Weather Risk Management Association 2006 India Meeting

1
Weather Risk Management Association 2006 India
Meeting

• A Global Perspective on Weather Risk Management
• Brian OHearne, Managing Director, Environmental
  and Commodity Markets, Swiss Re Capital
  Management and Advisory
• Past President, Weather Risk Management
  Association
• February 26, 2007

2
Weather Risk Management Association 2006 India
Meeting

• A Global Perspective on Weather Risk Management
• Brian OHearne, Managing Director, Environmental
  and Commodity Markets, Swiss Re Capital
  Management and Advisory
• Past President, Weather Risk Management
  Association
• February 26, 2007

3
Implications of global warming on the weather and
commodity markets

• Weathers Impact. Companies have profits/costs
  that are weather dependent and achieving
  predictability is nearly impossible due to
  weathers chaotic and increasingly volatile
  nature.
• Despite its magnitude, there is little that can
  be done to eliminate weather risk. Climate is
  what you expect, weather is what you get--
• Weather cant be avoided
• Weather cant be prevented from occurring
• Weather risk cant be segregated or isolated.
• Until recently, companies typically retained
  their weather risk, or attempted to hedge with
  traditional financial or commodity products,
  often not meeting desired results. As weather
  and commodity prices have become more volatile,
  this is an increasingly risky proposition. With
  the introduction of weather-based instruments, a
  better alternative is available.

4
Weather VolatilityObserved global warming
Northern hemisphere
Deviation of annual mean temperatures (C) from
the average of the period 1961 1990
Data from temperature gauge values (red) and from
annual rings on trees, corals, ice and historical
recordings (blue).
Source IPCC 2001
5
Atmospheric CO2 increase
Source IPCC 2001
6
Weather Definition and Value Proposition

• Contracts cover weather-related uncertainty in
  demand/supply volume and related cash flows
  (sales income and/or costs) on time scales of
  months to years.

• Advantages
• Decreased volatility allows a more
  efficient use of equity
• Stakeholders (i.e. government, investors,
  financial markets) honor more predictable cash
  flows by increasing the market value of a company
• Potential for lower debt costs and higher advance
  rates

7
Total Notional Value of weather risk contracts
2000/1-2005/6(in millions of U.S. dollars)Price
Waterhouse Coopers market survey
45,244
9,697
4,709
4,339
4,188
2,517
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Market Scale
Results

• The total value of trades in the 2005/6 PWC
  survey ending March 31, 2005, reached 45
  billion, compared to 9.7 billion in the 2003/4
  survey
• CME experienced significant increases in both the
  number of trades and the value of those trades
• Most of the growth in the number of trades was
  for contracts based on North American weather
  measure due to strong pairing of weather and
  commodity trading and structures
• HDD remains most common type of trade, but larger
  share of market now traded on CME, both due to
  credit clearing mechanism as well as trading in
  conjunction with commodities

9
Chicago Mercantile Exchange Initiatives

• CME is helping to drive weather market growth
• Temperature contracts in the US trade in
  conjunction with energy as well as agriculture
• CME provides price transparency, liquidity and
  creditworthiness (TLC) through its clearing
  platform for its weather contracts
• CME and NYMEX
• CME electronic listing/trading of NYMEX energy
  with cross margining to weather
• CME and potential CBOT merger
• Tremendous opportunity between weather and
  agricultural contracts

10
Weather Risk Management Is

• Financial protection from weather conditions that
  adversely affect earnings.
• Protection from volumetric risk.
• Solutions designed to absorb exact portion of
  weather exposure, leaving a residual risk that is
  commensurate with risk tolerance with strikes at
  or away from the mean.
• Techniques combined with price risk management
  tools to provide complete risk management
  solutions and mitigate basis risk.

11
Commonly traded weather indices

• Degree Days (HDDs, CDDs, Customized such as
  growing degrees).
• Temperature (Max, Min, Events). Increasingly
  popular and great traction in Japan in
  particular.
• Precipitation/Streamflow (Inches, Events).
  Hydroelectric concern low precip, water and
  construction companies concern high
• Wind. Wind direction, windspeed coverage for
  outdoor events, fruit drop
• Weather linked notes and bonds. Is it time for
  more issuances?
• Combinations (Custom Index such as frost days,
  Quanto, Multiple Trigger).
• Load Yield Products
• Electricity Demand Products (e.g. PJM demand
  swap)
• Agricultural Yield Products (e.g. Grain Yield)

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Structures

• Contracts - Swaps, Calls, Puts, Collars, Exotics,
  Baskets, etc.
• Term Monthly, Seasonal, Multi-Year, etc.
• Limits Most transactions capped to create
  finite exposures.
• Hybrids Weather-linked financings,
  securitizations.
• Various instrument forms derivative, insurance,
  reinsurance.

13
Benefits of risk management ...

• Industries as diverse as energy, manufacturing,
  entertainment, banking, agriculture, insurance
  and retail are using weather risk management
  instruments to

• Trade as well as hedge commodity exposurehuge
  growth area in the US.
• Compensate for loss of product demand, primary
  utility risk
• Cover increased operational costsinterest from
  landlords, universities in increased
  heating/cooling volumes/costs
• Reimburse lost opportunity costs
• Drive sales through marketing effortsrebate
  programs such as seed
• Diversify investment portfolios, good
  non-correlated returns
• Protect crop yields and crop handling revenues

14
Global Weather Markets

• US and Western European Markets
• Primarily Energy but also construction
• Increasing Demand from Asia-Pacific
• Japan, Australia, Taiwan, Korea
• Non standard indices/products
• Developing markets
• Significant agricultural scope
• India, South Africa, Latin America
• World Bank/IMF promoting concept

15
Weather and Commodity Trading Opportunities

• The weather, energy and emissions markets are
  growing rapidly. Agricultural markets have
  always been weather sensitive.
• Weather drives price action in the energy markets
  from the demand (cooler or warmer heating/cooling
  seasons) and supply sides (hurricane damage in US
  producing region) and in the agricultural markets
  from the supply side.
• Creates additional liquidity and transparency for
  weather market with great depth of established
  commodity markets.
• Energy and agricultural markets have key weather
  sensitivities heat, cold, drought, storm
  tracks,.

16
Weather Impacts on Energy Trading

• Supply
• Relatively stable in the short term
• Unexpected weather events such as Hurricanes or
  other natural/terrorism disasters can disrupt
  supply
• Increased supply in long term through capital
  investments
• Demand
• Domestic and Global Economic Productivity
• Weather
• Expect volatility in energy commodity markets to
  continue

17
Adelaide AustraliaPower prices/daily max C temp
18
Situation in the agricultural sector

• Farmers and the agricultural industry face
  financial risk from yield variability due to
  weather mainly drought.
• Many farmers depend upon pre-financing against
  their future revenue streams for seed,
  fertilizer, and other agro chemical products.
• Food processing companies need to purchase
  commodities on spot markets in case of a bad
  harvest.
• Agro chemical companies are exposed to
  weather-related fluctuations in the demand for
  their products services additionally they are
  exposed to the farmers credit risk.
• Weather is a good predictor of crop yields and
  prices

19
Crop Yield

• Crop Yield is highly dependent on weather
  conditions
• Depending on the stage of development the weather
  interaction with the crop expected yield varies
• Winter wheat requires approx. 150 days of growing
  conditions. Stages
• Planting and Emergence In September. Requires 4
  to 8 weeks.
• Dormancy During the winter, plant stops growing
  at temperatures below 50F.
• Re-emergence Active growth, development of
  tillars, skillets, kernel.
• Filling Kernel growth
• Harvest

20
Crop Yield Environmental Relationships
21
Temperature and Yield Relationship (source
National Weather Service and National
Agricultural Statistical Service)
22
Importance of Agriculture

• India sustains 16 of the worlds population on
  small percentage of land resource
• Agriculture contributes approx 1/4 of the Indian
  GDP
• Livelihood support to two-thirds of the
  population
• Employment to more than 1/2 of work force
• Single largest private sector occupation
• Raw material source to large number of industries
  (textiles, silk, sugar, rice, flour mills, etc)
• Any change in this sector has a multiplier effect
  on the economy

23
Weather Risk Management Association

• 60 members in 14 countries
• Regular, associate and end user membership
  classes
• Devoted to
• standardizing documentation and regulation
• Promoting awareness
• www.wrma.org
• Regional committees and meetings

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In Conclusion ...

• The volatility and interdependence of weather,
  commodity and emissions prices is increasing and
  their interdependence creates new trading and
  risk management opportunities. Unpredictable
  weather no longer means unmanageable risks.

• Weather, like natural gas or corn, is a commodity
  and can be managed via an increasingly robust
  market
• Interdependence and increased liquidity of
  weather market creates new trading opportunities
  in both weather and commodity markets
• Structures only limited by creativity (i.e.
  mitigate warm winter exposure through sale of
  calls monetize inherent long position)
• A portfolio, or layering, approach (long-term,
  mid-term, spot) to risk management may provide
  advantages, already actively practiced by some
  utilities such as Centrica/Accord

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In Conclusion ...
By managing volumetric and price exposure,
companies can continue to focus on delivering
shareholder value via

• Focusing on core businesses
• Continued savings initiatives and earnings
  improvements
• Further strengthening of the balance sheet
• Maintenance of adequate liquidity via improved
  and predictable cash flow.

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Contact Information

• For additional information, please contact
• Swiss Re Capital Management and Advisory
• 55 East 52nd Street
• New York, NY 10055
• Brian OHearne, 212-317-5516
• Managing Director-Environmental and Commodity
  Markets
• Brian_Ohearne_at_swissre.com

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Disclaimer

• Unless otherwise agreed in writing, Swiss Re
  Capital Management and Advisory and its
  affiliates act solely in the capacity of an arm's
  length contractual counterparty and not as an
  adviser or fiduciary. Accordingly, you should
  not regard transaction proposals or other written
  or oral communications from us as a
  recommendation or advice that a transaction is
  appropriate for you or meets your financial
  objectives. Any financial transaction involves a
  variety of potentially significant risks and
  issues. Before entering into any financial
  transaction, you should ensure that you fully
  understand the terms, have evaluated the risks
  and determined that the transaction is
  appropriate for you in all respects. If you
  believe that you need assistance, you should
  consult appropriate advisers before entering into
  the transaction. This material does not
  constitute an offer to enter into any
  transaction. Such material is believed by us to
  be reliable, but we make no representation as to
  its accuracy or completeness. This brief
  statement does not purport to describe all of the
  risks associated with financial transactions and
  should not be construed as advice to you.