As unpredictable weather patterns become more common, businesses are turning to financial products called weather derivatives to manage risks associated with temperature fluctuations, rainfall, and other meteorological events. Unlike traditional catastrophe bonds, weather derivatives offer protection from less severe but more frequent weather changes, helping companies stabilize revenue streams and mitigate losses.
As the world’s climate becomes increasingly volatile, businesses that depend on predictable weather are turning to financial products that compensate them when there’s a heat wave, a drought or an unusually persistent bout of rain.
Many businesses that purchase weather derivatives use them to stabilise revenue streams that would otherwise be more erratic due to fluctuating weather.Some contracts focused on temperature are listed on the Chicago Mercantile Exchange . Using so-called heating degree days and cooling degree days as parameters, they pay out when temperatures deviate from daily averages against an 18C baseline.
Demand for weather derivatives is soaring, with average trading volumes for listed products jumping more than 260 per cent in 2023, according to the CME Group. The number of listed weather derivative contracts that year was 48 per cent higher than the previous May. They took off more recently as weather became more unpredictable and businesses were forced to find new ways to track related risks. Part of the impulse for this has come from their own investors, who leaned on companies to disclose their climate-related risk exposure and make plans to address it.
Weather derivatives first emerged in the US and are now expanding rapidly across the developed world, especially in energy and agriculture. Other industries are also getting involved. For example, the New York City Metropolitan Transportation Authority has reportedly used them to hedge the risk of colder winters that could disrupt mass transit services.
Climate Change Weather Derivatives Financial Risk Management Business Adaptation Agriculture Energy Tourism
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