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German utility to trade weather derivatives

As a hedge against the uncertainty of the weather, German utility, Bewag is to offer its trading partners a weather-based derivative product. Bewag has hedged itself against a warm winter in order to manage this risk more effectively.

“Approximately 30 per cent of the German economic activity depends directly or indirectly on weather. This shows the importance of weather derivatives as a risk management tool. This is especially true in the utility industry. Therefore, Bewag will offer this innovative product to his business partners”, explained Anders Hedenstedt, board member in charge of generation and sales.

Weather derivatives are usually traded between two companies. The goal is to hedge the firm against a potential decline in revenues due to unfavorable weather conditions. Bewag has hedged itself against a warm winter. Using mostly heat driven Combined Cycle Power Plants to generate electricity, the company’s electricity generation depends on the production of district heating. In the event of a warm winter, the company would be selling less district heating and in consequence, less electricity can be generated. Therefore, in this situation, it has to buy the difference on the spot market for a much higher price. At the same time, Bewag would have a decline in revenues due to declining sales in district heating.

Bewag’s first derivative was for a four month period and covered the group’s power plants Mitte and Klingenberg. The average temperature during December to March was 2.2௿½C compared with the year before, when it had been 3.4௿½C. As a result, electricity generation was up 100 kWh. Consequently revenues from electricity and district heating were also up and therefore no payment was due under the derivative.

Weather derivatives have been existing for five years now. During this period, more than 2000 contracts have been signed involving over $6bn in risk transfer. In most cases it is temperature deviations that are hedged although companies can also hedge against rain, snow and storms.