Weather Derivatives FINC 782

Weather Derivatives FINC 782 - FINC 782: Energy Markets...

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1 Weather Derivatives 01 Dec 2004 FINC 782: Energy Markets Portfolio Analysis AB Freeman School of Business, Tulane University, New Orleans, Fall 2007 Leslie McNew Email at Lmcnew@tulane.edu 865-5036
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2 Weather Risk is the uncertainty in cash flow and earnings caused by weather volatility. Energy Companies: weather is their largest source of financial uncertainty. Weather Derivatives Top 200 U.S. Utility Company Annual Reports 80% cite weather as major determinant of earnings performance 50% claim weather responsible for poorer than expected performance
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3 “Warm weather will result in lower fourth-quarter earnings this year” CFO of a Minnesota Power Company: 12/97 Weather Derivatives
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4 Risk Management Price can manage price risk Volume need a way to manage volume risk Total Volume x Unit Margin = Gross Margin Weather risk Price risk Weather Derivatives
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5 Weather Derivatives allow you to disaggregate supply and demand factors that impact revenue Weather Generation Capacity Fuel Storage Transportation Constraints DEMAND SUPPLY REVENUE Manage demand risk with weather derivatives Weather Derivatives
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6 Proxy for electricity demand (volume risk) demand for power (heating/cooling) is clearly related to outside temperature demand varies with demographic and climatic differences Protect revenue from weather variations: revenue stability Provide revenue offsetting for adverse weather conditions Tradable Market Temperature more manageable weather parameter lots of data temperature is continuous in the environment Weather Derivatives
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7 MILD temperatures result in: Reduced retail summer cooling demand and lower sales volumes Foregone revenue from unutilized peaking capacity Reduced demand for high margin non-interruptible power EXTREME temperatures result in: Higher prices for non-interruptible power Start up costs for bringing on peaking units Weather Derivatives
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8 Link Between Power Usage and Temperature Weather Derivatives
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This note was uploaded on 03/10/2008 for the course FINC 782 taught by Professor Mcnew during the Spring '08 term at Tulane.

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Weather Derivatives FINC 782 - FINC 782: Energy Markets...

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