The first Global Warming Index
The first Global Warming Index
A good link for those of you interested in weather derivatives
A pertinent comment on the previous post is offered by Bespoke Investment Group (May 2007)
Hurricane Hedging (USA / 2007)
Last weekend we highlighted the prediction market contracts for year-end oil prices and the odds of a recession in 2007.
Another group of contracts we found interesting on Tradesports track the 2007 hurricane season. The contracts are based on whether a category 3 hurricane or stronger will make landfall on certain states. At right [see previous post] we highlight where contracts are currently trading for each state. If one were to buy the Florida contract at 57.5 and a category 3 or stronger hit the state this year, the contract would expire at 100. While category 3s have been more common in recent years, we're not sure if the historical odds for one hitting Florida are greater than 50%. The current odds look fairly high across the board -- NY, Deleware and New Jersey are even at 10%.
Remember, these are for a category 3 to make landfall. We've all heard or read the predictions for a very active hurricane season this year, but by the looks of these contracts, individuals may be too scared.
Trading Global Warming ?
UBS to launch first Global Warming index
By Paul J Davies
Financial Times, April 2007
The first Global Warming index is to be launched this week by UBS, allowing businesses most affected by the uncertainty of climate change – from ice-cream salesmen to makers of winter coats – to hedge their profits against it in a simple and transparent fashion.
Retail and institutional investors will also be able to buy exposure to, or short sell, the index in much the same way they would with the FTSE or Dow Jones stock indices. If temperatures rise, so will the value of the index.
Ilija Murisic, executive director of hybrid derivatives trading at UBS, said the impact of global warming had brought explosive growth in the weather derivatives market.
A recent report from PwC said the volume of weather derivatives traded on the Chicago Mercantile Exchange(CME) jumped from $9.7bn in 2004-5 to more than $45bn in 2005-6.
“Global warming has created much more volatility in temperatures and weather conditions, which has led to increased liquidity in the weather derivatives market,” Mr Murisic said.
“The weather derivatives market is very segmented and quite arcane but has good liquidity. We want to create an index where people can simply invest, like they can with a stock index.”
The index is based on weather derivative contracts for winter and summer traded on the CME. These “heating degree day” and “cooling degree day” contracts measure the difference between average daily temperatures and a given base in a number of cities around the world.
The UBS index will initially be based on 15 US cities, including New York, Chicago, Atlanta and Las Vegas, because these are the ones most actively traded on the CME. However, Mr Murisic said that, as the market continued to grow, cities in other regions such as London, Tokyo and Paris were likely to be added.
UBS hopes the index will turn the complex business of investing in the world’s weather into a popular asset class, one that is entirely uncorrelated with returns in other assets such as stocks or bonds.
[ Remarkable jump on the volume of weather derivatives traded at the CME ]
Even weather has a price
Bad weather fails to stop resources boom
Will climate advocacy pay off for shareholders ?
Watch U.S. to chart Australia dollar's path
To Invent New Bets
Lessons for investors: stay out of the deep end
IMF: Global Growth seen at 5.2% in 2007
Making Money From Weather Data
Hedge funds bet the weather
Debate is looming over ownership of open interest
Natasha de Terán - Financial News
03 Aug 2007
A definitive legal answer to the question may be needed
“Who owns the open interest” is the sort of geeky question that occupies derivatives experts’ minds from time to time. It has never been legally answered but it may be soon.
Open interest is the aggregate amount of unliquidated derivatives positions held at a clearing house and backed by broker or general clearing members’ funds, or the sum of economic interest in derivatives contracts.
The possible owners of open interest include exchanges that list the contracts, clearing houses that manage the associated risks, or traders whose capital backs them.
In the normal course of business, no one queries the ownership question – they just get on with work. But every time an exchange or clearing house upsets its core constituencies – brokers, GCMs or end users – by, say, raising margin requirements, increasing clearing fees or failing to deliver on a promised functionality, the issue comes to the fore.
The question also gains in importance when an exchange seeks to migrate its clearing from one venue to another.
Such was the case a few years ago when the Chicago Board of Trade said it would shift its open interest from the Board of Trade Clearing Corporation to the Chicago Mercantile Exchange. The move was controversial because it coincided with – and was a thinly veiled attempt to thwart – Eurex’s attempted entry to the US market. But although there were vociferous objections at the time, the move went unchallenged by GCMs and regulators.
As a result of the CBOT’s open interest move, CBOT and CME members have made savings through reduced margin requirements; exchange users benefited through increased margin offsets; Eurex US failed to gain traction and the two Chicago exchanges went from strength to strength. More recently the two exchanges merged.
Admittedly, Eurex US might have failed even if the CBOT’s open interest had remained at BOTCC, the Swiss-German exchange’s chosen US clearing house. And the two Chicago exchanges could equally well have enjoyed dramatic rises in business and profitability and buried their longstanding differences in a multi-billion dollar merger without the new clearing arrangement.
But the knock-on effects of the CBOT’s move have been mixed and many market participants regret not having opposed it more forcefully at the time.
The Intercontinental Exchange is preparing a similar course. Thanks to its flotation in 2005 and its purchase last year of the New York Board of Trade, the ICE has its US clearing house and public shareholders anxious to see profit growth.
This has led the ICE to pursue plans to repatriate its European clearing by setting up ICE Clear, a UK clearing house. The exchange plans to migrate its open interest from LCH.Clearnet to ICE Clear.
ICE executives have spoken openly about the move, which is scheduled for the second and third quarters of next year. The question is to what extent the market will support the move.
At the recent Futures and Options Association conference in London, there was a strong sense of antagonism towards the move from several GCM officials. LCH.Clearnet, which stands to lose valuable fees, is also undoubtedly unhappy with the idea.
Other observers are worried because they believe such a shift will only cement the exchange’s power and further shareholder interests at the expense of users and clearing members.
Other constituencies may object but, as yet, there has been little noise except from a third group. Over-the counter brokers are beginning to flex their muscles against the proposed move. Their objections go deeper but at present they are centered on the nascent OTC emissions market, in which ICE has staked a sizeable but controversial claim.
The history behind ICE’s involvement in the European emissions market is curious. A group of London-based brokers credit themselves with having kick-started the European Union OTC emissions market in 2004 and early 2005. Initially, there were no listed futures or any clearing mechanism for the OTC emissions credits they arranged.
But the European Climate Exchange entered the market in 2005, teaming up with the International Petroleum Exchange, now part of ICE, which lists the European Climate Exchange’s futures contracts and with LCH, which clears them.
Around the same time, LCH began offering cleared services for the OTC segment of the market run by brokers, with the stipulation that such trades had to be sent to the clearing house through the IPE/ECX.
What this meant was that any cleared OTC emissions trades would sit within the same clearing pool as the ECX’s exchange-traded emissions positions and be offset against them.
In other words, a single pool of open interest had been created for the emissions market. That was all well and good, indeed it was welcomed by end-users who took up the service with alacrity. But the brokers were less pleased. The way they saw it, the ECX had been handed a pool of open interest – worse, the open interest came from trades they had generated.
Having had its ear bent by the brokers, LCH subsequently set up a separate liquidity pool for OTC trades. But this did not take off, either because it was not widely marketed, or because the new pool had to compete with the existing one – and the ECX/IPE pool contained all the open interest.
The brokers have had little choice but to sit back and regret the set-up. But with the ICE gearing up to move all its open interest – including OTC emissions trades – they are preparing to step up their fight.
As yet it is unclear how this scrap will play out but the battleground will not be limited to the diminutive emissions market.
Brief introduction to weather derivatives
Festival's secret for good weather
READINGTON - USA (AP / July 26) -- Organizers think they've found the secret to good weather for this weekend's Quick Chek New Jersey Festival of Ballooning -- a virgin.
According to an imported superstition, good weather can be assured through a ceremony involving a virgin, some knives and fresh, whole onions and peppers.
And, no, Victoria Brumfield won't be sacrificed.
Festival organizer Howard Freeman said a colleague heard about it in Singapore several years ago. For the past two years, it has worked in Readington. Partly because of the superstition, Freeman no longer buys weather insurance for the event, which is expected to draw 175,000 people.
Brumfield, 28, has worked with Freeman in the past and is a devout Mormon, proud of her adherence to the church's rules, including not drinking, smoking, gambling or cursing -- and no sex before marriage.
She became the festival's official virgin last year after her younger sister, who had that role in 2005, moved to California.
It's a mixture of "fun and embarrassment," she told the Star-Ledger of Newark for Thursday's newspapers.
Here's how she does it: She drives a golf cart to the four corners of the festival site, picks up some grass, mumbles some random words, then penetrates the produce with a knife before jamming it and the knives into the ground.
The ritual was scheduled for Thursday afternoon.
The pressure is on this weekend. The National Weather Service says there's a chance of rain each of the three days of the festival, which was scheduled to start Friday.
How long can she go on doing the virtuous job?
"I might be eligible for a few more years," Brumfield said. "I'm waiting until I'm married and no one has asked yet."
It has not worked everywhere. Freeman says he used a different virgin for a festival he put on last year in Massachusetts. The driving rain broke, but strong winds kept the balloons on the ground.
Freeman said it seemed that that virgin had a loose definition of "virginity."
Merrill Lynch Launches First Temperature-Linked Certificate
WebWire - 7/27/2007
LONDON,— Merrill Lynch today announced the launch of a new two-year euro-denominated certificate that offers an annual return based upon the average temperature in Roma-Ciampino, Italy. The investment product is 100 percent principal-protected and offers a temperature-contingent coupon of up to 16 percent annually. The certificate will be issued as part of the Merrill Lynch Certificate Programme and will be publicly offered into the Italian region via an appointed distributor.
Fine temperatures at the Rome Ciampino Airport
Andrea Podesta, managing director and head of EMEA Debt Wholesale Distribution at Merrill Lynch, said, "The launch of this new certificate is a first for the retail market. It reaffirms our commitment to providing leading tailored innovative solutions and products to our clients as well as strengthening our position as a global leader in the weather risk management market."
Merrill Lynch, through its global commodities group, has been a market leader in weather derivatives trading since 1997 and is involved in approximately 20 percent of all global over-the-counter transactions.
Jens Boening, head of EMEA Weather Derivatives Structuring, Merrill Lynch, said: "This innovative product takes the weather risk market to the next level and enables investors to get easy access to this alternative ’asset class.’ At the same time it enables agricultural, commercial and retail clients in Italy, who have recently suffered from rising temperatures, to mitigate the risk of above average heat."
What is Weather Risk Management?
The business of weather has two facets:
The management of the financial consequences adverse weather for those with natural exposure to weather.
Commercial trading of weather risk, both in its own right and in conjunction with a variety of commodities.
1. Management of Weather Risk:
Weather challenges a wide spectrum of businesses: utilities, transportation, construction, municipalities, school districts, food processors, retail sales and real estate are simply a start to a long list of sectors whose revenues, costs and financial performance are sensitive to weather. Cold winters result in high heating bills which pressure the budgets of school districts and erode the margins of real estate property operators. Adverse financial impacts result from adverse weather. The weather risk market makes it possible to manage the adverse financial impact of weather through risk transfer instruments based on the weather element – temperature, rain, snow, wind, etc. – which affects revenues, costs or margins. In its simplest form an enterprise affected by weather pays a premium to a risk taker who assumes the risk, defined in terms of a weather element, posed by adverse weather. In exchange for the premium the risk taker, under certain pre-defined circumstances, will pay the buyer an amount of money which corresponds to the loss or cost increase caused by the weather.
Extremely cold weather increases heating costs for a university.
University budgets heating costs to conform to a winter with a daily average temperature of 40ºF. University also maintains a modest contingency fund for unforeseen expenses.
University reviews its use of heat and gas consumption and, on the basis of the review, negotiates with a weather risk taker to pay a set amount of $XX,000 per degree should the coming winter’s average temperature fall below 37.5ºF.
The winter’s actual average temperature was 34.2ºF.
The risk taker pays the buyer an amount equal to $XX,000 * (37.5ºF-34.2ºF).
The university uses this payment to defray the unexpectedly high heating costs, thereby limiting the impact of the extra heating costs on the contingency fund in the budget.
If the winter’s average daily temperature is above 37.5ºF the risk taker retains the premium. The University’s expenditure for heat has been less than the amount which critically affected its budget.
Actual structures may have more features, as you will see from the case studies to be found elsewhere in this section of the website. Some structures can become quite complicated: multiyear with variegated payout schemes and financially engineered premium provisions. There also are a myriad of sophisticated ways of discussing the benefits of weather risk management, e.g. establishing a floor for adverse variances or outsourcing contingent capital required to meet the weather risk. In essence, however complexly structured and however sophisticatedly evaluated, all weather risk management structures perform in the same way as the example above of the university seeking to limit the downside consequences of cold weather to its operating expenses.
In summary, adverse weather creates adverse financial conditions, which can be managed by financial instruments or insurance policies built around the weather element to which the buyer is exposed. The outcome of purchasing the risk transfer instrument is to limit the adverse impact of weather on the buyer’s economics and to finance the consequences of adverse weather conditions when and if they take place. Insurers, banks, financial houses, specialist companies and exchanges make their business in assuming weather risks from those with natural exposures, often through brokers and other intermediaries.
2. Trading of Weather Risk
A wide range of capital providers make markets in weather risk per se. The existence of this market makes it possible for risk takers in the risk management market to manage their portfolios of weather risk business and for market participants to find value in the dynamics of the market itself. A risk taker who has, for example, accumulated weather exposures around Chicago, may be able to sell a portion of these exposures to a counterparty who is looking for Chicago exposures or to exchange a portion of these exposures for weather exposures in South Africa, Belgium or Japan in order to diversify its business. Beyond this level of trading is the identification of anomalies within the weather space itself – e.g. aberrant behavior of climatological regions which normally are statistically correlated – which provide the opportunity to create value from the trading of weather risk. This trading activity creates value, increases diversity, restructures weather risk as it exists in the market and facilitates market efficiency within the realm of the weather risk business generally.
Over the last two years the cross trading of weather and commodities has grown significantly, adding a new component to the trading of weather. The two markets compliment and supplement each other in a variety of circumstances. For example, risk takers may develop exposures in the upper mid west to low precipitation (e.g. drought insurance) which may be managed in part by the purchase of calls on wheat prices given that drought usually results in lower than expected supply which usually drives up prices. Commodity traders can stand this thought process on its head to manage their price positions. There are a variety of such combinations in which the two markets interact. Additionally, it is possible to combine weather risk and weather-related commodity risk in bundled or triggered structures which will respond, for example, if winter weather is both exceptionally cold and the spot price of natural gas is unusually high. The combination of weather and related commodity risk adds depth and breadth to the weather market and is the source of innovative products being offered in the native risk management arena. The scope of this trading extends to areas beyond energy and agricultural commodities into stocks and also into new risk areas, particularly environmental risks such as emissions and carbon.
The Weather Makers
The Past and Future Impact of Climate Change
384 pages, 230 x 152 mm
Publisher: Text Publishing
Publication date: 2005
Paperback - ISBN: 1920885846 - AU $32.95
Description | Contents | Related Titles | Related Categories
The last 10,000 years have been humanity's day in the sun: we planted the first crops, domesticated animals, and built the first civilisations - and all of this happened not once but many times independently in different parts of the world. But all that is about to change.
Our civilisation is facing its greatest threat - an unprecedented heating of our planet that looks set to destroy the first global civilisation humanity has ever developed. Ironically, the very substance that allowed humans to develop that civilisation - fossil fuels - is the cause of the looming catastrophe.
In this groundbreaking and essential new book Tim Flannery argues passionately for the need to address - now - the implications of a global change that is damaging all life on earth and endangering our very survival.
The Weather Makers is accessible for every interested Australian. In addition to explaining the background story of global warming, it provides a clear outline of what each of us can do to avoid catastrophe.
The slow awakening
Part 1 – Gaia’s tools
The great aerial ocean
The gaseous greenhouse
The sages and the onion skin
Born in the deep freeze
Miking the long summer
Digging up the dead
Part 2 – One in ten thousand
The unravelling world
Peril at the poles
2050: The great stumpy reef
A warning from the golden toad
Liquid gold: changes in rainfall
An energetic onion skin
Playing at Canute
Part 3 – The science of prediction
The commitment, and approaching extreme danger
Levelling the mountains
How can they keep on moving?
Boiling the abyss
The pack of jokers
Civilisation: out with a wimper?
Part 4 – People in greenhouses
A close-run thing
The road to Kyoto
Cost, cost, cost
People in greenhouses shouldn’t tell lies
Last steps on the stairway to Heaven?
Part 5 – The solution
Bright as sunlight, light as wind
Of hybrids, minicats and contrails
The last act of God?
2084: The carbon dictatorship?
Over to you
Climate change checklist
Climate Change - Turning Up the Heat
Natural History : General
Environment : Issues, Policy & Sustainability
Environment : Meteorology & Climate
Printed from CSIRO PUBLISHING - Books & CDs http://www.publish.csiro.au/nid/18/pid/5172.htm