Silver lining for weather market

The collapse of Enron last year removed one of the biggest and most aggressive weather dealers from the market. But the dispersal of its team promises to speed up, rather than slow down, the growth of weather derivatives. Mark Nicholls reports

For the still-youthful weather market, it could have been so much worse. The collapse of Enron in December spelled the end of one of the largest weather dealers – and one that, apart from providing significant liquidity to the market, ran a hugely successful online trading platform and invested heavily in marketing and advertising.

But six months on, the majority of Enron’s 50-plus weather team – by far the largest in the market – has found new homes. Rather than depressing activity in the market, brokers say, the dispersal of Enron’s weather team has significantly bolstered existing weather desks, as well as promising to bring new participants into the market.

Perhaps the most significant development is the hire of five Enron employees – including Mark Tawney, the former head of weather at the firm – by Swiss Re. This promises a dramatic increase in activity in the market by the reinsurance giant, an enthusiastic early weather derivatives vendor, but one which scaled back its activities dramatically at the end of 2000. It largely pulled out of the traded weather market, concentrating instead on the structuring of larger, one-off deals for clients.

But a rethink at the firm coincided with the availability of staff following Enron’s collapse.“ Swiss Re has been in the weather business for three and a half years and

Phil Lotz, Swiss Re:“weather activities will be conducted under one umbrella”

was in the process of identifying steps that would ensure it would become a more effective player in the market when the team came to our attention,” says Phil Lotz, co-chief operating officer of Swiss Re Financial Products (SRFP).

“It had become clear to us that, in order to successfully tap into the potential of this market, we needed not only a strong structuring team but the capability to be active in the traded business,” he adds.

SRFP, the New York- and London-based capital markets arm of the firm, will provide a trading- based complement to the structuring side of the business. Lotz adds that “Swiss Re’s weather activities will be conducted under one umbrella” - a reflection, he says, of the convergence of the traditionally separate insurance and traded capital markets. The team will include Jürg Trüb, who previously ran Swiss Re’s weather operation, and Frank Caifa, associate director and weather specialist.

For Tawney, who had just watched Enron’s credit rating tested to destruction, with a knock-on effect on the ratings of other energy trading firms, Swiss Re’s financial health was a major attraction.“[Swiss Re is] a global player, whose AAA rating and appetite for risk was especially critical to us considering what was happening in the energy industry,” he says.

The firm is putting in place the internal infrastructure and documentation to begin trading “in the near future” and Lotz says it will look for business from the energy, construction and agricultural sectors.

Another weather desk – that of Goldman Sachs, one of Wall Street’s leading investment banks – also took the opportunity presented by Enron’s collapse to expand its weather derivative operation, this time into Europe.

Goldman set up its weather desk, which sits within its commodities operation, last summer. Despite the relatively small size of the full-time weather team – it has three staff dedicated to managing weather risk, although it taps the bank’s entire commodities salesforce to originate deals – Goldman has quickly become one of the most active firms trading weather derivatives, say dealers.

“We’ve been encouraged by what we’ve seen in terms of opportunities,” says Greg Agran, the New York-based desk head, “and that’s been reflected in our trading activity.”

The collapse of Enron, and the availability of experienced personnel, accelerated the push into Europe, says Agran: “Soon after we got into the weather market, our European clients began asking about weather hedges. We felt we needed to expand into Europe, but it happened more quickly than anticipated.”

The bank snagged Paul Murray, who had relocated from the US to the UK to head up Enron’s European weather operation only nine months before the doomed firm's collapse. “It was a good meeting of availability and need,” says Agran. “The opportunity was too good to pass up.”

Goldman’s focus, to date, has been squarely on energy clients (although the bank does engage in trading on its own account). Agran notes, however, that there have been “a couple of good leads” from non-energy firms, although these have not yet translated into deals.

Murray says the bank is seeing a similar pattern of demand in Europe: “There has been a fair amount of interest and curiosity in other industry sectors] but most of what we’ve seen is focused on energy.”

In Europe, Murray expects to see continued, steady growth in the use of relatively traditional weather products – temperature based, seasonal contracts – alongside growing interest in cross-commodity structures, that combine weather and energy risks.

In the US, however, Agran reports growing interest in daily contracts for the current summer season. “It makes sense that players that are exposed to the price of power will have daily [weather] exposures, in addition to seasonal ones,” he says. “Customers are hoping to take less of the basis risk that exists between their exposures and the standardised products that the market is offering.”

ABN Amro has also benefited in Europe from Enron’s demise. It picked up Catherine Woolgar, a London-based weather trader with the energy firm, to join its global structuring group on its ‘convergence’ desk, also in London. The desk boasts four staff dedicated to weather.

As its name suggests, the desk aims to benefit from the convergence of insurance and capital markets to offer risk management and investment products that combine characteristics of both types of market.

The bank began offering weather risk products last year, says Alex Schippers, the convergence desk’s Amsterdam-based head. “We see the weather business as part of our overall risk management offering to our clients,” he says, and reports growing interest from its customers globally – the bank is working on enquiries from South America, Asia, and Australia as well as from North America and Europe, where weather hedging is more widespread.

“There is a lead time involved in the weather derivatives business,” he concedes – it can take years, in some cases, before clients transact. “It’s a new market but we’re seeing [equity] analysts focusing on companies’ weather risk, creating more and more interest from chief financial officers.”

He is also confident that ABN Amro’s wide client network will generate that Holy Grail of the weather market – opposing weather exposures that can be offset by dealers. Indeed, late last year ABN Amro arranged one of the largest ever weather hedges, which provided a Dutch counterparty with protection against cold winter weather (most weather hedgers seek protection from mild winters).

Schippers adds that there is also interest in weather risk products from financial institutions. They see interest in diversifying investment portfolios away from the equity and bond markets – either by participating directly in weather deals, or by investing in weather-linked securities, he says.

Other weather market participants also found Enron’s collapse a good opportunity to build existing teams – or increase their geographic coverage. In February, Entergy-Koch Trading hired Marten Eriksson, a weather derivatives trader with Enron Nordic Energy in Oslo, to act in a similar role in its London office.

And his colleague Bjarne Schieldrop has moved to Cargill in Geneva as weather risk manager. Cargill, a leading US trading house that specialises in agricultural and energy products, already has a weather desk in the US, and has been using weather derivatives in Europe for the past 12 months. But Schieldrop’s hire, as the first dedicated weather risk specialist in Europe, will see the firm increase its activity, says Peter Bishton, head of Cargill’s European power generation business.

“He will be both hedging internal weather risk and offering weather-related products to Cargill’s customers, using the European market,” says Bishton. He adds that Schieldrop will initially concentrate on Cargill’s energy business – the firm began trading power in Europe at the end of 2000 – but will also increasingly look at agriculture-related weather risk.

Other Enron weather employees have landed with their former employer’s competitors. Aquila, a Kansas City-based energy firm, hired Valter Stoiani, a marketer for Enron, to join its business development group. And in Australia, Enron’s Sydney-based weather marketer Norman Trethewey has joined Element Re, the weather risk arm of reinsurer XL Capital.

One disappointment may be that few ex-Enron employees have – as yet – brought new firms into the weather market. One potentially significant exception is AEP, the largest electricity generator in the US. It hired Steven Vu, Enron’s former head weather trader, to set up a weather desk based at the firm’s headquarters in Columbus, Ohio.

Vu has his work cut out. Bill Reed, AEP’s senior vice president of energy trading, and Vu’s boss, says “I’m not yet sold that the weather market is vibrant and active enough to trade in. So we’re going to start small. We’re going to see if it’s viable as a business”.

The plan is for Vu to both manage AEP’s weather exposures – something the giant has not hitherto done – as well as offer weather hedges to the firm’s clients. He is in the process of building pricing models and undergoing internal risk management approval to trade the new products.

AEP has also taken on a small weather trading operation via its acquisition of Oslo-based Enron Nordic Energy in January. Although AEP axed around half of the unit’s 50 staff, it retains one and a half employees dedicated to weather risk (although they are supported by the sales team and structurers).

Not all of Enron’s key weather personnel have remained in the weather market. Claudio Ribeiro, head of new product development, and weather trader Eduardo Gil, have joined RWE Trading in Houston. The firm is a subsidiary of Germany’s RWE Trading GMbH, which is in turn part of utility giant RWE.

The Houston-based trading operation – which was formed in late 2001, and is now around 100 strong – is not yet offering weather products. However, the two Enron emigrés are working within the firm’s structuring team, where they are applying their understanding of the impact of weather on energy markets (RWE Trading is focusing on natural gas and power trading in the US) to the firm’s trading of structured energy products, according to a colleague who declined to be identified.

Meanwhile, NRG, a Minneapolis-based independent power producer, has recruited Rajib Saha, from Enron’s weather team. He has been hired to help coordinate the firm’s hedging strategy, says a spokeswoman for the firm, who adds that he will be using his weather trading experience as part of his role. However, she stresses that NRG is not setting up a weather trading desk.

Others have branched out further. Joe Hrgovcic, the team’s chief quantitative analyst, is now understood to be working as an equity quant for hedge fund Harvard Asset Management. However, he could not be reached for comment before press day. EF