| Hedging The Weather |
| Wednesday, 03 June 2009 19:33 | |||
 Minneapolis, Minnesota, June 2009 – Weather risk creates uncertainty in financial margins and earnings caused by the effects of weather on crop yields. Lower than normal precipitation in a growing area reduces potential yield of a given crop. The lack of a direct correlation between commodity prices and weather indices makes it virtually impossible to manage weather risk with a crop price based hedge, such as the CBOT futures contract.
Weather is unpredictable and unique, so learning to manage it in any way possible is a definite help. Weather risk management has special attributes that set it apart from normal commodity price risk management and other sources of risk. There are no physical markets for weather; it is localized and can vary township to township, section to section. Weather is entirely out of human control and often difficult to predict with any great degree of accuracy. It cannot be influenced by outside money, manipulated by outside influence, and is not at the mercy of what the FED or Government are doing to repair the current economic situation. To fight these uncertainties, Weather based risk management can help provide stability to cash flows in the event of adverse weather that impacts your company’s bottom line. History has proven that you cannot forecast weather more than a few days out with enough precision to know the exact impact it will have on your company. However, a weather hedge can help protect from abnormal weather events. This financial risk management tool is available on the Over the Counter (OTC) marketplace thru FCStone Trading. This makes it possible to derive financial risk management tools based on localized weather statistics and outcomes specific to the individual’s risk. This financially transfers weather risk to counterparties in a better position to manage it. The OTC marketplace offers an extremely diverse and effective toolbox for both commodity producers and consumers alike to hedge their exposure. These tools are highly customizable and can be tailored to specific volatility profiles caused by weather events – for example, an early frost or lower than average growing degree days. Weather hedging is reliable and the data for weather indices accurate, collected daily by the National Weather Service. The cost of weather hedging is low and is variant upon the parameters set in the structure with payments based on weather performance in a given area. Weather hedging is fairly straightforward; if the parameters are not met you are simply out the premium paid for the weather structure. In contrary, if there is a payout, there is no claims process or proof of loss as it cash settles based on the parameters within the structure. Here’s an example: ABC Specialty Food Company typically handles 500,000 bushels of sweet peas. Given the weather conditions over the course of the growing season, the rainfall total was below average for that specific growing region and the producer’s yields drastically reduced. Although each producer has his own crop insurance, this product is designed to supplement their existing crop insurance, allowing the producer to buy up coverage mid-season based on conditions. It also allows ABC Specialty Food Company to help protect against rising costs due to decreased supply, ultimately enhancing available margins. From the event of inadequate rainfall, ABC Specialty Food Company handled 450,000 bushels, a near 10% reduction in available supply. Through weather hedging, a program can be tailored to help minimize and transfer the risk of volume loss to a willing counterparty. ABC Specialty Food Company would be paid according to the parameters set within the weather structure to offset the decrease in volume handled. Other Examples: • Protect against excessive/lack of rainfall for a specific time period • Seasonal Coverage on Heating Degree Days (HDD)/ Growing Degree Days (GDD) • Cover increases in energy usage caused by warm summers and cold winters • Hedge lost event revenues due to poor weather conditions These strategy examples can be tailored to help an individual’s needs as situations vary. When this risk management tool is used correctly, it allows the manager or merchandiser to reduce risk and protect and widen margins. The key to remain competitive in today’s marketplace is knowing how to use this tool to protect and/ or enhance margins from a weather scare. Weather hedging is a unique twist on risk management and the managers who understand their weather risk can differentiate themselves in a very competitive industry. Weather OTC products are still relatively new. Though weather is unpredictable, never before has there been a wider variety of economical and effective tools available to hedge weather risk. FCStone cannot change the outcome of weather, but we can help change the financial outcome that is influenced by detrimental weather. From large multi-billion dollar operations, to the individual producer, the tools and strategies to hedge weather risk are similar and the goal remains the same, to provide stabilization to budgets and cash flows. FCStone Trading, LLC, along with its affiliates form an integrated commodity risk management organization providing risk management consulting and transaction execution services to commercial commodity intermediaries, end-users and producers. The firms assist primarily middle market customers in optimizing their profit margins and mitigating exposure to commodity price risk. In addition to risk management consulting services, FCStone, LLC, operates one of the leading independent clearing and execution platforms for exchange-traded futures and options contacts. The FCStone companies work in all the major commodity areas including agriculture, energy, renewable fuels, foods, forestry, cotton and textile, dairy and currency exchange. Headquartered in the Midwest, FCStone has offices located throughout the world. The company is a clearing member of all major North American Futures exchanges. For more information, contact Matt Ammermann at This e-mail address is being protected from spambots. You need JavaScript enabled to view it at 952.852.2905. SOURCE: Matt Ammermann; FCStone Trading, LLC
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