Weather futures buoyed by energy costs
By Kate Gibson, CBS MarketWatch.com
Last Update: 4:01 AM ET Dec. 24, 2004
E-mail it | Print | Alert | Reprint | RSS
CHICAGO (CBS.MW) - While a record number of weather futures contracts were traded at the Chicago Mercantile Exchange last Friday, the increasing volume has little to do with the winter blast now paralyzing parts of the Midwest and southern United States.
"We know winter is cold. It's when we depart from the expectation" that participants are drawn into the market, said Scott Matthews, president of WeatherEX, a brokerage and trading firm outside New York.
Rather, price fluctuations in the energy markets during the past two months are credited as a major driver for the expanded interest in the contracts launched by the CME in 1999.
The contracts let companies hedge their risk by offering them an alternative revenue source when weather harms their business. For instance, a supplier of heating oil could bet on warm weather in a specific city, offsetting a potential loss in demand should the warm weather come into play.
The contracts are based on heating degree days and cooling degree days, in effect how much the temperature in a given location varies from 65 degrees Fahrenheit over a given period. They are available for 20 cities in the U.S., Europe and Japan.
"We're getting a lot of cross-trading between energy traders... using weather to gauge where energy prices can go," said Allan Schoenberg, an exchange spokesman.
Matthews likens the fledging weather futures market to the once lackluster trade in natural gas.
When the New York Mercantile Exchange launched natural gas futures about 14 years ago, "nobody traded it; there was a little (trading) pit at NYMEX with wooden railing, people would meet for lunch there, drape their coats on it and lean on it like a bar," said Matthews. "Then when the hurricane hit oil rigs in the Gulf, all of a sudden phones were ringing off the hook, with people saying I've got to buy some gas."
Buyers and sellers of electricity and natural gas are the primary participants in the weather futures market, the demand for which came about as a result of industry deregulation, Matthews said.
Before deregulation, if a utility had to spend more on fuel, it passed the added expense onto its customers in the form of a rate hike. "If they saved a lot because it was warm in the winter, then regulators in each state made them lower the rate," Matthews said.
The contracts are essentially a hedge. Those who have a gas or power position in the market can place a counter bet on their risk. And, in the past few years, banks, insurance companies, natural gas day traders and speculators have joined the mix.
On Dec. 17, 4,350 weather futures contracts traded at the CME, a daily record. "4,300 is not a eurodollar contract," said the CME's Schoenberg, comparing the weather trade to the popular interest rate contract that had a daily volume of 1.82 million contracts traded in August.
Kate Gibson is a staff writer for CBS MarketWatch based in Chicago. |
