Published Tuesday, August 26, 2003 in the San Jose Mercury News

Weather Forecasting Can be an Economic Tool

Weather Corner
by Jan Null
Special to the San Jose Mercury


Forget pork bellies and soybean futures. Have your broker get you a trainload of heating degree days!

The Chicago Mercantile Exchange now deals in weather futures and options. Also called weather derivatives, these economic instruments allow companies to hedge their bets against adverse weather. Weather derivatives and other types of weather insurance are also available on the open market.

According to the CME, approximately 20 percent of the U.S. economy is directly affected by the weather, and about 70 percent faces some risk due to weather factors. Originally developed in the 1990s by the energy industry as a hedge against weather conditions that were too hot or too cold, the use of such weather-related financial instruments has continued to grow into other parts of the economy.

The CME uses heating degree days and cooling degree days as a measure of the impact of temperatures. Heating degree days and cooling degree days represent whether the average daily temperature is above or below 65 degrees. When the average temperature is above 65 degrees, cooling degree days accumulate because presumably energy would be used for cooling. The converse is true with heating degree days.

For example, a Sierra ski resort might get a contract that would pay out if there was insufficient snow for skiing during a given winter. They would pay a non-refundable premium, and if the snowfall was less than the designated level, called the ``strike point,'' the resort would be paid a set amount for each inch below the strike point. If the snowfall was above the strike point there would be no payout, but presumably a profit would be achieved by having lots of snow. The bottom line is that the resort could protect against a dry year and stabilize profits and losses.

There are a variety of ways that weather derivatives can be implemented. For example, a local energy company might insure against either extreme hot and cold weather. Oil companies with drilling platforms in the Gulf of Mexico might fund a weather derivative based on whether a hurricane will hurt their operations.

Financial instruments like weather derivatives address primarily seasonal weather variability. It is also possible to purchase weather insurance to cover a particular day or days. In this case, you would protect yourself from a loss of revenue caused by a specific weather event.

For example, the promoters of an outdoor art festival or sporting event might buy insurance that would pay off if rain cancels the event. The premium may cost more if you protect against just a light rain, and less if only a heavy and less likely storm occurs.

Even though the saying, ``Everyone talks about the weather, but no one does anything about it,'' remains true, companies can now protect themselves against the vagaries of nature.

Q How far north has a hurricane traveled in the United States? Clark Hagman - Menlo Park

A Hurricanes have moved along the East Coast as far north as Maine, or to a latitude of about 45 degrees north. This is about the same latitude as Portland, Ore., but there is a key difference between the east and west coasts.

On the East Coast, the hurricanes derive much of their strength from the 75- to 85-degree waters of the northward-flowing Gulf Stream. Along the West Coast, the ocean currents come from the north, with 55- to 65-degree waters, a condition not favorable for hurricanes.

The closest a hurricane came to California was in 1939 when a tropical storm struck the Long Beach area with winds of 40 to 60 mph. This storm -- they were not given names in 1939 -- was responsible for 45 deaths and extensive damage.

As hurricanes in the eastern Pacific dissipate, their moisture may spread northward into California and result in thunderstorms, heavy rain and flooding. Flooding from Hurricane Kathleen in September 1976 caused $65 million in damage to California's agriculture industry.
 
Jan Null, founder of Golden Gate Weather Services, is a retired lead forecaster with the National Weather Service. Send questions to him c/o Weather Corner, San Jose Mercury News, 750 Ridder Park Drive, San Jose, Calif. 95190. You also can telephone questions at (510) 657-2246, fax them to (510) 315-3015 or e-mail them to weathercorner@ggweather.com or fill out a form online at http://ggweather.com/questions.htm