Even though they’ve been traded for over a decade now on the
Chicago Mercantile Exchange, are weather derivatives nothing more than a way to
merely make money off climate change?
By: Ringo Bones
As many of us already know, weather derivatives are nothing
more than financial instruments that can be used by organizations / business
groups or individuals as part of a risk management strategy to reduce risks
associated with adverse or unexpected weather conditions. The difference from
other forms of tradable derivatives is that the underlying asset – rain / temperature
/ snow as in weather phenomena – has no direct value to price the weather
derivative. Thus make it to be classified under “exotic derivatives”.
Weather derivatives differ from bona fide insurance policies
which generally provide protection for low possibility big catastrophic events
like hurricanes and tornadoes, weather derivatives can cover more mundane
weather events like a heating oil company hedging against having a
warmer-than-expected weather. For all intents and purposes, a weather
derivative is a financial instrument that seems like an insurance policy for
climate change risk insurance but is more like an option. Most weather derivatives
are based on how much the temperature goes above or below 65 degrees
Fahrenheit, but weather derivatives can also be based on any measurable
meteorological phenomena.
Even though the Chicago Mercantile Exchange has been trading
the first exchange-traded weather futures contracts – and their corresponding
options – since 1999, I might not be the only one who is skeptical about the
long-term economic viability of weather derivatives and related financial
instruments. Unlike fire insurance companies that – since their establishment -
has been supporting the Underwriters’ Laboratories or similar research and
development organizations actually doing something to reduce fire losses and
spur fire prevention, business groups involved in weather derivatives trading
or climate change risk insurance underwriters seems to have little or no
involvement in supporting research and development organizations developing
ways to make the industrialized world to move away from intensive carbon
burning activities and preventable greenhouse gas dumping into the Earth’s
atmosphere. Would weather derivative underwriters still willing to cough up the
money if their heating degree days (HDD) and cooling degree days (CDD) payouts
will become unsustainable due to the wild temperature swings brought about by
climate change?
