Weathering Derivatives

Posted: Monday, Jul 28, 2003 at 0000 hrs IST
Updated: Monday, Jul 28, 2003 at 0000 hrs IST

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: From ice-cream makers and airlines to oil companies and energy traders, all businesses whose bottomline can be affected by the changing rainfall and temperature conditions are turning to weather derivatives to hedge their bets and guard against losses. What started as a hedge-tool for gas suppliers sometime in 1999 has developed into one of the fastest growing markets in the world and trebled in trading volumes in the last year. It is estimated that around $4.2 billion worth of weather derivative contracts were logged in the 12-month period preceding April 2003. Weather can negatively impact corporate revenues, increase inventory costs or cause volatility in input prices and weather derivatives provide a hedge against any such losses. And the Indian economy, which remains heavily dependent on weather, badly needs the shelters made possible by hedging risks through weather derivatives. They will help farmers and companies reduce income volatility caused by unforeseen weather conditions. The National Commodities and Derivatives Exchange Ltd (NCDEX), which has recently kicked off its membership drive and will start operations in October plans to offer weather derivative products for trading. NCDEX hopes to start out with two trading products — a rainfall index and a weather futures product. However, it hopes to stabilise its commodities trading business before launching these innovations sometime in early 2004. Weather derivatives markets abroad run parallel to weather insurance policies, which also offer a hedge against nature’s unforeseen tricks and actions. The last few months have seen two banks —- ABN Amro Bank and ICICI Bank (which is one of NCDEX’s promoters) — launch such weather insurance policies.

Weather insurance is different from the regular insurance products that cover the risk of natural catastrophes — it falls under the new head of non-catastrophic risk cover. Some markets even allow investors to convert insurance policies into a derivative product through a transformer. Together, the insurance and derivatives markets ensure a supply- demand balance in the market. The users of weather derivatives around the world include electricity and utility companies, agriculturists and farmers, the construction industry (which can be affected by weather related delays), offshore operations, soft drink manufacturers, transport and tourism related businesses and large retailers whose inventories could go awry due to unexpected weather conditions. In India, one expects that large corporates, especially food and commodities companies, that depend on any type of agricultural inputs will grab the opportunity provided by the derivatives market...

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