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18. November 2016

The meaning of weather markets for the energy industry

Author: Thomas Kammann, Managing Director Energy Risk Solutions, Baar, Switzerland

Depending on the season, weather and energy consumption have always had a correlation with energy sources and energy use. Just think of the relationship between external temperature and the consumption of heating oil in Europe, or that between external temperature and consumption of electricity by air-conditioning systems in the USA. The balance sheets of gas and electricity suppliers are therefore exposed to temperature fluctuations. This exposure can be managed with the use of weather hedging, either in the form of derivatives or insurance.

Since the end of the 90s, weather derivatives have been traded, initially only in the USA, then also in Europe and Australia. Up to about three years ago, the use of weather derivatives concentrated mostly on the thermal energy market; in Europe, gas suppliers in particular hedged against too warm winters. This was initially based on simple temperature hedging mechanisms, but over time these were expanded to include gas price components, the so-called “quanto” products. The latter could until recently only be obtained from the finance sector as purely financial products, but now a skilful purchaser can also negotiate them with his downstream suppliers.

With the introduction of renewable energies, weather hedging has also become of interest to electricity generators. The economic efficiency of wind parks with a high percentage of external financing is by definition massively dependent on the weather. The cutback in subsidies and the planned auction mechanisms for new installations sharpen the situation. The professional weather hedging sector finds itself in strong competition for the development of suitable hedging mechanisms.

On the 2nd E-world Weather Day on 8th February 2017, this and other topics will be discussied by representatives of the European energy industry.

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