Sat. Jan 18th, 2020

Weatherwatch: Weather Derivatives

Image Source Professor Simply Simple

SOURCE – The business of weather derivatives is growing fast. Unlike weather insurance that deals in extremes like floods, weather derivatives pay out on departures from average conditions. A simple example is an ice cream manufacturer who pays a premium against a cooler than average summer. Each day the temperature is below an agreed average then the manufacture gets a pay-out, but if it is a hot summer and ice cream sales boom then the premium costs are more than met from profits.

There are many versions. The construction industry loses in cold winters because bricks cannot be laid in frosty conditions. Too many cold days and companies could face costly penalties because of failing to meet construction deadlines. Utilities, on the other hand, lose profits in mild winters.

But not all derivatives involve paying premiums. There are swaps on offer, for example a colder than average winter with lots of snow is good for the skiing industry but expensive for the highway authority that has to clear roads. A swap could be arranged with the skiers paying for road clearing in the event of a bad winter and the highway authority subsidising the ski resort if it does not snow. Read more

Professor Simply Simple

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