to expand in more detail on Bill Windle’s analysis of why more companies should nail down their weather risk, especially as they are quick to mitigate against other risks in the economic cycle.

“It’s all about liquidity. Liquidity is more important than profit. A company can survive for a long time without profit, it cannot survive if it’s not liquid,” Pres remarked when highlighting exactly why a company would buy into a weather risk management contract. These contracts are designed to provide a company with liquidity. Pres added that the contracts on offer from Consus “secured the economic value of the company.”

Research by the Consus team has demonstrated how banks are far more likely to take a credit risk with a company if their risk exposure is mitigated. Therefore any ongoing projects are far less likely to stall, as capital is available in the form of liquidity. The well won’t run dry if the risk is properly managed. A company can continue to move forward despite profits temporarily take a back seat. Even if a contract is deemed expensive it usually makes more sense than no contract at all, “I have the mathematical formula’s to prove this, but I won’t bore you,” Pres reassured the audience.

An ideal partner
Companies that apply to Consus are partnered all the way from an initial assessment period all way through to settlement. The team will analyse the company and assess the level of financial risk they are exposed to due to changes in the weather. The parameters are established by ascertaining which climatic event – wind, precipitation, temperature, snowfall, frost etc – determines the level of loss. “In the energy sector 90 per cent is the temperature. That is the important index,” Pres observes. Consus take the historic data of weather in a specific area, for example, from a meteorological station near Warsaw, and builds a model for the forthcoming year to determine the weather’s impact on the company’s financial result. Pres simplified how the contracts worked, “It works on an index. It was 8°C lower than expected, so you receive x amount based on that. That’s it!”

Pres then moved onto highlight an interesting aspect of the nature of the weather contract. It is the most transparent market available. “You cannot create a speculative bubble for the weather market…as you can with other markets”. The data that settlements are made upon is objective and can be verified independently. Weather contracts come without the threat of a moral risk, “You can’t move around heating up thermostats so they give false data.” Pres concluded.

The Consus Group
Consus started business as an emissions trading company, offering consultation on green investment legislation and the management of profits with instruments such as the green certificate, a line of work which is still central to their continuing success. But they are now using this in-depth knowledge of the energy trading market to follow into weather derivatives. Consus are therefore ideally positioned to acts as consultants and educate energy companies as to the products available to mitigate the volumetric risk they are exposed to by the weather.

Fitting finale
The final keynote presentation was by former Polish President and Nobel Peace Prize recipient Lech Walesa. Walesa highlighted responsibility that we all have to maintain integrity in the search for economic stability. “We are merchants and, not warriors,” he reminded attendees. “Europe and the world no longer contain borders and we must agree on the traffic rules on the global economic roads”.