Weather derivatives…how a potential gold mine entered the deep freeze

Weather derivatives are financial instruments that can be used to reduce the risk associated with adverse or unexpected weather conditions. These exotic instruments have been around for over 25 years, and allow investors to hedge against damage caused by rain, extreme temperatures or snowfall…

But by 2013, the market in exchange traded snowfall derivatives in particular, had all but ground to a halt.  What happened?

In theory, the market for snow-related weather derivatives should be huge. Snowstorms affect a lot of businesses, and you often hear about significant financial damage caused by blizzards. Typically, the contracts are priced based on the expected inches of snow in a particular time period in a given city.  If accumulation is greater than the set amount, the seller of the derivative has to payout. But if the snowfall is less than that figure, the contract will expire worthless.

So why the lack of interest? Partly due to the lack of snow in recent years – companies generally want to protect themselves against too much snow rather than too little (large ski resorts never took an interest, perhaps because they pre-sell season tickets).

Also, Wall Street made a killing in the winter of 2011-12, which saw a record lack of snow across the US.  Since then, buyers of the contracts, who lost money on the insurance, have failed to come back.

In general, the markets for more esoteric derivatives have dried up since the financial crisis of 2008.  And, given the effects of climate change, the number of people expecting record snowfalls is rapidly shrinking.

And that’s how a potential gold mine entered the deep freeze.

More Lighterside articles written by Pamela Hellig.

Pamela Hellig
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