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Weather derivatives

26 energy risk energyrisk.com

Every cloud...

The weather derivatives market continues to gain end-user, hedge

fund and investor interest. Roderick Bruce examines the forecast and

finds a silver lining on the current Wall Street cloud

“A barometer of the market’s health is that end-user hedging transactions have been growing at a steady pace since the inception of the market” Martin Malinow, Galileo Weather Risk Management & WRMA

After a barren year in 2006/7, the weather derivatives market has come storming back. Notional value of over-the-counter (OTC) and exchange-based weather trades on the Chicago Mercantile Exchange (CME) rose 76% between April 2007 and March 2008 to reach $32 billion, while contracts traded rose by 35% to 985,000 over the same period, according to a survey by Pricewaterhouse-Coopers (PwC).

The market had reached a high of $45 billion in 2005/2006, and its decline the subsequent year led many to question its longevity. “Since its inception, the weather markets have faced challenges, but they continue to be resilient,” says Felix Carabello, director of alternative investments at CME Group.

Carabello says the 2006/2007 drop in trading volume came from a period of staff reorgani-sation within market participants. He noted that traders’ risk appetite was reduced as they settled into their new roles. “Because a number of traders were changing jobs, we saw a decrease in volumes,” he says. “The moves were caused by market evolution and organic growth. It was like a kid losing its milk teeth before it matures.”

End-user hedging business – particularly within the energy sector – remains the pillar that the weather market is built on. “In addi-

tion to the headline numbers in the PwC survey, which have grown quite a lot over the years, perhaps an even better barometer of the market’s health is that end-user hedging trans-actions have been growing at a steady pace since the inception of the market,” says Martin Malinow, CEO of Galileo Weather Risk Management and president of the Weather Risk Management Association (WRMA).

The weather markets look ripe for further growth. End-users are coming from a variety of new sectors, with increasingly advanced structured deals making risk transfer more effective, and innovative origination compa-nies such as Storm Exchange and Weather-Bill are offering improved access to derivatives for small businesses. Most significantly, as the winds of change sweep away investment banks and insurance companies on Wall Street, hedge funds and reinsurers are turning to the market in increasing numbers, as are investors seeking uncorrelated assets to diversify portfolios.

Energetic growthMarket participants say that around 90–95% of global weather derivatives volumes come from the US, with Europe supplying the bulk of the remainder, with some trades occurring else-where, particularly Japan, Australia and India.

The US energy sector, which pioneered the weather derivatives market in 1998 with a deal between Koch Industries and Enron, remains the biggest end-user, according to brokers. A CME Group / Storm Exchange survey carried out in April, which polled 205 risk and finance mangers across the US, found that 74% of respondents in the energy sector had attempted to quantify the impact of weather on their business, and 35% had actually employed

October 2008 energy risk 27

Nicholas Ernst, Evolution

Markets: “Weather is becoming

a cross-commodity market, and

around 20% of our business

now comes from these deals, up

from about 10% a year ago”

weather hedges to manage that risk. That compares to 29% of retailers – none of whom had employed derivatives.

“Energy companies are still the number one participant,” says Bill Windle, who began trading weather derivatives at Enron in 1999 and is now managing director at RenRe Investment Managers, a weather risk management company. “More and more unregulated energy providers are seeking our services because they do not benefit from regulatory mecha-nisms that limit their exposures – they’re in a truly free market, so volumetric and price expo-sure is significant.”

More energy compa-nies – producers, marketers and consumers – are getting involved in the market as product offerings advance. Significant new volumes are coming from cross-commodity deals that allow hedgers to offset both volumetric risk with tradi-tional derivatives and price risk with more complex structures.

For example, a deregulated natural gas provider depends on cold weather to drive sales. While the company can esti-mate sales based on temperature predictions (using heating or cooling degree day – HDD /CDD – indexes) and create a supply port-folio accordingly, if the winter is colder than expected then the company will be forced to enter the market to buy more gas when prices are at their highest.

To hedge this risk, the company can buy a natural gas-linked weather derivative. “If the temperatures are over a certain strike we’ll sell the company natural gas at a fixed or indexed price, allowing them some comfort that they won’t have to purchase in a high price envi-ronment,” says Windle.

Should the winter be warmer than expected, a put position then allows the company to sell any excess inventory at the end of the season at a predetermined or indexed price, allowing the company to better match their volumetric and price exposures in one combined product.

“There’s quite a bit of appetite for these products,” says Windle.

That appetite is not limited to the US. Whereas energy companies in Europe tradi-tionally hedge volumetric risk from warm winters, many gas distribution companies in the UK now hedge price risk from colder than expected winters. “If it’s much colder than normal, short-term natural gas prices in the UK tend to spike more than they do on the European continent,” says Jens Boening, managing director Europe & Asia at Weath-erBill, which provides customised products to end-users from utilities to small businesses.

Boening points out that end-user demand in Europe is not met efficiently in the traded market, as standardised products (such as those based on HDDs at London Heathrow) leave significant basis risk.

Cross-commodity products are therefore attracting new end-users to the market, and increased volumes from established

The weather

derivatives market

has come storming

back after a barren

year in 2006/7

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Weather derivatives

28 energy risk energyrisk.com

“WeatherBill will de!nitely give the end-user market a boost”

Jens Boening, WeatherBill

counterparties. “Weather is becoming a cross-commodity market, and around 20% of our business now comes from these deals, up from about 10% a year ago,” says Nicholas Ernst, head of the weather derivatives group at broker Evolution Markets. “The growth in the market is not just coming from new end-users, but also increased risk transfer from the natural gas, power and heating oil markets.”

Harvesting new businessAdvances in deal structuring, combined with soaring grain prices, have drawn significant interest in weather risk hedging from the agri-culture sector. “There is weather risk in the entire agricultural value chain, only a portion of which is covered by Federal crop insur-ance,” says the WRMA’s Malinow. “At these unprecedented price levels, there is more abso-lute value to lose than ever before.”

Weather risk manager and information provider Storm Exchange has seen its busi-ness grow dramatically, thanks in no small part to the agricultural sector. The company has tripled its staff in the past 12 months, hiring experts in agronomy and agricultural mete-orology to meet growing demand. Storm Exchange has developed crop-specific indexes, based on how weather impacts yield and crop growth, and offers structured derivative prod-ucts around them.

“The convergence of energy risk and agri-cultural risk is now more prevalent than ever, given the effect of yield and price volatility on many of the largest ethanol producers,” says David Riker, president and CEO of Storm Exchange. “The deals we’re doing now are multi-year contracts worth hundreds

of millions of dollars, whereas only a year ago we were dealing with more middle-market clients.”

Brian O’Hearne, managing director, finan-cial products at Swiss Re, says that agriculture is clearly the fastest growing end-user sector, as awareness of weather’s impact on crop yield – and how to hedge this risk – improves across North and South America. “We’ve seen interest from Australia, South Africa – anywhere with an agricultural economy has a need for weather derivatives,” he says.

One such economy is India’s, where 55% of the population (around 621 million people) depend on agriculture for their livelihood. The sector contributes 18% of India’s GDP, equiva-lent to $748 billion. Weather risk is concen-trated in precipitation: 75% of the country’s annual rainfall of 110 centimetres occurs during the summer monsoon season between June and September. In addition, 26% of India’s power generation comes from hydropower.

“Higher or lower than normal rainfall can create a huge problem for the economy, partic-ularly large sections of the rural population,” says Kolli Rao, chief manager of the Agri-cultural Insurance Company of India (AICI). “Weather derivatives and insurance could therefore be a huge market here.”

Janani Akhilandeswari, a consultant at The Centre for Insurance and Risk Management (CIRM), estimates that India’s OTC weather derivatives market is worth around $1 billion. At the moment, exchange-traded weather derivatives are not permitted under Indian law as they are “intangible assets”, but a bill being considered by the government is likely to allow trading in commodity options, weather derivatives and index futures within the next 12 months. Index-based weather insurance products currently meet the demands of the agriculture sector.

“We are currently working with the National Commodity and Derivatives Exchange [NCDEX] in designing and pricing exchange-traded weather derivative products to be traded once the regulatory barriers are lifted,” says CIRM consultant Rupalee Ruchismita. “We see huge potential in this market.” The Multi Commodity Exchange of India (MCX) is also said to be considering launching weather derivatives, according to AICI’s Rao.

Kendall Johnson, managing director and global head of weather derivatives at broker

“Since its inception, the weather markets have faced challenges, but they continue

to be resilient”Felix Carabello, CME Group

Weather derivatives

30 energy risk energyrisk.com

“Higher or lower than normal rainfall can create a huge problem for the economy, particularly large sections of the rural population

[in India]. Weather derivatives and insurance could therefore be a huge market here”

Kolli Rao, AICI

funds were reportedly keen to trade as the index was a counterparty of unprecedented size in the market.

Some participants aren’t so enthusiastic though. “When UBS enters the market it creates a ripple effect,” says one weather market participant. “It’s a problem for the market when someone puts out an auction, instead of taking a more calculated approach to execution. When someone comes in and shows their entire hand it pretty much paralyses the market for a lengthy period of time.”

Another participant observes that, as the index is weighted for locational liquidity rather than seasonal liquidity, the exposures are greater in October to April, instead of being weighted towards the more liquid mid-season. “Conceptually it’s great, but I ques-tion the longevity of it, given the way it’s being executed,” he says.

However, the majority of feedback from the market on the UBS index is positive. “There’s now plenty of liquidity in the market to absorb structures like this,” says Swiss Re’s O’Hearne. “Investors are looking for diver-sification, and weather derivatives offer very good non-correlated returns.”

Murisic told Energy Risk that he is now developing an investor index based on poten-tial Indian precipitation contracts, to be listed on the NCDEX. “The Indian monsoon derivatives market could be one of the world’s largest in terms of volume,” he says. He is also hoping to develop an index for the burgeoning hurricane derivatives market (see ‘Hurricane derivatives’ box).

Investors may be poised to play a major role in the weather market’s expansion, but there is a consensus among participants that growing end-user business is the key to assuring long-term market integrity. “From the beginning people thought our markets would be revolu-tionary, but they have been evolutionary,” says RenRe’s Windle. “There is no next big thing that will come in and double market volumes, but I’m confident that there will be continued double digit year on year growth in the trading of weather-related products.”

Bright forecastOne platform seeking to harness the global potential of weather risk management is WeatherBill, by offering a service that allows businesses to customise, price and buy weather coverage online. Since being founded in 2006 it has protected a diverse range of clients, from travel companies to car washes and hair salons. The company itself does not actively trade the market, but rather develops a portfolio of offsetting – negatively correlated or uncorre-lated – weather derivative contracts.

WeatherBill offers online access to around 20 different contract types combining tempera-ture, precipitation, snow and frost across seven countries including the US, UK and Germany. “We are the first to offer this level of custom-isability in terms of the indices available and weather stations being offered – we will defi-nitely give the end-user market a boost,” says WeatherBill’s Boening, formerly of Merrill Lynch and vice-president of the WRMA. “Our mission is to democratise the weather market.”

WeatherBill is currently seeking registration with the UK’s Financial Services Authority, which will allow it to offer its products to every UK business. The level of granularity offered is very different to the standard-ised CME contracts that have so far been the market driver. “Companies like WeatherBill and Storm Exchange provide an invaluable service, a different kind of risk transfer tool

“The auction might come from one country and place the risk in two di!erent countries

or time zones. It’s becoming a truly global market and the auction format

helps us to cover that”Kendall Johnson, TFS Energy

Weather derivatives

32 energy risk energyrisk.com

from us,” says CME Group’s Carabello. “It’s more customised, less commoditised.”

Market veterans Brian O’Hearne and Bill Windle view WeatherBill’s emergence as the next step for the market. Windle feels the increased liquidity will benefit all market players. “The tide will rise, and as it rises it will lift all boats,” says Windle. “I wish WeatherBill success, because it will be beneficial to all of us.”

O’Hearne meanwhile points to Swiss Re’s agreement to provide risk capacity

to CelsiusPro, a Europe-focused platform similar to WeatherBill, as a signal that online origination could be the way forward.

With end-user and investor interest on the rise, the forecast looks bright for continued growth in weather derivatives trading, despite the testing times currently being experienced in the global markets. Indeed, the very nature of the weather market means it may benefit as institutions seek diversification.

Malinow is cautiously optimistic. “We haven’t seen much impact on weather markets so far, but it would be naive to think there won’t be some fallout given the general credit contraction and deleveraging we have been facing,” he says. “The good news is that there is new apprecia-tion that falling asset prices don’t change the temperature in London.”

“The good news is that there is new appreciation that falling asset prices don’t

change the temperature in London” Martin Malinow, Galileo Weather Risk Management & WRMA

Index-based hurricane futures and options, launched on the CME in March 2007, stand at the crossroads between the insurance / reinsurance industry and the capital markets. The products were formulated in a joint-venture between specialist reinsurance company Carvill, the index provider, and CME Group as a result of the devastating 2005 hurricane season, which caused an estimated $79 billion worth of damage. Such was the hit on the insurance market that some claims from Hurricane Katrina remain unsettled.

“The problem that the reinsurance companies faced was a concentration risk – companies had been warehousing risk so it was concentrated too much in one space,” says CME Group’s Felix Carabello. “Some reinsurance companies believe that warehous-ing of risk was an unsustainable business model and they realize that they have to shed their risk through different types of coun-terparties accessible through CME Clearing.”

Insurance companies previously insured their risk through a reinsurance contract called an Insurance Loss Warranty (ILW), brokered by companies such as Aon or Guy Carpenter. Now prod-ucts such as catastrophe bonds, which pay out to investors based on large weather events, or ILW-based insurance futures (traded on London-based Insurance Futures Exchange, IFEX) are allowing hedge funds, investors and energy companies to hedge hurricane risk, at the same time diversifying the insurance market.

The CME contracts have increased accessibility to the market, as they do not feature an indemnity piece; no receipt for loss needs to be shown to guarantee a payout (unlike ILWs). “With these futures you can parametrically calculate the risk and infer statistical losses, and it settles immediately,” says Ilija Murisc of UBS. “For a utility company that’s very useful.”

The underlying index measures hurricane size and maximum wind speed. Contracts trade at $100 for each 0.1 points on the index. A relatively small hurricane with a 60-mile radius and 74

mph winds would score 2.5 on the index. Hurricane Katrina would have scored 19. “The Carvill index is a more precise proxy for storm damage and intensity than the Saffir-Simpson scale [which rates hurricanes in categories 1 to 5]” says Martin Malinow of Galileo Weather Risk Management. “It’s a purely parametric index, so it’s effectively a weather derivative and seems to be a product that’s here to stay.”

Nicholas Ernst of Evolution Markets, which recently set up a desk to broker cat bonds, ILW derivatives and the CME’s hurricane futures, says that hedge funds prefer to trade the CME/Carvill futures as the index format is ideal for algorithmic trading. “The problem is that it doesn’t fully cover all insurances risks – it leaves significant basis risk,” he says. “Right now it’s maybe too big a leap from the way business is traditionally done, but the market is two or three years away from really exploding.”

After little interest in 2007, an active 2008 storm season has seen 32,600 hurricane contracts traded on the CME up to August this year; notional value has yet to be calculated, according to the CME.

Swiss Re’s Brian O’Hearne says that more point-specific and location-specific products have helped to encourage insurance companies to trade on exchanges. “Insurance derivatives are poised for significant growth,” he says.

One participant who wished to remain anonymous says that many insurance hedge funds are up 10-15% for the year, because they are uncorrelated to floundering financial markets. “With AIG having gone belly up there will be more reinsurance opportuni-ties,” he says. “The fact these assets have done well when every-thing else has performed poorly means there will be significant capital inflows.”

And of course, institutional and retail investors are on the lookout for uncorrelated assets. “There are opportunities to create an index in the catastrophe markets, just as UBS has done in the weather markets,” says Kendall Johnson of TFS Energy.

Hurricane derivatives

14 UBS News for Banks / Winter 2007

Bank to come up with the world’s first

index that tracks temperatures on a

national and regional rather than a local

basis. Launched in April this year, the UBS

Global Warming Index (UBS-GWI) is a trad-

able benchmark for global investments in

the weather derivatives market. It provides

a rational and simple way to obtain finan-

cial exposure to large-scale trends in the

climate. The index should also prove useful

to industries that need to hedge against

damaging climatic trends. Potential users

could include many branches of agricul-

ture, tourism and construction.

How it works

The UBS-GWI is based on existing CME

weather futures contracts that settle on

the difference between the average daily

temperature and a base temperature of

65ºF. These are Heating Degree Day (HDD)

and Cooling Degree Day (CDD) contracts,

so-called because they measure how far it

is necessary to heat or cool buildings in the

prevailing weather conditions. At present,

the index comprises contracts on the 15 US

A broader swathe of investors can now give climate derivatives a whirl

Weather derivatives have been traded

for the best part of a decade. In theory, ski

resorts could use them to hedge against

warm winters or brewers to protect them-

selves against cool summers. In practice,

though, most users are in the energy sec-

tor. The Chicago Mercantile Exchange

(CME) established a weather derivatives

exchange for temperature contracts ref-

erenced to certain US cities in September

1999, later adding European and Asian

references. More recently, the CME has

added contracts on snowfall, frost and

hurricanes. These innovations helped lift

total CME turnover in weather contracts

to some $45 billion in 2005–2006. This

success has attracted attention elsewhere.

In mid-2006, China’s Dalian Commodities

Exchange announced that it planned to

start trading weather futures, with the aim

of helping Chinese farmers hedge their

exposure to bad weather.

Weather, though, is not climate. As cli-

matologists like to say, weather is what

you get while climate is what you expect.

This insight prompted UBS Investment

Getting a grip on climate riskA new index lets investors express their views on how fast the planet is warming

Solutions

cities – including New York, Chicago,

Atlanta, and Las Vegas – that are most

actively traded on the CME’s weather

derivatives exchange. Between May 2 and

September 3 this year, an excess temper-

ature of 0.68ºF on these contracts caused

the index to climb by almost 35%. This

performance showed minimal correlation

with any other investible asset class, a fact

that could make the climate an interesting

candidate for inclusion in otherwise tra-

ditional portfolios. Access to the index

would be via structured products, perhaps

in combination with other types of asset.

More cities could potentially be included

in the index. The CME currently trades

weather derivative contracts for 18 US and

nine European cities, as well as six Cana-

dian and two Japanese locations. To be

eligible for inclusion in the GWI, however,

the volume of futures traded for any given

city must represent 1% or more of the

total weather derivatives contracts traded

on the CME. Provided they meet this con-

dition, European and Asian cities are likely

to be included in the GWI over the me-

dium term. A UBS-GWI governance com-

mittee will meet annually to determine

the composition and the weighting of the

UGWI index and its family of sub-indices,

which currently covers four US regions: the

Northeast, Midwest, West and South.

Although there has been a dramatic in-

crease in weather derivatives volumes over

the course of the last few years, traded

products using weather remain inacces-

sible to the vast majority of the financial

community. Used mainly as a hedging in-

strument by energy, insurance and com-

modity professionals, weather derivatives

remain largely untouched as an asset

class in their own right. UBS’s new Global

Warming Index could change that by pro-

viding a simpler way for a broader range

of institutional and private investors to

gain financial exposure to global tempera-

ture trends.

Ilija Murisic UBS Investment Bank, Non-standard derivative products ilija.murisic@ubs.com

19UBS News for Banks / Summer 2008

Turning up the heatNew index broadens the choices for investors concerned with climate change

Unless you are a dairy farmer in Green-

land, climate change is an inconvenient

truth. For most such inconveniences,

though, there is a convenient tool for

hedging their effects. Climate change was

the exception until April last year, when

UBS launched its Global Warming Index

(UBS-GWI). Rolling into a single instrument

a selection of intensively traded weather

derivatives, the index offers investors a

new and handy way of expressing views

on regional or national climate trends in

the US. (See News for Banks, Winter 2007

edition for more details.)

This invitation was taken up with enthu-

siasm. Since inception, the Global Warm-

ing Index has attracted some $100 million

in contracts. Even more significantly, it has

built a new user base for weather deriv-

atives. While traditional weather futures

tend to be patronized mainly by energy

professionals and a few specialized hedge

funds, the GWI has pulled in insurers, pen-

sion funds, and even retail investors. GWI

investors have been rewarded by a 53%

rate of return since inception (as at mid-

February), as well as minimal correlation

with other asset classes.

Inconvenient truth: now you can hedge against it with the UBS Greenhouse Index

Solutions

If it chooses, this clientele can now focus

even more selectively on the human-

induced element in climate change. The

recently launched UBS Greenhouse Index

(UBS-GHI) is a play on both temperature

trends and, indirectly, on the amount of

carbon dioxide in the air, an important

cause of global warming. Half the index

by value is based on the existing Global

Warming Index, while the other half

tracks futures contracts on two princi-

pal markets for carbon emissions, the EU

Emission Trading Scheme (40% of the

index) and the Kyoto Clean Development

Mechanism (10%). Thus the index delivers

ex posure to temperatures across a selec-

tion of US cities, as well as prices for

carbon dioxide in the EU and for carbon

dioxide reductions sold by developing

nations to developed ones.

For investors preferring to concen-

trate solely on greenhouse gas emissions,

a family of sub-indices is available that

track either the European emissions trad-

ing scheme or the Kyoto Clean Develop-

ment Mechanism or both in combination.

As in the emissions part of the parent in-

dex, the European scheme accounts for

four-fifths of the combined emissions in-

dex by value, reflecting its greater underly-

ing market volumes. As index components

are weighted according to the volume of

underlying transactions, new weather con-

tracts or carbon reduction schemes could

be added to the GHI in future, if justified

by their popularity.

As the existence and pricing of carbon

reduction schemes depend wholly on

human agency, the GHI is a more complex

instrument than its predecessor. It should

appeal to institutional investors looking for

additional portfolio diversification, reckon

the product’s designers within UBS Invest-

ment Bank’s hybrid derivatives trading

unit. Other users could include businesses

exposed to the risk of adverse climate

change and those that need to hedge

against the risk of legislation designed to

curb carbon dioxide emissions. You could

even sell the index short to hedge against

the unlikely risk of global warming going

into reverse.

Ilija Murisic UBS Investment Bank, Hybrid Derivatives Trading ilija.murisic@ubs.com

15UBS News for Banks / Autumn 2008

Blue Sea thinkingA new index on sea-freight derivatives helps investors tap into the China story

In the same week that UBS launched

its Blue Sea index on freight derivatives,

the 203,512-tonne bulk carrier China

Steel Team was booked to carry iron ore

from Brazil to China. At a record-break-

ing $303,000 per day, the freight rate

was more than three times higher than

the ship’s last fixture, just one month pre-

viously. China Steel Team is one of fewer

than 600 Capesize bulk carriers in the

world. And as the name of this particu-

lar one suggests, China’s prodigious appe-

tite for raw materials is keeping all of them

busy. That’s not surprising, when you con-

sider that Baosteel, China’s leading steel

producer, needs 150 ship-loads of ore

every year to feed its blast furnaces.

Statistics like these explain why sea

freight rates are rocketing, particularly for

dry bulk cargoes such as iron ore or coal.

According to Simpson Spence & Young, a

consultancy, average dry bulk freight rates

reached almost $220,000 per day in May,

up from $80,000 or below in January

and a previous long-term average of

$15,000 – $20,000. Capacity shortage is

responsible for part of this squeeze but

a lack of tonnage is not the whole story.

Even if the 185 or so Capesizers on order

could be delivered tomorrow, ports and

cargo terminals are too choked with ship-

ping to allow them to load and unload

The sea may be calm but the freight rates are volatile

Solutions

on time. The upshot is a rising trend in

freight rates, coupled with spectacular vol-

atility; the benchmark Baltic Exchange sea

freight index for dry commodities sagged

by more than a third between November

last year and mid-January 2008 on fears

of a US recession, although it has since

bounced back.

That volatility, of course, has already

attracted banks, hedge funds, and other

financial institutions. So far, would-be

investors have looked to the existing mar-

kets for sea-freight derivatives, which are

based mainly on futures and forwards on

the principal reference indices. What was

lacking, however, was a packaged instru-

ment that offered a balanced exposure to

a representative spectrum of the dry-bulk

freight market. It was this gap that UBS

sought to fill when it launched its Blue Sea

Index on May 22.

Congestion factor

UBS Blue Sea is the first fully integrated in-

dex to be benchmarked on the most ac-

tively traded dry-bulk forward freight

agreements. FFAs are non-standardized

over-the-counter forward contracts based

on one of several underlying freight indi-

ces. They are agreed between two parties

for a specific route, for a specific delivery

rate and a specific vessel type. The index

also incorporates a “Port Congestion Fac-

tor” that takes into account the effect on

freight derivative prices of loading or un-

loading delays in more than 60 iron ore

and coal ports worldwide.

The index is aimed primarily at investors

who are interested in freight as a generic

asset class. In addition, shipowners and

charterers could use the index to hedge

their total exposure to freight rates. For

this purpose, sub-indices are also available.

These are based on the three categories of

bulk carriers that comprise the main index,

namely the Capesize giants and the hand-

ier-sized Panamax and Supramax types.

It’s too early to say which types of

investor will make the most intensive use

of the new index. But Blue Sea has cer-

tainly captured the attention of industry

experts. Lloyds List, the longest-standing

daily newspaper for the maritime industry,

commented as follows: “This new UBS

initiative deserves to be watched as it may

introduce a new level of sophistication to

the freight derivatives market by opening

it up to investors who are not necessarily

freight professionals. The Blue Sea Index is

indeed blue sky thinking.”

Ilija Murisic UBS Investment Bank, Hybrid Derivatives Trading ilija.murisic@ubs.com

!!!!!!!!!!!!!!!!""""""""""""""""""""""""""""""""""""

34 ALTERNATIVES

WEATHER Derivatives

According to the Chicago Mercantile Exchange,weather has an impact on revenues for around 30%of the US economy. For many companies, this ishigher than foreign exchange risk or other types ofrisk that are widely hedged. With the impact of cli-mate change making weather conditions moreunpredictable, the business risk from weather looksset to rise. Yet, the majority of companies do nothedge against the weather and weather derivativesremain a young and relatively immature market. Isthis likely to change as climate change becomesmore potent?The first widely-known weather derivatives deal wascompleted between fallen energy behemoth Enronand Koch Energy in 1997. It was structured aroundtemperature conditions: Like a spread betting deal,Enron would pay Koch $10,000 for every degree thetemperature fell below a set level, while Koch wouldpay the same for every degree above it.

It was picked up by energy companies who foundthat fluctuations in weather were hampering theirability to deliver steady earnings to investors. PeterBrewer, chief investment officer of Cumulus Funds,says: “It came down to people would use gas if itwas cold to heat things up and electricity if it washot to cool things down. The contract would paymoney out if the temperature changed.”

Insurance companies then became involved, whosaw it as a means to move risk around. In 1999, theChicago Mercantile Exchange (CME) began to listtemperature futures. These were vanilla contractsbased on the temperature in certain cities on certaindays. Brewer says that this was an attempt to turnwhat had been an over-the-counter market into anexchange-traded one, but it generated little interestfrom any of the market participants at the time.The implosion of Enron in late 2001 caused consid-erable dislocation in this nascent market. It had beenthe biggest player and the market was left with a dis-parate bunch of investors and traders, which includ-ed some insurers, some banks and some energycompanies. But Enron employees started to moveinto the insurance groups and banks and resumetrading there.

Brewer says: “It really started to happen post-Enron. There was more focus on counterparty risk.The Chicago Mercantile Exchange removed thatcredit risk and began to pick up a lot more business.By 2002, it had a 90% share of trading activity inweather derivatives.”

The weather derivatives market now splits neatlyinto two main areas: There is the secondary market,which trades on the CME and then there is the moreesoteric off-exchange market, which allows for morestructured deals. According to statistics from theWeather Risk Management Association (WRMA),around 730,087 derivatives contracts were tradedfrom April 06 to March 07. This was down on theprevious year when hurricanes Katrina and Ritaincreased the appeal of hedging weather risk andover one million contracts were traded. HurricaneKatrina, in particular, proved one of the most cost-ly in US history, with estimates of damages aroundUSD65bn.

Volumes on weather conditions in the US werelargely stable, while European contracts declined.However, the WMRA said that it was seeing rapidunderlying growth in the weather business in otherregions of the world, notably India, which are yet tobe captured in the survey. The WRMA says thatearly indications for the 2007/2008 survey period

Cherry Reynard reports on thelatest hot product to change thederivative landscape

Weather Derivatives

ALTERNATIVES MAGAZINE 35

WEATHER Derivatives

suggest that the number of contracts traded will benearer the 2005/2006 figures. If catastrophic weath-er conditions continue to be a predictor of tradingvolumes (as they have been in the past), then2008/2009 is likely to be even stronger, encompass-ing the earthquake in China, cyclone in Burma andfurther hurricanes in the mid-West of the US.For the exchange-traded market on the CME, themain volume is in contracts on heating degree days(HDD) and cooling degree days (CDD) on 18 citiesaround the world. Temperature contracts accountedfor volumes of USD18.9bn in 2006/2007. Althoughmuch of the trading is in US cities, CME offersfutures on temperatures in Amsterdam, Barcelona,Berlin, London, Madrid, Paris, Rome andStockholm. These are well-traded, liquid contractsand are mostly traded by energy companies, funds(including hedge funds) and insurance companies.The presence of large energy companies meansmost arbitrage opportunities quickly disappear.

The CME has tried to expand its range recently,finding that demand for weather hedging goesbeyond temperature. As such, it has introducedproducts focused on frost, snowfall, rainfall andeven a hurricane future. However, trading in theseareas remains relatively limited with rain and windcontracts attracting volumes of just USD142 millionand USD36 million respectively in 2006/2007.

The key problem for the CME in developing newproducts remains access to quality data. Eric Gisigera member of the investment committee of ManECO says that few companies actually understandthe impact the weather has on their bottom line. Headds: “They know they might get depressed resultsdue to poor weather conditions , but have less ofan idea how much is attributable to the weather andtherefore how much they need to hedge. Availablestandardised weather contracts such as the onestraded on the CME could be used but usually have abasis risk, in other words do not perfectly hedge theunderlying risk.”

He believes that although these contracts are use-ful, they can only ever represent standardisedhedges. There is therefore a basis risk. The weatherin central London is not necessarily the same as inHeathrow and therefore the standard products donot always reflect the exact market risk.

The off-exchange weather derivatives are onlymarginally captured by the WRMA statistics.Examples of this type of contract could be whetherit is going to rain at a sporting event or whether itwill snow in Meribel this season. Stephen Doherty,chief executive officer at Speedwell Weather, says:“These more exotic structures will be based on thefair value for the trade plus a profit margin for tak-ing the risk. These products are unlikely to tradethereafter.”These tend to be smaller volume trades, but there are

more in the market. It is difficult to quantify theexact size of the market as there is no centraliseddata point, but it is thought that this market is nowmuch larger than the exchange-traded market.

Catastrophe, or "cat" bonds are also a growingarea. These are issued by insurance companies anddesigned to cover particular risks. Investors will buyon the assumption that an event won't happen. Ifthe event happens, the investors lose their moneyand the insurance company makes enough money tocover a proportion of the money it has to pay out toits clients. These bonds are also being picked up byhedge funds in a blurring of the lines between insur-ers and weather derivatives investors. Traditional'catastrophic' events have been seen as the domain ofthe insurers alone.

The corporate users of these products are dis-parate. For example, the CME launched snowfallfutures and hurricane futures primarily to help stategovernments manage their budgets. In addition toenergy companies, beverage producers are subject tothe vagaries of the weather - Britvic, for example,made several references to its vulnerability to weath-er conditions in its recent results statement.

Construction projects can be influenced by theweather as can ski resorts and other holiday groups.Retailers are often affected by high rainfall and poorconditions as people don't tend to go out shopping.On the other hand, WH Smith benefited from lastyear's terrible weather because people stayed insideand read books.

San Francisco-based WeatherBill has just pub-lished a study identifying the relationship betweenweather conditions and flight disruptions. It showedthat 14% of the 21 million flights evaluated in thestudy were delayed or cancelled due toweather. More than 25% of all flightsstudied were cancelled or delayed ofwhich 55% of those disruptions (3 mil-lion flights) were weather-related. Thesurvey showed some airports such as SanFrancisco, Reno and Chicago's O'Haresuffered disproportionately from weath-er-related delays.

These corporate will use the basic con-tracts available to them on the CME andalso structure their own deals if theyneed more tailored, specific hedging.They need to make sure that this type ofhedging is cheaper than insurance.Doherty says that some of the most complex dealsare now within agriculture. This has felt the earlyeffects of climate change most significantly withcrop destroyed by poor weather conditions. He adds:“There has been an explosion in this area. Weatherconditions affect crops - including rain and temper-ature. Timing is also important. You are seeing someexotic weather structures in this area.”

“This market is stillvery immature andstill very opaque,that's why hedgefunds like it”

Stephen Doherty,chief executive officerat Speedwell Weather

Investment buyers of weather derivatives will tendto be standard investors such as pension funds andasset managers looking for a non-correlated assetclass. This is where UBS has seen most demand com-ing for its Global Warming index (see box-out).Gisiger says that hedge funds active in the space alsolook at the non-exchange traded , insurance market.He says: “This market is still very premature andopaque, a key reason why hedge funds like it. Thebespoke insurance market is bigger and more attrac-tive in terms of potential margins to be earned butalso requires a specific skill set rarely available.Market participants assume that a lot of the hedgefund money goes into the bespoke deals, thoughthere are hedge funds actively trading through CMEcontracts. ”

There are a number of specific weather fundsinvesting in the derivatives market. Brewer runs theCumulus Climate fund, which launched in February,and has a technical, quantitative-driven approach.The fund is a long-short equity fund which seeks toprofit from the financial impacts of climate change.It has not been running long enough to deliver mean-

ingful performance statistics, but Brewer says that ithas been run on a formal 'paper trading' basis for 16months and delivered annualised returns of over15% to end-December despite considerable volatility.It targets 15-20% returns on 10% volatility.

The Nimbus fund, based in Bermuda and run byNephila has also proved popular. The Nephila spidercan apparently predict hurricanes, spinning its webclose to the ground when a hurricane is approachingand high up in the shrubs and trees when the weath-er is nice. The group has recently signed an agreementto provide risk capacity and collateral to WeatherBillto support weather contracts sold to customers.

There are also a number of more mainstreamweather-related investments launched in the retailmarket such as the Schroders Climate Change fundand the Virgin Climate Change fund. This demon-strates that demand is there among retail investors forthis type of product, but so far these have beenentirely equity-based.

So how big is the weather derivatives market likelyto become? Doherty says: “The Enron idea thatweather derivatives will be as big as FX is not realis-tic. Weather risk is important, but the market willgrow quietly. It will be resilient but unexciting. Thereis a flexible and deep pool of capital and so far theability of the market to adapt and step up to the platehas been surprising.” Hel believes there is amplecapacity in the market and it won't be constrained bya lack of capital.

Gisiger says that at the moment corporate buyersare restricted by the assumption that weather is sim-ply a hazard of day-to-day business and thereforedoes not need to be hedged in the same way as otherrisks, though he believes more companies are becom-ing aware of the options for hedging their weatherexposures.

Brewer concludes: “A lot of people said in the earlydays that this could be the biggest business on theplanet. That's not something we would argue. This isa specialist market for companies concerned aboutthe weather. It will grow, but we are not about to seea doubling of volumes every year. That said, morecompanies are becoming aware of the possibilitiesand we are seeing more catastrophic weather condi-tions.”

For the market to take off, there would have to beincreased shareholder pressure on corporates tohedge out weather risk, plus an increased number ofinvestment buyers seeking uncorrelated returns. Asyet, there is little shareholder pressure, but corporateare becoming aware of the potential of the weatherderivatives market and a growing number of buyersare looking for new, alternative asset classes to hedgeout risk. Increased unpredictability of weather conditions is also likely to stimulate demand. Themarket is unlikely to see the sort of bullish partici-pants it had in Enron, but should see steady growthover the next few years. A

36 ALTERNATIVES

WEATHER Derivatives

The UBS Global Warming index

The UBS Global Warming index (UBS-GWI) is the only index that currentlyexists for the weather derivatives markets.The index grew out of demandfrom multi-asset clients for new uncorrelated assets. Ilija Murisic, ExecutiveDirector, Hybrid Derivatives Trading at UBS says:“In 2007, the equity andcommodity markets had rallied and investors were looking for asset classesthat were truly uncorrelated.We started to look at weather derivatives andthought they were a very interesting market.There was empirically no corre-lation with equities.”The UBS-GWI was launched in May last year and is constructed using theHeating Degree Day (HDD) and Cooling Degree Day (CDD) weatherfutures contracts traded on the CME.The index is currently composed ofweather futures contracts on 15 U.S. cities.To be eligible for inclusion, thevolume of futures traded for any given city must represent 1% or more ofthe total weather derivatives contracts traded on the CME.At the moment,futures on New York weather form the largest part of the index at 31%.Cities from Europe and Asia are expected to become part of the index in themedium term.The UBS-GWI Governance committee meets annually in September to revis-it the weightings of the index and its sub-indices family (currently composedof four US regions: Northeast, Midwest,West and South).Since launching this index, UBS has moved into similar areas, launching carbontrading, energy, commodities and freight indices. Murisic believes there isgood potential growth in these markets, pointing out that the weather deriva-tives market has grown from $2.2bn in 2004 to around $40bn in 2007.Murisic says that although the underlying instruments are complex, the indexitself is designed to be very simply and trade like the S&P index. Investorsdon't need to look at seasonal variations.The index performance has movedfrom around 100 at launch to around 250 today.Investors have been varied. Murisic says:“We have had a lot of interest frominsurance companies. Many of our investors come from Europe, particularlyScandinavia and from Asia. Hedge funds have not been a big buyer, but therehas been a lot of interest from wealthy private individuals.Asset managersand pension funds use the asset class to diversify - they have an allocation toalternatives and they put some of it into weather.” In general, he believes thatinterest has not come from specialist weather funds and weather investors,but more from normal investors looking for diversification.

Panorama – 17-Jul-08

30 Børsen Fredag den 27. april 2007FINANS

KlimaAF SIMON R.NIELSEN

LONDON – Klimaforan-dringer er for alvor rykkettil toppen af dagsordenen iden globale finansielle sek-tor. I løbet af denne uge bli-ver det langt nemmere atafdække risikoen eller ud-nytte muligheden for, at dersælges mindre vintertøj ogflere is i varmen.Seneste skud på stam-

men er nemlig lanceringen

! af verdens første indeks, derdirekte er bundet op på un-derliggende forandringer iklimaet.Det er storbanken UBS,

der står bag det nye GlobalWarming Index, som rentteknisk er baseret på eksi-sterende finansielle instru-menter på råvarebørsen iChicago. Her kan man alle-rede i dag købe og sælge fu-tures-kontrakter, hvor detunderliggende aktiv er tem-peraturen i store amerikan-ske byer.

Det er imidlertid førstegang, at de mangemulighe-der samles i et indeks, derdirekte kan afspejle de om-skiftelige vejrfænomenerog udsving i temperaturen,som menes at berøre denglobale opvarmning.Helt enkelt vil Global

Warming Index stige, hvistemperaturen stiger.UBS har store ambitio-

ner om, at det ny indeks bli-ver bredt forankret blandtinvestorer, der dels ønskerat sikre sig mod klimafor-

andringer, og som samtidighar en unik egenskab i ogmed indeksets udvikling erhelt uafhængig af bevægel-serne på aktie- og obligati-onsmarkedet.I de senere år er marke-

det for vejr-kontrakter ste-get betragteligt på ChicagoMercantile Exchange. I åre-ne 2005 udgjorde værdienaf handlede kontrakter 53,4mia. kr. Sidste år steg mar-kedet til næsten 250 mia.kr., viser en analyse fra Pri-cewaterhouse ifølge Finan-cial Times.»Global opvarmning har

skabt mere volatilitet i tem-peraturer og vejrforhold,hvilket har medført stør-re likviditet i handlen medvejr-derivater,« siger direk-tøren for handel med hybri-de derivater, Ilija Murisic,til Financial Times.Tidligere i år har finans-

huset Lehman Brothersudsendt en meget omfat-tende rapport om de er-hvervsmæssige og finan-sielle konsekvenser af denglobale opvarmning. Fi-nansmarkedets store inte-resse for klimaforandringerblev for alvor vakt til live, daden tidligere verdensbank-økonom Nicholas Stern påvegne af den britiske rege-ring konkluderede, at derer store økonomiske kon-sekvenser, hvis den globaleopvarmning fortsætter.

simon.nielsen@borsen.dk

Global opvarmningindtagerfinansmarkedet

Global opvarmning skaberikke kun indsøer i en ellerstilfrossen norsk fjord, den giverogså storbanken UBSmulighed for at oprette et nytfinansielt indeks. Foto:Scanpix

BonusAF SIMON R.NIELSEN

LONDON – Selv om hedge-fond-industrien genereltmøder stigende kritik forhøje omkostninger og for la-ve afkast, fejler evnen til atforgylde personerne bag ik-ke noget.Undersøgelsen af bonus-

betalinger i 2006 er foreta-get af investeringsmagasinetAlphaMagazine, der kan be-rette at hele tre personer harbrudt den magiske grænsepå 1 mia. dollar. Godt nok erden amerikanske valuta svagfor tiden, men de spekulati-ve og avancerede fonde hareftertrykkeligt og endnu en-gang bevist, at de bedst for-mår at aflønne stjernerne iden finansielle sektor.Så her bringer vi en lille

lønstatistik, som opgørelsentager sig ud ifølge FinancialTimes.Jim Simon fra Renaissan-

ce Technologies tjente 9,4mia. kr.Ken Griffin fra Citadel In-

vestment Group tjente 7,7mia. kr.EddieLampert fraESLIn-

vestments tjente 7,2mia. kr.Sidste år formåede bare to

personer at runde denmagi-skemilliardmålt i dollars.Hele listen med de 25 hø-

jest betalte forvaltere tjen-te 82,5 mia. kr., hvilket iføl-ge Financial Times svarer tilnationalindkomsten i Jor-

! dan. I gennemsnit er lønnenfordoblet på to år.Bag de enorme lønninger

gemmer sig en mere struk-turel historie om en enormtilstrømning af ny kapital,da især pensionskasser ogandre institutionelle inve-storer jagter det lille meraf-kast i forhold til markedet,der er så afgørende.Samtidig kan mange

hedgefonde tilbyde en langthøjere grad af beskyttelsei dårlige tider, da de i mod-sætning til traditionelle in-vesteringsfonde benytter sigaf derivatmarkedet for at af-dække og optimere afkast ogrisiko i porteføljen.Uanset baggrunden vil de

store lønninger blive ansetsom endnu et eksempel påden grådighed, som mangefagforeninger og flere politi-kere hævder florerer blandthedgefonde og kapitalfon-de, der beskyldes for at split-te selskaber og skære ned,mens de forgylder sig selv oginvestorerne.Blandt investorer i hedge-

fonde er der en større for-ståelse for lønningerne, dertrods alt er bundet op påfondenes afkast.Typisk har hedgefondene

omkostninger efter det så-kaldte 2-20-princip. Det ko-ster 2 pct. omåret i faste om-kostninger og 20 pct. af detpositive afkast.

simon.nielsen@borsen.dk

Hedgefondeudbetaler bonus

BankerAF DAVID BENTOW

Væksten i de islandske ban-ker, der de seneste år harværet nærmest eksplosiv,er ved at stilne lidt af. ForKaupthing Bank steg bund-linjen i første kvartal med7,9 pct. i forhold til sammeperiode sidste år, til 20,3mia. islandske kronur (2,1mia. danske kr.), mens egen-

!

kapitalforrentningen blevpå 27,6 pct. mod 42 pct. forhele 2006.»Første kvartal sidste år

var fantastisk, og regnskabetsidste år var bl.a. også påvir-ket af salget af aktier i Exista,men eksklusive engangspo-ster var egenkapitalforrent-ningen på 28 pct. i 2006,det vil sige på samme niveausom første kvartal i år,« sigerkoncernchef Hreidar MárSigurdsson til Børsen.

Meget tilfredsHan er i øvrigt »meget til-freds« med udviklingen iKaupthings største datter-bank, danske FIHErhvervs-bank.»Siden vi blev ejere af FIH

i 2004, er både antallet afansatte og bundlinjen blevet

fordoblet, og det er lykkedesat tiltrække nogle særdelesattraktive medarbejdere,«siger Sigurdsson.På trods af det islandske

ejerskab har FIH beholdt siteget navn og identitet. Så-dan vil det formentlig fort-sætte.»Indtil nu har vi anset det

for vigtigt at holde den se-parate identitet, bl.a. fordiFIH-navnet er meget kendtog respekteret på de euro-pæiske obligationsmarke-der, hvor de henter kapital.Og i England bruger vi og-så fortsat Singer & Fried-lander-navnet,« siger Hrei-darMár Sigurdsson, der dogdirekte adspurgt siger, atdet »ikke er utænkeligt,« atFIHpå et tidspunkt vil skiftenavn til Kaupthing.Også investeringsbanken

Straumur-Burdaras kommed regnskab i går, samtidigmed at det blev meddelt, atder vil blive åbnet et kontori Stockholm. Investerings-bankens bundlinje faldt iførste kvartal til 69,2 mio.euro (516mio. kr.)mod217,5mio. euro i første kvartal sid-ste år. 2006-tallene var dogpåvirket af et salg af en ak-tiepost på 21,1 pct. i Islands-banki, der i dag hedder Glit-nir.

Fantastisk år»Begyndelsen af 2006 varhelt fantastisk på aktiemar-kederne, og det afspejledesig i vores resultat. Men i århar vi fortsat kunne noterevækst i både nettorente- oggebyrindtægterne, og voresegenkapitalforrentning på

19,9 pct. svarer til voresmål-sætning om 15 pct. årligt til-lagt den risikofrie rente,«siger koncernchef FidrikJóhannsson til Børsen.Han vil dog ikke love, at

banken opfyldermålsætnin-gen for egenkapitalforrent-ningen for hele 2007, fordiinvesteringsbanken fortsatekspanderer kraftigt.»Vi ønsker at være den le-

dende investeringsbank iNorden, og vi foretager fort-sat nyansættelser, også iDanmark, hvor vi kan note-remarkant fremgang for vo-res corporate finance-akti-viteter, og en god udviklinginden for vores ejendoms-rådgivning og låneforretnin-ger,« siger Johannsson.

david.bentow@borsen.dk

Væksten forislandske bankerbremser op

Koncernmio. EUR

Nettorenteindt.Gebyr- & provis.indt.Rente- & gebyrindt.KursreguleringerOmkst. & afskrivn.Tab og hensæt.Resultat før skatPerioderesultat

UdlånIndlånEgenkapitalBalancesum

Egenkap.forr., pct.Udlån/egenkapitalOmkostningspct.Antal ansattewww.straumur.net

1. kvt.2007

11,230,358,6

-38,712,32,9

77,469,2

1.706,92.269,01.539,55.191,6

4,981,1113,2117

1.kvt.2006

5,527,040,462,78,63,0

264,4217,5

i.o.i.o.i.o.i.o.

–––

i.o.

–2,5%Dagskurs

–68%Resultat

–71%Res.f.sk.

+45%Indt.

Straumur-BurdarásKoncernmio. ISK

Nettorenteindt.Gebyr- & provis.indt.Rente- & gebyrindt.KursreguleringerOmkst. & afskrivn.Tab og hensæt.Resultat før skatPerioderesultat

UdlånIndlånEgenkapitalBalancesum

EK-forr. f. skat, pct.EK-forr. e. skat, pct.Indtj./omkst. kr.Udlån/egenkapitalResultat pr. aktie, ISKAntal ansatte, gns.

Adm. direktør: Hreidar Már SigurdssonBestyrelsesformand: Sigurdur Einarssonwww.kaupthing.com

1. kvt.2007

16.26512.33728.60213.45617.707

1.42324.93020.694

2.559.121892.170313.900

4.198.385

7,76,4

2,308,1526,7

2.805

1.kvt.2006

10.4848.602

19.08613.50512.552

71022.18919.594

1.870.318548.281223.888

3.071.244

10,49,2

2,678,3527,8

i.o.

–1,7%Dagskurs

+37%Udlån

+6%Resultat

+50%Indt.

Kaupthing Bank

To islandske ban-ker er kommetmed kvartalsregn-skaber,der viserlidt lavere vækstend hidtil

Canadian MoneySaver • PO Box 370, Bath, ON K0H 1G0 • (613) 352-7448 • http://www.canadianmoneysaver.ca • JUNE 2008

Beating The TSX

Global Warming AndYour PortfolioDavid Stanley

Science and politics are often at odds. The bestcurrent example is the global warming debate. Un-deniably, our planet is getting warmer and this islikely to continue. An overwhelming majority of

the world’s scientists agree that human activity is responsi-ble, but politicians in many countries continue to ditherabout how to contain this huge problem. The object of thiscolumn is not to enter the debate but to examine invest-ment opportunities emerging from the global warmingevent.

To review, global warming is the current and ongoingincrease in the earth’s surface (air and water) temperature.Its cause is almost undoubtedly the proliferation of green-house gases (carbon dioxide, methane, and other gases) dueto, among others, industrial pollution. These gases form alayer around the earth that traps some of the heat from thesun, thus warming the planet and also causing more ex-treme weather variations. While scientists embrace this view,politicians have been slow to agree and even slower to takesteps necessary to abate greenhouse gas emissions.

Just as an exercise for myself, I downloaded (http://www.almanac.com/weatherhistory/locations/index.php)some historical weather information for the site closest tome (Waterloo-Wellington Airport) that had weather records.

Unfortunately, these only exist since 1976, but mean, maxi-mum, and minimum temperatures were available, if onlyin °F. I picked two days, April 9 (spring) and October 9(fall), and eight dates over the period from 1976-2008. Iaveraged the two days and looked at the mean temperatureand the difference between the minimum and maximumtemperatures (Figure 1). The slopes of both lines are up-ward, indicating an increase in these data, but, of course,there are too few data to draw a statistically meaningfulconclusion. Readers may wish to gather data for their loca-tions and draw their own conclusions.

However, if we consult Environment Canada (http://www.msc-smc.ec.gc.ca/ccrm/bulletin/national_e.cfm), wesee that winter temperatures have generally been increasingnationally with a warming trend of 2.3°C over the last 61years (Figure 2 shown on the next page).

World data also show a distinct warming trend. Figure3 (shown on the next page) gives results for three climateparameters. From these and other data, the IPCC predictstemperature rises of 1.1-6.4°C by 2100.

The warming of our planet will have significant effectson the human population as well as all living species andthe natural environment in which we exist. Economistspredict reduced GDP levels, and, in particular, agriculturewill face many difficulties. Some of these are grain short-ages, increased food prices, more soil erosion, and loss ofsoil fertility. The effects of global warming will not be feltequally around the globe and Southern Africa is thought tobe the most at risk. In the last several years 15 food riotshave occurred, 10 of them in Africa. We need to rememberthat modern agricultural practices, including fossil fuel us-age, massive deforestation and burning, and increased live-stock production also contributes significantly to greenhousegas emissions.

Global warming is not only an environmental issue,but also a financial and economic one. Scientists andengineers, leaving politicians to argue over such subjectsas the Kyoto Protocol and trading of carbon emissions,are engaged in worldwide research aimed at reducing theimpact of greenhouse gases, whether by developing

Figure 1 - Weather data for the Waterloo-Wellington Airport, ON, from1976-2008.

Canadian MoneySaver • PO Box 370, Bath, ON K0H 1G0 • (613) 352-7448 • http://www.canadianmoneysaver.ca • JUNE 2008

Figure 3 - Changes in (a) global average surface temperature; (b) global averagesea level rise from tide gauge (blue) and satellite (red) data and (c) northernhemisphere snow cover for March-April. All changes are relative to correspondingaverages for the period from 1961-1990. Source: 2007 Intergovernmental Panel onClimate Change (IPCC) Fourth Assessment Report

Figure 2 - Canadian winter national temperatures from 1948-2008. Source: Environment Canada.

alternate energy sources or reducing pollution. Reconstructing the

world’s energy infrastructure awayfrom fossil fuels will be a humanactivity for many years and there isa universal call for more researchand development. Undoubtedly,numerous investment opportunitieswill arise from this work. Let’s lookat some ways the individual investorcan participate.

First, let me say that the mentionof any particular investment doesnot constitute an endorsement onmy part. As always, you need to doyour own due diligence. Severalasset classes are open to investors:

• Futures trading - While this isnot appropriate for either theamateurs or the faint of heart, I wassurprised at the number of possi-bilities. The weather derivatives

market, traded on the Chicago MercantileExchange (CME), is larger than I thought. Lastyear a new index appeared, the UBS GlobalWarming Index (UBS-GWI), composed cur-rently of weather futures contracts of 15 U.S.cities, although cities from Europe and Asia areexpected to join the index. The price of thisindex depends on the difference between theaverage daily temperatures and the given basetemperatures. There are also specific Canadianfutures, one being the Canadian MonthlyWeather Heating Degree Day (HDD) index thatis geared to how much below 18°C the tempera-ture averages in a given city in Canada in a givenmonth.

• Exchange-Traded Funds - ETFs have the advan-tages of providing the investor with a portfolio ofstocks in a sector for a reasonable management fee.The three available sectors that match up mostclosely with global warming are agriculture, solarenergy, and water. Here is an example of each one.

The Claymore Global Agriculture ETF at-tempts to match an agricultural index containingcompanies specializing in fertilizers and agricul-tural chemicals (57%), farm machinery (22%),packaged food and meats (12%), and agriculturalproducts (9%). The top 4 holdings in the ETF areDeere, Monsanto, Potash, and Syngenta, totalling36%. The U.S. and Canada are the two top coun-try weightings. This fund (COW on the TSX) hasa management fee of 0.65%. COW began trading

Canadian MoneySaver • PO Box 370, Bath, ON K0H 1G0 • (613) 352-7448 • http://www.canadianmoneysaver.ca • JUNE 2008

TABLE 1 - SOME POSSIBLE CONSTITUENTS OF A LARGE-CAP GLOBAL WARMING PORTFOLIO.

Company Ticker Business Price ($) Yield (%) P/E

General Electric GE (US) Electrical engineering, water purification 66.44 2.60 20.5Johnson Controls JCI (US) Automotive control, energy management 35.05 1.50 15.5Waste Management WMI (US) Waste management, recycling 35.76 3.10 16.9Alcoa AA (US) Aluminum, automobile parts 36.26 1.90 13.9Caterpillar CAT (US) Earth moving equipment 85.28 1.70 16.0DuPont DD (US) Chemical, agriculture, biotechnology 52.02 3.20 15.9FPL Group FPL (US) Electric utility, fiber optic network 66.44 2.60 20.5Archer Daniels ADM (US) Agricultural processing, ethanol 46.47 1.10 18.3John Deere DE (US) Agricultural equipment 92.68 1.10 20.8Siemens A G SI (ADR) Industrial automation, building tech 113.95 2.10 11.0Magna Intl. MG.A (CAN) Automotive systems 72.01 2.00 12.0ITC Holdings Corp. ITC (US) Electricity transmission infrastructure 56.38 2.10 32.9Dow Chemical DOW (US) Chemical, plastic, agricultural products 39.98 4.30 10.5Honeywell Intl. HON (US) Diversified tech. and manufacturing 60.99 1.90 18.2Trinity Industries TRN (US) Rail services, highway construction 27.10 1.10 7.0Source: Alt Energy Stocks (http://www.altenergystocks.com)

late in 2007 at a price of$20.00 (CAD) and as ofApril 18, 2008 had ad-vanced to $25.75 (CAD)with a dividend yield of0.84%.

Another ETF operatingin the global warming areais the Claymore Global So-lar Energy Fund (TAN onthe NYSE Arca Options)that attempts to match theresults of a global solar en-ergy index. The top threecountry weightings areChina, Germany, and theU.S. This ETF just begantrading on April 15, 2008and as of April 18, 2008was priced at $26.60 (U. S.)with a management fee of 0.65%. Most observers are ofthe opinion that while the solar industry does have a viablebusiness model, many of the small companies in this spacehave gotten ahead of themselves considering that they haveyet to turn a profit. Solar energy is very early in its growthphase and shareholders should exhibit patience, realizingthat this is a long-term investment.

Finally, a third Claymore offering focuses on water-re-lated businesses. The Claymore S&P Global Water ETF(CWW on the TSX) is composed mainly of water utilitiesand water equipment companies. It has a management feeof 0.60% and pays a yield of 1.52%. This ETF has beentrading since early in 2007 and has declined from about$20.00 (CAD) to a current price of $18.33 (CAD) as ofApril 18, 2008. The top three country weightings are theU.S., France, and the U.K.

These are just three examples of sector ETFs that arerelated to global warming. Other funds are available andmay be more or less suited to individual investor’s needs.

• Individual stocks - If, upon inspection, the above ETFsseem a little too risky and volatile for your taste, you maywish to consider formulating a portfolio of engineering,industrial and utilities companies composed of large-cap,blue-chip, dividend-paying stocks characterized by inter-national exposure and a likelihood of participating in theeffort to curb global warming. Conveniently, the folks overat Alt Energy Stocks (http://www.altenergystocks.com/ar-chives/2007/11/our_blue_chip_alternative_energy_stock_list.html) have composed such a portfolio, some of whichis shown in Table 1. While not all of these companies mayappear on lists of “most eco-friendly”, they do stand to profitwhile working to help the environment. This portfolio has

a definite U.S. slant. Some Canadian stocks that might beconsidered for a large-cap portfolio of sustainable environ-mental development include Suncor (SU), TransCanadaCorp (TRP) and Petrobank (PBG), among others.

• SRI (Socially Responsible Investing) - Last, but certainlynot least, is the concept of investing in SRI funds that arededicated to filtering out heavy polluters or those compa-nies with a sub-par environmental record. Some Canadianfunds that use this approach include Acuity Funds, EthicalFunds, and Meritas. Further information can be found athttp://www.socialinvestment.ca/mutualfunds.htm. SRIfunds not only do not invest in bad corporate citizens, butalso use their leverage to encourage companies to under-take environmental reform.

As always, I hope this column will generate discussionand I will attempt to answer your questions.

David Stanley, PhD, Rockwood, ON, DavidS5209@aol.com

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"#$%&!

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