The Weather Risk Problem

The U.S. Department of Commerce estimates approximately 35% of the United States’ $16.8T economy is affected by weather. For the agricultural industry, this equates to $150B of economic value that is affected by climate variations every year. Weather events and cycles drive commodity prices, input costs, profitability, and largely determine the financial health of the industry over time. Seasonal weather events can greatly impair the industry’s financial stability, and longer term adverse weather cycles can threaten the existence of industry participants.

Frost and freeze events reduce grain yield and grain quality. The extent of damage depends on the physiological stage of maturity and the severity of the frost or freeze event. Temperatures between 30 – 32⁰F for just several hours can damage upper plant leaves, while temperatures below 30⁰F for only several minutes can kill the plant entirely.

In addition to lost yield, a number of other impacts also reduce the financial value of the crop:

‐ Lower oil content and reduced grain quality
‐ Higher moisture contents, and
‐ Increased drying costs.

Using the critical temperatures table, a soybean producer can determine the expected financial loss at each growth stage when a frost or freeze event occurs. With eWeatherRisk’s program, that same producer can then design and purchase a weather contract to offset that expected financial loss if a frost or freeze does occur.

Critical Temperatures Table

The eWeatherRisk Solution

Utilizing eWeatherRisk’s solution and the critical temperatures table, our Fargo, North Dakota-based soybean farmer client designed a weather contract to mitigate the financial impacts of a freeze event. By incorporating the expected stage of development for his soybean crop, he determined the total financial loss scenario would amount to $500,000 should a freeze event occur on or before September 20th, the date the soybean crop would reach maturity.

The Weather Risk Problem

The U.S. Department of Commerce estimates approximately 35% of the United States’ $16.8T economy is affected by weather. For the agricultural industry, this equates to $150B of economic value that is affected by climate variations every year. Weather events and cycles drive commodity prices, input costs, profitability, and largely determine the financial health of the industry over time. Seasonal weather events can greatly impair the industry’s financial stability, and longer term adverse weather cycles can threaten the existence of industry participants.

Sufficient moisture is vital in attaining maximum yield. Not only must rainfall be plentiful, it must occur consistently over the growing season. However, water deficiencies occur frequently and in almost any environment, leading to water stress which directly decreases kernel weight. Irrigation is an effective tool but is limited by site characteristics, water sourcing issues, agronomic impacts and economic costs. (“Wheat growth and physiology”, E. Acevedo, P. Silva, H. Silva).

Water shortages present early in the growing season affect germination and establishment. The minimum water content required in the grain for wheat germination is 35 to 45 percent by weight. Tillering is highly sensitive to water stress, being almost halved if conditions are dry enough. As a result, leaf area development is the most affected process during this stage. Double ridging to anthesis is also a critical period of active plant growth, and the severity of the rainfall deficit has an increasingly greater impact on plant functioning and growth. Grain number decreases sharply when water stress occurs during the spike growth period and yield reduction is greatest when water stress occurs ten days before spike emergence. Moisture deficits during anthesis until maturity do not affect the total number of kernels but the net effect is to accelerate plant development, ultimately shortening the grain-filling period and reducing kernel weight. (“Wheat growth and physiology”, E. Acevedo, P. Silva, H. Silva).

The eWeatherRisk Solution

Using historical experience and corresponding weather data available from eWeatherRisk, a producer can determine the expected financial loss when rainfall is below normal. That same producer can then design and purchase a customized weather contract that will trigger payment when total moisture is less than the desired amount.

Our Garden City, Kansas-based wheat farmer designed a weather contract to mitigate the financial impacts of below-normal cumulative precipitation during the critical spring months. He determined his expected financial loss scenario to be $500,000 in the event precipitation fell below normal between February 1st and June 1st.

The late spring and early summer of 2013 saw continued drought conditions in Kansas, particularly in the Garden City Area. Precipitation totals between February 1st and June 1st amounted to just 3.33”, 50% of the historical average and well below the contract’s payment trigger. This resulted in a payment to our producer of $278,390! The weather contract effectively offset lost revenues as a result of lower yields, and ultimately protected our farmer’s operating income for the year.

The Weather Risk Problem

The U.S. Department of Commerce estimates approximately 35% of the United States’ $16.8T economy is affected by weather. For the agricultural industry, this equates to $150B of economic value that is affected by climate variations every year. Weather events and cycles drive commodity prices, input costs, profitability, and largely determine the financial health of the industry over time. Seasonal weather events can greatly impair the industry’s financial stability, and longer term adverse weather cycles can threaten the existence of industry participants.

A wet spring can cause significant issues for growers, preventing planting during critical windows and altering the local crop mix and yield potential as producers must substitute shorter-season corn varieties or switch to soybeans altogether. A wet planting season creates a number of problems for an ethanol plant that depends on local corn supply to support margins and profitability including:

‐ Higher local prices and basis as a result of the local crop shortage
‐ Greater freight expenses as draw areas must expand to accommodate production needs, and
‐ Shrinking margins as a consequence of higher input costs.

Using the Southwestern region of Ohio, we performed an analysis of the long-term implications of increasingly wet cycles during critical planting windows and the resulting decline in harvested corn acres. The percentage of Average Rainfall and percentage of Average Harvested Acres for the period 1950 – 2013 are plotted in Figure 2 on the following page.

The trend of increasing average rainfall and escalating volatility of moisture during this period is evident from the chart, and the corresponding decline in corn Harvested Acres is also clear, showing the detrimental effects of a wet planting season for an ethanol plant that relies on local corn production to meet revenue and margin targets.

The eWeatherRisk Solution

We collaborated with our Greenville, Ohio-based ethanol client to design a weather contract that mitigated the financial impacts of a wet spring planting season. By incorporating the expected lost number of corn acres in a wetter than average spring, and the resulting increase in local prices, basis and transportation expenses, and decline in margins, our client determined the total financial loss scenario would amount to $2,000,000. The chosen contract parameters and the contract’s Payment Profile are shown below:

The 2011 spring planting season was one of the wettest in history in the Southwestern Ohio region with total precipitation amounting to 20.40” between April 1st and June 15th. Based on the contract’s chosen parameters, this resulted in a $1,930,000 payment to the ethanol plant! The payment on the weather contract offset the higher local prices, basis and transportation expenses, ultimately protecting the ethanol plant’s operating margins for the current year.

The Weather Risk Problem

The U.S. Department of Commerce estimates approximately 35% of the United States’ $16.8T economy is affected by weather. For electric utilities, variability in seasonal temperature patterns can create substantial volatility in electricity demand, power prices, and resulting revenues and income. Utilities are heavily regulated and highly leveraged, creating a narrow band of profit opportunity each year. Since summer cooling demand accounts for about 30% of all yearly revenues, utilities are greatly exposed to cool summer risk. The summer of 2009 marked the coolest summer since 1992 in the upper Midwest, and many utilities’ earnings were impacted as a result of weakened demand. According to U.S. Energy Information Agency (EIA) data, Commonwealth Edison, a large electric utility serving Chicago and the surrounding suburbs, averaged only $108 in per-customer revenues in 2009; a figured that jumped over 17% to $130 in 2012. The financial impact of the cool summer was not localized to just the Chicago area either. Per-customer revenues for all of Illinois, Iowa, Minnesota and Wisconsin were only $157 in 2009 as compared to $194 in 2012. In looking to weather for the answer, we see that temperatures in those two years were drastically different. In 2009, temperatures were up to five degrees below normal, while in 2012, temperatures were as much as three to four degree above normal. As we saw in the relative per-customer revenues between the two years, the hot weather increased per-customer revenues by 24% in 2012 over 2009. Cooler weather clearly weakens consumption and revenues, but the adverse financial effects of a cool summer can be mitigated by consistently applying a sound weather risk management program.

The eWeatherRisk Solution

Utilizing eWeatherRisk’s solutions, our Chicago, IL-based client designed a weather contract to mitigate the financial impacts of a cool summer. By comparing revenues during an average summer relative to those generated in a cool summer, the revenue impact was estimated at $50,000,000. Between June and August of 2009, only 488 CDD’s were accumulated. Based on the contract’s parameters, this resulted in a payout of over $20M! The weather contract effectively offset the lost revenues from power consumption during the cool summer, and provided an earnings floor for the current year.

The Weather Risk Problem

Cities, towns and municipalities prepare for upcoming winters by budgeting for annual snow and ice management costs early in the fall. In developing budgets, state and local departments will look to the recent past and compare weather and corresponding financial data to determine the appropriation of funds for the upcoming winter. Although historical expenses can serve as a reasonable baseline for allocating spending, the random and unpredictable nature of weather can cause actual outcomes to vary widely from historical experience, exhausting even the most conservative budgets very quickly. The winter of 2013-2014 devastated an enormous number of cities, towns and municipalities as the relentless cold and persistent snowfall necessitated continual salting and snow removal. By early 2014, as spot prices of salt soared and fuel consumption skyrocketed, city managers had already consumed much of their financial resources and could see the accumulation of huge deficits for the balance of the winter.

The eWeatherRisk Solution

Utilizing eWeatherRisk’s solutions, our Cleveland, OH-based client utilized our extensive network of weather stations and data to design and incorporate a weather hedge into their planning process to mitigate the expense overruns of an above-normal number of ice events during the winter months. Based on current cost estimates for salt and de-icing applications, snow hauling costs, and labor per man hour, the client’s budget allowed for cost coverage of up to 24 ice events. As a result, our client chose a per-ice-event payment of $62,500 which would cover all excess ice management costs after the 24th ice event.

The Weather Risk Problem

The U.S. Department of Commerce estimates approximately 35% of the United States’ $16.8T economy is affected by weather. For companies that rely on river transportation, varying weather patterns can intensify operational difficulties by affecting river levels, increasing the number of rain or fog delays, or progressing ice extent beyond navigable levels. Weather risk is not isolated to certain industry participants or specific geographic regions either. In the Gulf region, hurricane season subjects companies to revenue loss, business interruptions and equipment and facilities damage as a result of weather events. In the northern Midwest, river ice forces the upper Mississippi to close annually from approximately mid-December to mid-March and icy river shutdowns can extend much further south, hampering navigability. High or low river levels caused by intensive rainfall or flash droughts can be experienced almost anywhere and can necessitate lock closures and affect towboat speeds, tow sizes and loading drafts. Terminals may also experience operational interruptions as a consequence of unfavorable weather or river conditions. Furthermore, a weather-driven heat or drought event can reduce the volume of grain produced and harvested, and impact harvest timing and shipping pricing. In the event of a diminished harvest, demand for barging services will likely decrease and companies could experience a decline in revenues.

The eWeatherRisk Solution

Utilizing eWeatherRisk’s solutions, we collaborated with our St. Louis, Missouri-based barge company client and designed a weather contract to mitigate the price, revenue and expense volatility resulting from a low river stage. Using a river height hedge at the Memphis gauge, and setting the weekly payment caps equal to the total cost of diverting to rail and ground transport in the event of an insufficient river stage, the total financial loss scenario was estimated to be $10M.

The Weather Risk Problem

The U.S. Department of Commerce estimates approximately 35% of the United States’ $16.8T economy is affected by weather. For construction firms, outdoor projects are inherently exposed to weather risk which, when managed improperly, can reduce or eliminate project profitability. Contingency budgeting and planning can provide a financial cushion against adverse weather events, but precisely forecasting the random and unpredictable nature of weather is nearly impossible and companies often lack the necessary knowledge and resources to develop accurate forecasts. Instead, builders must resort to making conservative assumptions regarding weather-related losses which may be wildly inappropriate and layer in enough additional cost to render proposals uncompetitive during the bidding process. Once a project has begun, the operational adversity weather creates is a critical focus. Abnormally cold temperatures can increase machinery maintenance and operational costs, while warmer weather can slow workforce productivity. Rain, wind, and snow are just a few of the many other weather considerations that can temporarily suspend certain disciplines’ activities or shut down an entire project completely. Multiple weather events impacting a project during its tenure can result in added delays, liquidated damages, poor project outcomes, and damaged reputations.

The eWeatherRisk Solution

Utilizing eWeatherRisk’s solutions, we collaborated with our New York-based construction services client and designed a weather contract to mitigate the financial impacts of a rainy project period. By incorporating the total value of the project, total cost per working day, and total variable cost per working day, the total financial loss scenario was estimated to be $1.5M. The structure was designed to provide a payment to offset the daily fixed and variable costs of the project if a daily rainfall event occurred. A rainy day was defined as any 24-hour precipitation total equal to or greater than 3.00”. Our client chose a per-event payment which would cover their total fixed and variable cost for each rainy day.