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Lecture Financial derivatives - Lecture 20: Financial management of weather risk with energy derivatives

This chapter presents the following content: To explore the advantages of using weather derivatives, issues in weather risk management, development of the weather risk management, role of weather derivatives as financial tools for weather risk management. | issues in weather risk management development of the weather risk management role of weather derivatives as financial tools for weather risk management Global climate change is gaining intensity Impacts of weather vary with economic sectors geographic regions What is the Weather risk? specific weather indices facilitates the development of innovative hedging structures Weather indices can be used for: Different locations Different time periods Basic questions: How much weather risk can be tolerated? What is the minimum acceptable revenue? How do the Board of Directors and senior management view hedging? Are premium payments acceptable? Is there any accounting or tax implication associated with hedging weather risk? Are there any regulatory issues to consider? Decision criteria: Cost benefit analysis Future contracts Options Weather is current, rather than average, atmospheric conditions Weather variables include humidity, temperature, sunshine hours, cloud cover, visibility, and precipitation (fog, rain, snow, sleet, and frost) Climate is a summary of mean weather conditions over a time period; usually based on thirty years of records Climates are largely determined by local geographical features Sensitivity is the degree to which a system will respond to a change in climatic conditions economically weather sensitive In 2000, 39.1% of the U.S. GDP was affected by weather one-third of the private industry activities, representing annual revenues of some $3 trillion, have some degree of weather and climate risk in U.S.A. the possibility of injury, damage to property or financial loss due to severe or extreme weather events, unusual seasonal variations such as heat waves or droughts or long term changes in climate. All possible changes of weather affect consumed volumes of commodities. Thus, weather risk is commonly titled also as volumetric risk. Prices of commodities are also affected by weather changes. . | issues in weather risk management development of the weather risk management role of weather derivatives as financial tools for weather risk management Global climate change is gaining intensity Impacts of weather vary with economic sectors geographic regions What is the Weather risk? specific weather indices facilitates the development of innovative hedging structures Weather indices can be used for: Different locations Different time periods Basic questions: How much weather risk can be tolerated? What is the minimum acceptable revenue? How do the Board of Directors and senior management view hedging? Are premium payments acceptable? Is there any accounting or tax implication associated with hedging weather risk? Are there any regulatory issues to consider? Decision criteria: Cost benefit analysis Future contracts Options Weather is current, rather than average, atmospheric conditions Weather variables include humidity, temperature, sunshine hours, cloud