weather products

Dog Days and Degree Days
By J. Scott Mathews
p r e s i D e n t, W e at h e r e x l lc

com/weather Many residents in the Northeast and Midwest are wondering if the cool summer was a late spring or an early autumn. July 31.1ºf il -5.5ºf pa -5. August 4. If you scanned the midsummer news headlines.9ºf Wv These states experienced the coldest July in over 100 years of keeping temperature records. one theme in July kept “bustin’ out all over” (see Figure 1). figure 2 2 . 2009 in new york.0ºf in -4. 2009 you call this summer? by Globe Staff Indiana’s New Center. July 31. It isn’t just that July was a bit on the cool side: records were broken (see Figure 2).A. August 1. 2009 the summer that hot forgot by Steve Pardo The Boston Globe. August 1. Now.2ºf oh -3. it’s the summer that isn’t by Sam Roberts Minneapolis Star Tribune. August 1. -5.cmegroup. When Weather is cool neWs The New York Times. 2009 coolest July ever by Mason Meyers L. 2009 Where’s the heat? from the staff of the Los Angeles Times figure 1 July 2009 Was extraorDinarily cool in six states forming a banD from ioWa to pennsylvania. 2009 July in minnesota: the big chill by Tim Harlow The Detriot News.8ºf ia -3.

Chan Wine Press Northwest. for one.. experienced a different problem as they’ve been battling hotter than normal temperatures. a few farmers are projecting a windfall. the news industry doesn’t seem to cover this storyline as dramatically (see Figure 3). Illinois farmers were concerned about corn root depth and worried that harvest time could be as late as November. 2009 how hot is it? too hot for grapevines by Andy Perdue Grand Junction (CO) DailySentinel. 3 .. as some agricultural products seem to enjoy the anomalous season. the Michigan Cherry Committee. Apparently. Corn pollination was delayed. 2009 surprise! July Was hotter than usual by Darcy Wytko abc15. a 50 percent increase over their 2008 yield. looks forward to a 300 million pound crop. in the northwest by Megan H. When Weather is hot neWs The Associated Press. 2009 it’s too Darn hot. On the other hand.com (AZ). 2009 July of 2009 Was the hottest on record! by Bill Bellis figure 3 The repercussions of Mother Nature have affected an already stressed economy. July 29. 2009 pacific northwest sweats as heat Wave continues by Ryan Kost USA Today. August 3. August 3. July 28. Even though heat is what summer is supposed to be about. the slower pace of ripening has also improved the quality of the cherries.Dog Days and Degree Days Residents in the Southwest and Northwest. 2009 trees offer leafy relief from searing summer sun by Melina Mawdsley Yakima (WA) Herald-Republic. August 5. thereby suppressing kernel development and reducing yield. Some crops did not get the heat they needed in order to mature. July 31. Many farmers in the Midwest and Northeast fear a systemic breakdown in the growing process.

and a curse for others (see Figure 4). 2009 impact of cool weather is double-edged sword for slow-growing soybean crop: farmers say it’s helped. and these dollars can be protected. with contracts that span the spectrum from insurance and reinsurance. to an extent. sunshine or humidity and hurricanes by entering into weather derivative agreements. 4 . as well as institutions and municipalities that depend on certain weather conditions can diminish the uncertainty of temperature. 2009 let it rain: power of a shower is good for some. recreation. August 3. August 3. snowfall.com Pioneer Press (MN). while traders think yields will be cut by Tom Webb The Mountain Press (TN).com/weather In the cooler regions. travel. 2009 benefits of cool July: cleaner air. windiness. Revenues and expenses can ebb and flow from changing weather. better wine. but bad for others by Derek Hodges figure 4 Industries like energy. to futures. garbage with less stink by Gary Rennie Reuters. Consumers saved money due to lower demand for electricity at the expense of suppliers working “north of the meter” who saw lower revenue flows. Bad weather can be a blessing for some. entertainment. insurance. transportation. July 23. rainfall. options and over-the-counter transactions.cmegroup. the baD anD the ugly The Windsor Star (ON). Weather neWs: the gooD. August 3. producers and consumers of electric power noticed the financial impact of the “severely mild” temperatures. 2009 temperature Wars: the struggle between energy savings and employee comfort by GreenBiz.

counted during the course of that period. One HDD or CDD is worth $20. then the buyer receives $1.com figure 5 5 . hoW are cme group Weather futures priceD? Each contract is referenced to one of 24 U. 2) If a day in Tucson averages 90°F then there were 25 CDDs recorded. That day would be “$400 hotter” than a 70°F day with only 5 CDDs. cities. then settles on Dec.) 3) If the December Philadelphia contract trades on Dec. 4) A short seller of May Dallas futures whose entry level is 385 CDDs would make $600 per contract if the end of month total was only 355 CDDs. 31st at 1080. Source: firstenercastfinancial. and is financially settled according to the cumulative tally of the daily HDDs. or CDDs. or series of months. An HDD is 65°F minus a given day’s TAVG. A CDD is the day’s TAVG minus 65°F. Note: TAVG = { TMIN + TMAX } ÷ 2 Daily Examples: 1) A day in Kansas City having 14 HDDs is “$100 colder” (per contract) than a day with 9 HDDs. Monthly Examples: (Each CME degree day futures contract is based on a specific calendar month.Dog Days and Degree Days The most prominent weather derivatives are heating degree day (HDD) and cooling degree day (CDD) products that are traded at CME Group (NYSE: CME).100 per contract from the 55 HDD colder outcome. 1st at 1025 HDDs.S. HDD are designed for winter and CDD for summer (see Figure 5).

three in Australia and three in Japan. an energy supplier that loses money in a cool summer can swap that risk with a company that consumes more electric power for cooling buildings when the weather is hot. and insurance/reinsurance companies. For example. proprietary trading companies.com/weather Felix Carabello. there are 24 cities in the United States (see Figure 6). ten in Europe. among others. 6 . By using CME Group’s contracts traded with a futures commission merchant (a clearing brokerage firm). Other participants in the weather futures market are investors or speculators who may be hedge funds.cmegroup. institutional commodity desks. six in Canada.” Degree day contracts enable risk avoiders and risk takers to exchange their temperature exposure through the secure financial mechanism of CME Clearing. CME Group’s director of alternative investment products. Each one is solely contracting with CME Group. Each futures contract at CME Group is pegged to a specific city. the two parties in this example don’t have the added exposure to one another’s credit worthiness. For temperature index transactions.” says Carabello. ”These products are engineered for any industry that faces business uncertainty as a result of extreme weather. “CME Group facilitates the transfer of their financial risk exposure to the capital markets. says weather derivatives appeal to customers representing a broad array of sectors.

cities.C.S. West Colorado Springs Las Vegas Los Angeles Portland Sacramento Salt Lake City Tucson figure 6 south Atlanta Dallas Houston Jacksonville Little Rock Raleigh miDWest Chicago Cincinnati Des Moines Detroit Kansas City Minneapolis northeast Baltimore Boston New York Philadelphia Washington D.Dog Days and Degree Days cme group Weather Derivatives Futures customers can trade contracts based on the temperature index in any of 24 U. 7 .

For example. but volumetric uncertainty. but an acceptable loss since a hot period will greatly increase the volume of energy sold. the participants value their analysis from the temperature measurements taken at specific airport weather stations that are nearest to the location of the risk. a hot July would render the short hedge a financial loss.5 CDD) X 1000 contracts X $20 = $3.com/weather Each degree day is valued at $20 per contract.5 accumulated CDD. Weather traders and hedgers look at historical averages (see Figure 7) to determine the probability of various scenarios in the future. Because the weather did turn out to be cool. this seller was probably hedging itself against a cooler than average month. Cincinnati’s data is collected at the airport across the state line in Covington. the outcome would have been a loss on the hedge.19 million on its hedge: (324 CDD – 164. 8 . If an energy company had placed a short position (sold) of 1000 contracts of July Cincinnati futures at 324 CDD (the 10 year average). then the company would have earned $3. in the event of a hotter than average July in Cincinnati. This fact underscores the basic premise of degree day hedging: it is not price uncertainty that is managed. In the weather market. Because the purpose of hedging is to limit downside risk.cmegroup.000 Of course. Kentucky.190. and the final settlement price was 164. The airport code for Covington is “CVG”.

2 -2.6 1. ‘09 -1.2 73.5 69.020) $420 ($2.5 338.4% -16.7 -4.5 78.0% 18.6 -4.2 0.8% Atlanta Baltimore Boston Chicago Cincinnati Colorado Springs Dallas Des Moines Detroit Houston Jacksonville Kansas City Las Vegas Little Rock Los Angeles Minneapolis New York Philadelphia Portland (OR) Raleigh Sacramento Salt Lake City Tucson Washington D.5 -148.5 107 -10 -173 45.210) ($1.5 11 -7 -66 83 -69 July 2009 $ per contract vs avg ($890) ($1.1 90.3% -28.9 10 year avg temp 1999-2008 79.5 75.4% -54.3 -3.9 87.5 -3.8 -5.2 -2.1 2.5 121.2 73.5 -101 21 -143.1% -13.140 ($200) ($3.0% -15.5 693 503 264 919.5 -3.9 76.7 -2.5 72 68.340) ($1.2% -18.980) ($3. figure 7 (ATL) (BWI) (BOS) (ORD) (CVG) (COS) (DFW) (DSM) (DTW) (IAH) (JAX) (MCI) (LAS) (LIT) (CQT) (MSP) (LGA) (PHL) (PDX) (RDU) (SAC) (SLC) (TUS) (DCA) source: msi guaranteeWeather traDing ltD.480) ($2.290) $2.1 4.5 -101 13 -164.7 73.1 68.1 76.5 293.C.5 273.5 -2.430 $220 ($140) ($1.Dog Days and Degree Days city airport code July 2009 actual temp 78.660 ($1.4 79.4 72.5% -2.5 75.7 79 74 70 74.2 July 2009 actual cDD 406.2 87.3 -0.1 July 2009 temp avg vs.870) ($2.5 -110.290) ($2.9 81.9% -18.3 74.4 70.5 433 280 164.2 82.6% 3.9% -39.5 -64.6 79.380) July 2009 percent vs avg -9.1 74.4 79.9 3.460) $910 ($2.0 -5.6 75.8 83.4 -5.6 86.5 126.9% 4.4 75.6% 5.0 78.9% -50.6 81.5 79.5 85.5 -0.0% 79.6 76.9% 2. TEMPERATURES IN DEGREES FAHRENHEIT 9 .020) $260 ($3.3% -1.6 70.2% -42.320) $1.4 81.5 94.8 73.5 136 668 220.9 0.5 299 187 146 164.2% -39.970) $2.0 69.9 73.1 93.2 75.5 451 321 436 777 368 10 year avg cDD 1999-2008 451 366 261 295 324 237 647 364 275 586 513 437 874 534 267 329 404 403 152 440 328 502 694 437 July 2009 cDD avg vs ’09 -44.5% -49.190) ($2.5 -2.1 0.1% 12.5 -67 -74 -149 -159.6 79.4 -5.4% -50.0% -27.

71 4 29 -25 30 30 -139 15 -98 66 59 69 21 -183 -121 -176 -159 -56 129 -61 8 -130 -230 -131 73 -164 9 -189 cum. Dev. regional anD national averages Climate Prediction Center-NCEP-NWS-NOAA state Week total Week Dev. Dev. a publisher of daily energy and weather market information (see Figure 8). from norm. Dev. Transactions can be structured as insurance coverage.com/weather Energy businesses are active in hedging their degree day exposures in the weather risk market because demand is closely tied to temperature. from last year 32 0 -13 26 -7 -3 27 47 47 11 27 1 -17 48 55 27 36 44 16 23 58 32 51 24 33 38 -13 20 cum. Dev. total cum. 9 0 -12 -9 3 7 6 18 26 9 13 1 -15 11 12 6 -3 8 4 1 29 3 15 16 6 0 -5 -1 Week Dev. cooling Degree Day Data Weekly summary population-WeighteD state. from last year pct (%) 0 -999* 9 -4 -11 -30 -40 -9 -14 -1 2 -8 -6 -16 -6 -10 -5 -5 5 -30 -7 -44 -35 -14 3 -5 -17 -12 ALABAMA ALASKA ARIZONA ARKANSAS CALIFORNIA COLORADO CONNECTICUT DELAWARE D.C.cmegroup. FLORIDA GEORGIA HAWAII IDAHO ILLINOIS INDIANA IOWA KANSAS KENTUCKY LOUISIANA MAINE MARYLAND MASSACHUSETTS MICHIGAN MINNESOTA MISSISSIPPI MISSOURI MONTANA NEBRASKA figure 8 110 0 130 96 57 28 53 91 123 127 106 112 24 70 69 62 92 82 123 23 99 42 56 50 114 82 18 67 1358 17 1947 1227 599 253 308 794 1005 2179 1248 2556 369 493 563 487 895 802 1856 128 769 231 223 274 1508 765 202 591 10 . over-the-counter instruments. pct(%) 6 -999* 2 -2 5 13 -31 2 -9 3 5 3 6 -27 -18 -27 -15 -7 7 -32 1 -36 -51 -32 5 -18 5 -24 cum.” said Ben Smith. president of First Enercast Financial. from norm. or CME Group products (futures or options on futures). from norm. “To get an idea of weather’s impact on energy demand I like to look at population weighted cooling demand figures for the major cities across the nation. from last year -5 11 157 -57 -74 -107 -209 -80 -167 -25 22 -218 -23 -95 -39 -56 -51 -43 85 -56 -56 -182 -121 -45 45 -43 -42 -81 cum.

from last year -13 -108 -179 61 -179 -21 -44 -67 -19 54 -108 -230 -26 -88 -34 116 -106 -50 -47 86 -14 -59 -96 cum. Dev. Dev. from norm. Dev. 2009 accumulations are from January 1. 2009 to August 15.Dog Days and Degree Days state Week total Week Dev. -76 -110 -87 5 -108 106 -131 -93 -11 129 -72 -99 46 -199 -22 257 13 -100 27 112 -44 -178 -48 cum. -15 8 15 -4 14 15 13 22 -7 -6 24 3 7 -1 4 13 -10 13 21 -7 14 16 -5 Week Dev. pct(%) -6 -43 -15 1 -23 11 -35 -16 -1 78 -14 -27 4 -34 -2 14 3 -43 4 78 -8 -44 -20 cum. from norm. total cum. from last year pct (%) -1 -43 -26 10 -33 -2 -16 -12 -1 23 -20 -46 -2 -19 -3 6 -17 -28 -6 51 -3 -21 -33 NEVADA NEW HAMPSHIRE NEW JERSEY NEW MEXICO NEW YORK NORTH CAROLINA NORTH DAKOTA OHIO OKLAHOMA OREGON PENNSYLVANIA RHODE ISLAND SOUTH CAROLINA SOUTH DAKOTA TENNESSEE TEXAS UTAH VERMONT VIRGINIA WASHINGTON WEST VIRGINIA WISCONSIN WYOMING region NEW ENGLAND MIDDLE ATLANTIC E N CENTRAL W N CENTRAL SOUTH ATLANTIC E S CENTRAL W S CENTRAL MOUNTAIN PACIFIC uniteD states 97 35 73 54 63 98 49 72 109 16 73 46 105 52 86 141 43 36 90 12 67 54 19 1273 145 500 688 368 1098 239 473 1312 294 439 267 1309 380 949 2046 527 131 795 256 533 228 191 42 68 65 69 107 96 131 68 48 79 4 16 16 6 15 7 8 -3 3 10 30 47 53 29 30 38 12 -11 -8 26 231 418 406 567 1369 1114 1869 925 528 849 -106 -87 -149 -147 64 18 201 55 85 0 -168 -157 -82 -52 -24 -15 82 4 -42 -50 -31 -17 -27 -21 5 2 12 6 19 0 -42 -27 -17 -8 -2 -1 5 1 -7 -5 (2000 CDD normals implemented 1/1/2003) *Last date of data collection period is August 15. 2009 -999 = normal less than 100 or ratio incalculable figure 8 cont’D 11 . Dev. from last year -22 34 46 -4 38 35 17 61 20 -18 60 26 17 6 40 8 -15 36 48 -10 42 47 -9 cum. from norm.

According to that Kansas City was actually cooler than Portland (by one tenth of a their annual report. increased costs or companies do have a geographical reach across several regions. and they also offer tailor made weather insurance policies through their affiliate. An was. requirements.” this reach can serve as an intrinsic volatility hedge. other disruptions in business operations. supply obligations. Despite all the record cool and hot spots. total population weighted weather for the country equaled out to be about average for the season. futures. some of which resemble the CME Group futures and options.) 12 . Brad Davis. OR. of course. Despite the temperature extremes. Others might be integrated in several ways. Weather market participants also include dealers who sell protection to companies and institutions seeking to reduce weather risk. whose origin goes back to 1816 when it was known as The Gas Light Company of Baltimore. the net energy demand turned out to be average on a national basis. (Baltimore is one of the cities whose weather risk is traded through CME Group products. Vortex Insurance Agency.5 degrees warmer than Portland.” Smith said. some of the largest energy variations that may result in reduced revenue. They offer standard derivative structures. coal and other commodities. weather exposure. To implement this strategy. purchase and sale commitments. Readers will note that Smith’s observation is evident in the table (Figure 8) column “Cumulative Deviation from Normal” which has a zero value for the last line (United States). but to supplement such insurance and help protect against significant. is a global provider of weather risk management products. The average July temperature in Kansas City is to lower financial risk by hedging many of the uncertainties: fuel 9.cmegroup. as well as having regulated and non-regulated businesses.” The group’s flagship unit is the Baltimore Gas and Electric Company. Constellation reports they “utilize fixed-price forward physical purchase and sales contracts. LLC. inventories of natural gas. MSI GuaranteedWeather Trading Ltd. Kansas. The west coast heat and the Midwest coolness were so extreme example is Constellation Energy Group (NYSE:CEG). Constellation routinely enters into contracts degree Fahrenheit).com/weather “This summer was a very even split. (MSIGWT) in Overland Park. and. financial swaps and option contracts traded in the over-the-counter markets or on exchanges. weather In taking advantage of this netting effect. but non-catastrophic. where the eastern half of the country had recorded population weighted CDDs that were much lower than normal while the western cities experienced much higher CDD totals. having operating units all along the supply The graph in Figure 9 illustrates just how unprecedented July really chain. says “Products sold by Vortex are not intended to replace traditional property and casualty insurance. President and CEO of MSIGWT.

The 6th largest municipal utility in the United States is SMUD (Sacramento Municipal Utility District). the only time this has occured in the 60 year history depicted here. the shortfall of power is supplemented by generating. Since 2000. Kansas City July CDD Kansas City 60 Yr Avg Portland July CCD Portland 60 Yr Avg source: msi guaranteeWeather traDing ltD.Dog Days and Degree Days Kansas City. and the payments are derived by factoring in the price of electric power in Northern California. SMUD pays out cash to the counterparty. SMUD produces and delivers hydroelectric power to serve a portion of its load. A dry winter and spring.” 13 . Simply stated. more expensive power produced by burning natural gas. or purchasing. MO vs. whose customers own the utility. OR July cooling Degree Day history Kansas City was cooler than Portland in July 2009. In exchange. and if there isn’t enough precipitation in a given year. including option positions known as “puts” and “collars”. followed by a hot summer. SMUD’s Risk Manager. “collars” enable SMUD to receive cash from the other party in the transaction. can lead to much higher unit costs (more cents per kilowatt hour) for everyone on a SMUD meter. Pam Taheri. Portland. The initial transactions were structured as various financial hedges. says “We use these types of hedging mechanisms to help manage weather volatility and to stabilize the price uncertainty for our customer/owners. in order to buy replacement power in low rainfall years. The actual formula is based on specified levels of precipitation. SMUD mitigated the risk of rainfall uncertainty by going to the weather market. This works well for both sides. figure 9 The marketplace in weather risk management for energy suppliers also includes rainfall hedges. during rainy years.

000 miles away impacting costs three years later. as in the Sacramento example. Mathews writes "Weather to Buy or Sell. strength and size of named storms during hurricane season: the CHI (CME Hurricane Index). because of the damage to the energy infrastructure in the Gulf of Mexico. Mr. with hurricanes 2. WeatherEX LLC. 14 . His weather market consulting firm. Scott Mathews is a commodity risk specialist. J. CME Group was there to respond with hurricane products. and those asoaring gas prices flowed to the SMUD expense line a few years later. including CME Group. there can be a downside with this kind of solution. Not to be fazed by Mother Nature.com/weather However. Now we must keep an eye on "OPW" (other people's weather) that can affect us financially.cmegroup.” Actually. The extremely active hurricane season back in 2005 (Katrina. too. First Enercast Financial’s Ben Smith says. “When I speak with people lately. Rita and Wilma) led to a steep rise in the price of natural gas. In 2008 there were some surprises as people opened their SMUD electric bills. depending on where they live. He manages a branch office and weather desk for an introducing broker firm. they can’t stop talking about what an unusually hot or cold summer they have had. because the fuel purchase agreements made in late 2005 were for forward delivery." in the weekend edition of The Wall Street Journal. on various aspects of the weather market. The SMUD customer/owners who thought their weather risk was hedged. it isn’t just about where you live. advises companies. These were futures contracts and related options based on the landfall location. ultimately found out that they had a “hurricane premium” baked into their electricity costs.

com 800 331 3332 312 930 1000 New York London São Paulo 212 299 2000 + 44 20 7796 7100 Houston Singapore 713 658 9292 +65 6322 8595 Washington D. Illinois 60606 cmegroup. COMEX is a trademark of Commodity Exchange Inc. WT133/0/1109 .com info@cmegroup. Tokyo 202 638 3838 +81 3 5403 4828 +55 11 2565 5999 CME Group is a trademark of CME Group Inc. All other trademarks are the property of their respective owners. All rights reserved. New York Mercantile Exchange and ClearPort are trademarks of New York Mercantile Exchange Inc.cmegroup.C. Further information about CME Group and its products can be found at www. Chicago Mercantile Exchange and Globex are trademarks of Chicago Mercantile Exchange Inc. CME.com.For more information on Weather products. CBOT and Chicago Board of Trade are trademarks of the Board of Trade of the City of Chicago. Copyright © 2009 CME Group.cmegroup.com/weather. NYMEX. visit www. The Globe logo. CME GROUP HEADQUARTERS CME GROUP REGIONAL OFFICES 20 South Wacker Drive Chicago.

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