In the regulated energy market, utilities were allowed to pass through losses associated with the weather to ratepayers, or customers who pay rates. No longer. Utilities and power marketers now turn to the over-the-counter weather derivative markets to hedge exposure to the elements. As the first major participants, some utilities and energy marketers have become market makers with proprietary trading firms operations.
Insurance and reinsurance companies are the natural supply of risk capacity for the market. Historically, their role has been to provide catastrophic insurance for major weather events such as hurricanes and floods. Recently, they have begun writing non-catastrophic weather insurance policies. Although most of these companies do not deal directly in the derivatives market, writing weather insurance is an important part of supply-demand balance of the market.
Financial institutions involved with weather derivatives markets bring major benefits. One is the opportunity to cross-market weather products to their existing customer base, another benefit is the depth and breadth of their trading experience.
Hedge funds have emerged as one of the weather market's largest segments, contributing to deep market liquidity. Hedge funds not only use weather derivative markets to hedge weather risk in their investment portfolios, but they also often play a speculators role.
RETAIL/AGRICULTURE/OUTDOOR ENTERTAINMENT COMPANIES
Retail, agriculture and outdoor entertainment companies are new entrants who use weather risk management tools to manage day-to-day weather conditions in order to smooth cash flows, reduce costs and protect against profit losses.
Brokers have been instrumental in growing the weather business to its current size. Their role is to find a buyer and seller for each of their trades. In addition, they work with their customers and the exchanges to transform OTC weather products into standardized contracts for clearing.
Index providers have a critical function in providing the market participants with the daily index. EarthSat provides the daily weather index for most of the CME Group weather products. Carvill is the Hurricane Index provider. In the OTC market, deals are structured around weather indices based through the weather data of either EarthSat or SpeedWell.
Weather forecasters are also very important in providing traders with weather data in real time so that, as weather conditions change, traders can take advantage of trading opportunities. The most widely used forecasting companies are EarthSat, WeatherBug, Weather Insight and WSI.