And in the green environment, renewable energy sources-hydropower, wind and solar, and even biofuels-carry weather risk. A $200 million wind farm in New Brunswick, Canada, with enough capacity to power 20,000 homes could suffer a loss if its turbines freeze one winter. With biofuels, companies face weather risk involving crops: The weather could be too hot, too cold, not rainy enough or so rainy it causes flooding.
More and more tsunamis, earthquakes, floods and hurricanes are damaging homes, mines and farmland. In Thailand recently, flooding closed down scores of factories and wreaked havoc with companies' supply lines. How much economic growth can be wiped away because of volatile weather?
It's one thing to see bad weather as an inconvenience. But in the business world, Mother Nature's impact is measured in dollars and cents, sometimes big dollars. Just look at what happened last winter when businesses were pummeled by weather.
Indeed, rising demand for protection from such events is propelling more businesses today to respond proactively by using weather risk-management tools-futures contracts, customized over-the-counter derivatives and reinsurance-to protect their bottom line against weather hazards. The insurance industry is embracing these derivatives, and other market players like hedge funds are climbing aboard.
The economic impact of weather is estimated to be $485 billion annually, according to a recent study in the Bulletin of the American Meteorological Society. According to Bill Windle, president of the Weather Risk Management Association (WRMA) and managing director of Woodlands, Texas-based RenRe Energy Advisors Ltd., weather risk is just as important a factor in business revenues and bottom lines as interest rates, exchange rates or other risks. And in some cases, more so, he says: Think Hurricane Katrina or Irene.
"Very few companies would fail to manage their interest rate or foreign-exchange risk," says Windle. "Why would they not focus on the weather?"
"Although it would be challenging for retail investors to buy these products themselves, financial advisors should be aware of their use because many companies that comprise the portfolios of their clients are exposed to the weather, and it's important to understand if and how they are managing this exposure," says Marty Malinow, the CEO of Galileo Weather Risk Management Advisors in New York and a former president of WRMA.
For advisors, the best way to be involved and protect clients is to evaluate companies for their exposure to weather risk and make sure they are doing enough to insure against it. You can determine how weather affects the bottom lines of these companies in their annual reports and other SEC documents.
"When you're evaluating companies, you want to take into consideration their full risk exposure, which may include their weather risk exposure, and what methods or products they're using to mitigate that risk," says Lauren Newberry, the WRMA's executive director.
Companies use such products when catastrophic insurance policies don't cover losses from certain kinds of weather, such as hurricanes, earthquakes, volcanic eruptions and fires caused by drought.
Some companies are even making weather risk part of their marketing. CelsiusPro AG, a weather risk management firm, and Switzerland camera maker Nikon recently hatched a promotion using rainfall data to offer camera buyers in Switzerland a refund for certain periods when the weather turns bad.
Weather risk management tools came into use in the late 1990s. Energy companies and utilities were early adopters and remain major users. Now, forward-looking companies in other sectors such as retail, construction, agriculture, transportation and leisure are also increasingly taking up the cudgel against Mother Nature's furies, using derivatives and recording the results for the shareholders' benefit.
For example, Washington Gas Energy, a subsidiary of WGL Holdings in Washington, D.C., derives a significant portion of its revenues from natural gas it delivers to residential and commercial heating customers during the winter heating season. According to its annual reports, the company received more in payments from weather derivatives than what it spent in premiums in two of the last three years. During fiscal 2008, it received a benefit of $4.6 million (pretax) from its weather insurance (against a cost of $3.4 million in premiums) after facing warmer-than-normal weather, and in fiscal 2010, Washington Gas made $1.3 million over and above what it paid out in premiums.
Meanwhile, Alliant Energy Corp., a public utility holding company based in Madison, Wis., showed in its fiscal 2010 annual report an estimated $1.38 per share of higher revenues "from changes in sales due to weather and impacts of 2009 hedges."