Features, November 2000 US traders go global Activity in the weather markets has picked up in recent months as US firms, particularly, have branched out into European and Asian markets. Emily Saunderson reports The weather derivatives market has finally reached its adolescence, according to traders and consultants. Dealers report that more trading firms are operating outside their domestic markets, more end-users are transacting and enquiring about weather hedges, and, in the US, the oldest weather market, this winter hedging season is the busiest yet. But delays in energy deregulation and cultural differences between markets remain barriers to market development. European traders are having a quieter time than they expected this winter because of delays to regional electricity deregulation and the resulting lack of demand for weather risk management from energy companies. But the local markets have stayed relatively liquid because more US trading houses are dealing in Europe. In fact, weather traders generally are starting to look for opportunities beyond their usual hunting grounds. US weather market-makers such as Koch Energy Trading and Aquila Energy are expanding their operations across the Atlantic; more European firms are getting involved in the US market with, for example, European funds investing in US weather risk; and there is growing interest in potential markets in Asia including Japan and Australia, consultants say. But most activity so far has involved US dealers in Europe. Some US firms, including Enron and United Weather, have had a European presence since the region's weather markets began, but more US firms have completed their first European deals over the last few months. "Few people in Europe a year or so ago knew what a weather derivative was. But now the market is really starting to take off," says John Polasek, vice president of sales at Koch in Houston. Koch has done more European deals this year than ever before. "We are one of the world's major weather dealers so it made sense for us to get involved," he adds. Not only will US firms expanding into the smaller markets benefit as these markets mature, but they diversify their risks by dealing in different global locations since weather is less correlated across different continents than across the same country, says Rob Preston, a director at Speedwell Weather Derivatives, a UK-based consultancy. "You cannot hedge weather derivatives using underlying instruments, as you can with other derivatives, so global diversification is one of the few risk management tools available," he adds. US firms offer prices for weather trades on a wider range of European locations than their European counterparts, says Peter Brewer, chief executive of Weather Risk Advisory, a UK-based consultancy. This is because they have years of experience analysing weather data for cities all over the US so they can analyse new European data faster than domestic firms, he adds. Investment in European weather derivatives marketing is also paying off, says Philippe Chauvancy, vice president for business development at United Energy, and co-president of the Weather Risk Management Association for Europe. United has dealt weather in Europe for two years, but Chauvancy says there has been a noticeable increase in enquiries about weather hedging in the last month. "Companies in Europe are getting used to the idea that weather risk is actually manageable, and even a few individual private investors have expressed an interest in speculating with weather derivatives," he adds. Despite delays in European energy deregulation, weather traders are confident that business will pick up even more next year. But it is not certain when full deregulation will happen. In the UK, for example, the New Electricity Trading Arrangement (Neta), which will open up more electricity price competition, was supposed to come into effect on November 21, but the industry regulator says Neta will not happen until late March 2001 because the system still needs to be tested. Some traders doubt the reforms will be made before next winter. "This year has been a dress rehearsal for weather derivatives trading before we can go for full liquidity next year," says Nick Ward, head of weather trading at Spectron, a UK broking firm. "Delays to Neta has certainly put development of weather trading back, but the addition of more US firms doing European deals has maintained liquidity," he adds. European dealers have also tried to broaden the locations at which weather deals are based. "Stockholm-based deals have traded this year, and market-makers are currently trying to agree on locations in Germany," says Ward. There has also been increased interest in weather hedging from firms in Italy, Spain, Portugal and Scandinavia, says Brewer. Most European deals are still based on temperature, specifically heating degree days and cooling degree days (HDDs and CDDs, which are a measure of daily average temperatures). Some players say there has been more interest is HDD options this winter than in the past. "More European firms are getting comfortable using weather derivatives, and options use is increasing mainly because options offer hedgers relatively cheap and straight-forward protection," says Dan Tomlinson, a broker with Garban Intercapital in London. An increasing number of European leisure companies have expressed an interest in hedging this winter, according to dealers. Traders say this is partly because of the publicity London-based bar chain Corney & Barrow received for the temperature based deal it transacted in the summer (see Environmental Finance June 2000, page 9). The deal protected the firm from reduced business caused by lower than average temperatures. "Leisure and retail companies have been asking which of their competitors are using weather derivatives, and this has been driving some of our recent business," says Preston at Speedwell. "The Corney & Barrow deal was relatively small but the huge publicity it received has made it easier for power companies with trading arms to market weather derivatives to their clients," adds Tomlinson. FOR THE FULL STORY EVERY MONTH, SUBSCRIBE TO ENVIRONMENTAL FINANCE, OR CONTACT info@environmental-finance.com FOR OUR BACK ISSUES SERVICE