19 December 2019
The dramatic expansion of wind power is creating new demand for weather hedging and bringing new users to weatherXchange, says Speedwell co-CEO David Whitehead.
Environmental Finance: The growth of renewable energy has triggered growing interest in climate risk management. What does the market offer in terms of hedges for renewables?
David Whitehead: Certainly, renewable energy is responsible for a big part of the growth we're seeing in weather risk management, with demand coming from across the sector – from wind, solar and hydro generators.
Companies have been hedging hydro power for a while, perhaps over a decade, and we've seen individual wind farms hedging low wind speeds for a few years. Now, the secular growth of wind power as the cost of generation has fallen means it is having an impact across entire energy markets. So, as well as wind farm operators looking to put on five- to 10-year hedges to protect their cashflows, we're seeing energy traders entering into short-term hedges to protect either against a lack of wind, or against a lot of wind depressing wholesale power prices.
EF: What are the challenges in putting together hedges linked to wind speed?
DW: The main challenge, in the past, has been a mismatch between the data available and the exposure that wind farms faced. Most wind data, if available at all, was observed data at 10 metres height. That is not hub height: most modern wind turbine hubs are 100 metres or more off the ground. We found a solution to that problem through the use of gridded data. Gridded data uses meteorological information from satellites, radar, surface observations, weather balloons and forecasts, and models that information, deriving a fixed interval grid across the Earth's surface and at different vertical levels. That's the starting point: a more sophisticated meteorological product that allows us to create wind indexes.
If we know the location of a wind turbine, its hub height, and its manufacturer, we can tell you, in theory, how much wind power will be produced by that wind turbine over a given period. We can construct wind indexes over a single wind farm, over a region, or over an electricity market – the German power market, or ERCOT in Texas, for example. We call these regional indexes "Wind Benchmarks" and offer them for over 20 countries and regions.
Wind indexes have been offered in the past, but what's different now is that we are providing the whole package to make a wide range of standard and tailored indexes tradeable. We're offering the data, making it transparent, we provide forecasts, documentation, settlement data, and access to the market through weatherXchange.
EF: Which other industries are getting involved in the weather risk market?
DW: Wind is the big growth area, but we're seeing a range of weather risks being examined: if you can create a weather or climate index, you can transact on it. We're seeing interest from the hemp industry – they produce a very valuable crop, which is highly exposed to precipitation, and which falls outside US federal crop insurance programmes. We're seeing interest from port operators hedging against damage caused by extreme tides, and we're seeing hedging against river heights dropping to a point where transport companies can't move freight.
EF: How can newcomers to the market access weather hedges?
DW: There are more brokers joining the market, and what we're hearing is that weather specialists within those broking firms are getting flooded with enquiries from their colleagues in more traditional broking lines. WeatherXchange also acts as a direct gateway for new entrants to the market. It's positioned as the hub for new market activity – whether for brokers, protection sellers or end-users.
EF: How does weatherXchange work?
DW: WeatherXchange is an online platform which allows users to structure a hedge, free of charge, and get instantaneous indicative prices from six markets. That's price discovery within 30 seconds – that was unheard of before we introduced the service. It would have taken two weeks in the past. Finally, it allows hedgers to access firm prices from multiple counterparties at a press of the button.
EF: How do you expect to see the market evolve in 2020?
DW: One thing the market is currently lacking is some sort of flexible clearing solution – to absorb the credit risk between counterparties – that exchanges and clearing houses provide in other traded markets. As climate trading moves into mainstream energy trading as well as longer-term hedging, as we feel it inevitably will as wind energy becomes an increasingly important component of power markets, so clearing will become more important, helping other balance sheets to enter the market, such the hedge funds. In the meantime, we see a growing need for margining – we do a lot work here, providing the metrics to allow users to exchange collateral over the life of a trade as it changes in value.
We also see a greater role for new types of gridded products, which will allow companies to hedge things such as wave height, or soil moisture for agricultural customers. That will drive market growth in 2020.