Howworks

Companies looking to buy Weather Protection

NOTE weatherXchange^® is only available to larger corporate users, not private individuals.

How Are Weather Risk Contracts Priced?

The price of an index-based weather protection contract depends on the frequency of the event and the size of the payout. There is no single "correct" way to price such contracts and different Protection Sellers will use different methodologies, just as is the case in other markets such as property insurance.

The simplest methodology, which would usually set the lowest theoretical price, is to look at historical weather data and to calculate what the average payout would have been for the required contract over a large number of historical years. This may be adjusted for any views the Protection Seller has relating to trends and other factors. As is the case in other markets, firms providing such protection also have to cover other costs such as administration and cost of capital.

The price of a given contract may also depend on what other contracts a Protection Seller already has on their books. As a result, there are likely to be some benefits in comparing prices from multiple Protection Sellers.

Weather Hedging Terminology

• Basket: index-based weather protection contracts always reference a weather index. This index can be based on a single site or multiple sites. The latter are described as "baskets". A basket may be useful where, for example, a propane distribution company is looking for protection against warm winters in their customer area. By using a mixture of different weather stations in that area, it is possible to get an index that closely reflects the customer profile. weatherXchange® can list baskets on request to reflect the needs of a particular protection buyer.
  
• Broker-Advisors: can provide investment advice and act on the Hedger's behalf in placing weather risk. The financial arrangement between Hedgers and Broker-Advisors is discussed directly. weatherXchange® is not involved in, and has no financial interest in this process. Broker-Advisors are listed on the Participants section.
  
• Cap: the level of a weather index units above which (or below which) the payout ceases to rise. For example, a building company may find that more than 50 millimetres of rain over a particular period causes a problem, but that at 200 millimetres the disruption reaches a maximum. In this case the Cap is 150 millimetres. The maximum payout is equal to the Cap multiplied by the Tick Size. Alternatively, it may be that too many days of extreme rain (say more than 5 days with rainfall above 20mm on each day) causes a problem for a tour operator. However, there are a limit to how many such "Critical Days" impacts revenues as they only ever run 15 tours. In this case the Cap is the difference between the number of such Critical Days where the payout starts (i.e. Strike is 5 days) and where the payout stops increasing (i.e. 15 days). So, in this case the Cap is 10.
  
• CDD: Cooling Degree Days. A measure of energy demand related to cooling. Using the average temperature for the day, every degree above 18C (or 65F in the USA) contributes one CDD. If the daily average temperature is below 18°C / 65°F, zero CDDs accrue for that day. The daily CDD values are added up for the required period.
  
• Critical Day: a Critical Day is one where an extreme weather condition applies. For example, in agriculture this could be a day where the maximum temperature is above 35°C causing crop damage, or, in construction where daily rainfall above 5mm prevents work. A Weather Index can be based on the number of such Critical Days experienced. For example, a construction company may be able to cope with 4 days of rainfall greater than 5mm but beyond that is exposed to project delay costing $10,000 per day of delay. In this case the definition of "Critical Day" is "rainfall>5mm", the Strike is 4 and Tick Size is $10,000.
  
• Gridded Data: these are weather data sets based on interpolated terrestrial observations, historic forecast model output, satellite data, or any mixture of those sources. Gridded data sets can provide weather data for weather variables where little or no observed data is available, for example 80m wind speeds or for marine data such as wave height. Gridded data can also provide data in areas where there are no or few terrestrial observations. Gridded data is often used for weather protection contracts in the renewable power sector. A number of indexes based on gridded data are Listed on weatherXchange®. weatherXchange® can List additional gridded data sets, including Baskets, on request to reflect the needs of a particular protection buyer.
  
• HDD: Heating Degree Days. A measure of energy demand related to heating. Using the average temperature for the day, every degree below 18°C (or 65°F in the USA) contributes one HDD. If the daily average temperature is above 18°C / 65°F, zero HDDs accrue for that day. The daily HDD values are added up for the required period.
  
• Index-Based Weather Risk: Index-Based Weather Risk hedging uses an observed weather variable at a chosen weather station to create an index on which a payout can be based. This index could be total rainfall over a relevant period, or the number of days of minimum temperatures below zero. Most contracts pay out when an index is above or below a certain level (see "Strike") with the payout proportional to how much above or below that level the index is (see "Tick Size"). The period, the Strike and the Tick Size is chosen by the buyer of the risk protection to fit with their needs. Unlike traditional indemnity-based insurance cover, there is no need to demonstrate that a loss has been made. Settlement is completely objective, based on measured rain, or measured temperature or other chosen weather variable over the period of interest. There is no loss-adjustment process.
  
• Instant Indicative Pricing (IIP): a number of weatherXchange Protection Sellers offer a service whereby Hedgers and Broker-Advisors can request indicative prices and receive a price immediately. These are not normally tradeable prices but may still be helpful in the "structure discovery" stage of creating a weather protection contract. IIP can help answer the question of whether a particular weather hedge is within budget. IIP is technology-driven using sophisticated software configured by the Protection Seller. While IIP helps the Hedger it also saves the Protection Seller time by reducing the cost of turning around an initial quote and by allowing them to service more potential new business.
  
• Investment Advice: this term is used in a regulatory context. While weatherXchange® is authorised and regulated by the Financial Conduct Authority, we do not provide Investment Advice. So while we can offer practical user-help on using the structuring tool, we cannot advise as to the suitability of a particular contract for a particular Hedger's needs. weatherXchange’s Broker-Advisors are able to provide Investment Advice and can be contacted directly through the Platform.
  
• National Wind Benchmarks: Designed for weather risk transfer and provided by Speedwell Climate Ltd. National Wind Benchmarks are indexes which replicate national energy output. Based on native 3-hourly MERRA2 data set, each Benchmark is a daily time series which uses a power curve adjustment to produce a time series denominated in MWh.
  
• Protection Seller: this is the term we use to describe the (re)insurance company or fund which is able to offer the weather risk protection that hedgers require. Protection Sellers are listed on the Participants section in random order.
  
• Reference Station: the weather station chosen as the basis of the weather risk contract.
  
• RFP: "Request for Proposal" or sometimes "Request for Price". To receive a firm price for a weather protection contract, it is necessary to send the Protection Sellers all the details of the weather protection contract require. weatherXchange makes it easy to send an RFP to multiple Protection Sellers at a click of a button. RFPs are sent both in human-readable form and in machine readable form. The latter reduces error and helps increase the speed of response.
  
• Settlement Data: the quality-controlled weather data used to calculate the index upon which a weather protection contract is based. This is provided by Speedwell Settlement Services Limited.
  
• Start Data/End Date: the Start Date and End Date define the period over which the weather index is measured at the Reference Station. This could be critical period in a crop planting cycle, or the period of ground works in a building project, or a winter period for an energy company looking to protect against warm weather reducing demand for gas.
  
• Strike: the level at which the protection starts paying out. For example a building project may be sensitive to more than 50 millimetres of rainfall in the week before construction starts. In this example the Strike is 50 millimetres.
  
• Synthetic Wind Farm Benchmarks: Designed for weather risk transfer and provided by Speedwell Climate Ltd, Synthetic Wind Farm Benchmarks are indexes which replicate energy output for specific windfarm assets. Based on native 3-hourly MERRA2 data set, each Benchmark is a daily time series which uses a power curve adjustment to produce a time series denominated in MWh. They are produced in cooperation with specific owner operators.
  
• Term Sheet: this defines all the "moveable parts" of a weather protection contract. It is the Term Sheet that Protection Sellers need to price a Index-Based Weather Risk contract and which will form the legal basis of the contract between the Hedger and the Protection Seller. weatherXchange® allows the Term Sheet to be generated automatically. This can be sent to Protection Sellers to request a price or to Broker-Advisors to seek investment advice or to discuss retaining them to act on the Hedger's behalf in finding the best price.
  
• Tick Size: The payout required per millimetre of rain or degree of temperature or per day of freezing temperature (etc) above or below the Strike. For example a building company which experiences increased disruption due to excessive rain might set the payout to be €1,000 per millimetre of rain for each millimetre of rain above a 50 millimetre Strike.
  
• Trading Participants: described on the weatherXchange® Platform as the users who are interested in not just sending but also receiving RFPs for exchange-traded sites. The architecture of the weatherXchange® Platform allows any user to be provided with the option of sending RFPs to any other user. For most users, these are set by default to Protection Sellers only. However, Trading Participants are able to request the addition of any Participant listed as a Trading Participant, subject to their agreement.
  
• Weather Element: the weather variable of interest as measured at the Reference Station e.g. rainfall, daily maximum temperature etc...
  
• Weather Index: the starting point of buying Weather Protection is to define what type of weather causes the problem: this is represented by the Weather Index. If it is total rainfall, the Weather Index required is cumulative rain. If it is the number of days of extreme temperature then the index could be the number of days where the daily maximum temperature is above 30°C.
  
• weatherML: a proprietary "mark-up language" implement by Speedwell Climate Limited used to define the parameters of Index-Based Weather Risk Contract. In effect it is used to generate a machine-readable Term Sheet. A weatherML document can be read either by humans or machine-read by software. When a Hedger sends an RFP pricing request to a Protection Seller from the weatherXchange® Platform, it is sent in weatherML format.