Alternative Asset Markets - Ilija Murisic -

8/7/2019 Alternative Asset Markets - Ilija Murisic -

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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 Bruceexamines the forecast and

finds a silver lining on the current Wall Street cloud

A barometer of the markets health

is that end-user hedging transactions

have been growing at a steady pace

since the inception of the marketMartin 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, whi le 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 part icipants. 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 themarkets 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 r isk transfer more

effective, and innovative origination compa-

nies such as Storm Exchange and Weather-

Bill are of fering 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 growth

Market participants say that around 9095% of

global weather derivatives volumes come from

the US, with Europe supplying the bulk of the

remainder, with some trades occurring else-

where, particula rly 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 actua lly employed


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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 stillthe number one participant,

says Bill Windle, who began

trading weather derivatives

at Enron in 1999 and is now

managing di rector 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

theyre 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

natura l 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 ga s-linked weather derivative. If the

temperatures are over a certain str ike well sell

the company natural gas at a fixed or indexed

price, allowing them some comfort that they

wont 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.

Theres 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 ri sk from warm

winters, many gas di stribution companies

in the UK now hedge price risk from colder

than expected winters. If its 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 d irector 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

iStockphoto.com/TobiasHelbig


27/75

Weather derivatives


WeatherBill will denitely give the

end-user market a boostJens 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 groupat broker Evolution Markets. The growth in

the market is not just coming f rom 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 agricultura l value chain, only a portion

of which is covered by Federal crop insur-

ance, says the WRMAs 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 agricultura l 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 were doing

now are multi-year contracts worth hundreds

of mill ions of dollars, whereas only a year

ago we were dealing with more middle-

market clients.

Brian OHearne, managing director, finan-

cial products at Swiss Re, says that agricultureis clearly the fastest growing end-user sector,

as awareness of weathers impact on crop

yield and how to hedge this risk improves

across North and South America. Weve

seen interest from Australia, South Africa

anywhere with an agricultural economy has

a need for weather derivatives, he says.

One such economy is Indias, where 55% of

the population (around 621 million people)

depend on agriculture for their livelihood. The

sector contributes 18% of Indias GDP, equiva-

lent to $748 billion. Weather risk is concen-

trated in precipitation: 75% of the countrysannual rainfa ll of 110 centimetres occurs during

the summer monsoon season between June and

September. In addition, 26% of Indias power

generation comes from hydropower.

Higher or lower than normal rainfa ll 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 Akhi landeswari, a consultant at The

Centre for Insurance and Risk Management

(CIRM), estimates that Indias OTC weather

derivatives market is worth around $1 bill ion.

At the moment, exchange-traded weather

derivatives are not permitted under Indian law

as they are intang ible 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 barr iers 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 AICIs 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 resilientFelix Carabello, CME Group


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Weather derivatives


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 hereKolli Rao, AICI

funds were reportedly keen to trade as the

index was a counterparty of unprecedented

size in the market.

Some participants arent so enthusiastic

though. When UBS enters the market it

creates a ripple effect, says one weather

market participant. Its a problem for the

market when someone puts out an auction,

instead of tak ing a more calculated approach toexecution. 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 its great, but I ques-

tion the longevity of it, given the way its being

executed, he says.

However, the majority of feedback from

the market on the UBS index is positive.

Theres now plenty of liquidity in the market

to absorb structures l ike this, says Swiss Res

OHearne. 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 worlds

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 markets expansion, but there is

a consensus among participants that growing

end-user business is the key to assuring long-

term market integrity. From the beginningpeople thought our markets would be revolu-

tionary, but they have been evolutionary, says

RenRes Windle. There is no next big thing

that will come in and double market volumes,

but Im 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 al lows

businesses to customise, price and buy weathercoverage online. Since being founded in 2006

it has protected a diverse range of clients, from

travel companies to car washes and ha ir 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

WeatherBills 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 UKs Financial Services Authority,

which will a llow it to offer its products to

every UK business. The level of granular ity

offered is very dif ferent 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 dierent countries

or time zones. Its becoming a truly

global market and the auction format

helps us to cover thatKendall Johnson, TFS Energy


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Weather derivatives


from us, says CME Groups Carabello. Its

more customised, less commoditised.

Market veterans Brian OHearne and Bill

Windle view WeatherBills 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 al l of us.

OHearne meanwhile points to Swiss

Res 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 br ight for continuedgrowth in weather derivatives trading, despite

the testing times cur rently 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 havent

seen much impact on weather markets so far,

but it would be naive to think there wont 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 fall ing asset prices dont change the

temperature in London.

The good news is that there is new

appreciation that falling asset prices dont

change the temperature in LondonMartin 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 Groups 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 thats 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. Its a purely parametric index,

so its effectively a weather derivative and seems to be a product

thats here to stay.

Nicholas Ernst of Evolution Markets, which recently set up a

desk to broker cat bonds, ILW derivatives and the CMEs 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 doesnt fully cover all insurances risks it leaves significant

basis risk, he says. Right now its 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 Res Brian OHearne 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


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34/75

Bank to come up with the worlds 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 theclimate. 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

65F. 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

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 20052006. This

success has attracted attention elsewhere.

In mid-2006, Chinas 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

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 CMEs weather

derivatives exchange. Between May 2 and

September 3 this year, an excess temper-

ature of 0.68F on these contracts caused

the index to climb by almost 35%. This

performance showed minimal correlation

with any other investible asset class, a factthat 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 thetotal 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, tradedproducts 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. UBSs 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


35/75

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 viewson 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. GWIinvestors have been rewarded by a 53%

rate of return since inception (as at mid-

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

exposure 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.

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 complexinstrument than its predecessor. It should

appeal to institutional investors looking for

additional portfolio diversification, reckon

the products designers within UBS Invest-

ment Banks 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.

Ilij M i i UBS I t t B k


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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 ships 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, Chinas prodigious appe-

tite for raw materials is keeping all of them

busy. Thats not surprising, when you con-

sider that Baosteel, Chinas leading steelproducer, 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

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 waslacking, 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 basedon one of several underlying freight indi-

ces. They are agreed between two parties

also incorporates a Port Congestion Fac-

tor that takes into account the effect onfreight 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.Its 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.

Ilij M i i


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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 derivatives

remain a young and relatively immature market. Isthis likely to change as climate change becomesmore potent?

The first widely-known weather derivatives deal was

completed 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 it

was 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 turn

what had been an over-the-counter market into anexchange-traded one, but it generated little interest

from 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 in weather derivatives.The weather derivatives market now splits neatly

into 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 the

Weather 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


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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 trading

volumes (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 goes

beyond 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 wind

contracts 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 it

will 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 money

and 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 the

weather 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 between

weather conditions and flight disruptions. It showedthat 14% of the 21 million flights evaluated in thestudy were delayed or cancelled due to

weather. More than 25% of all flightsstudied were cancelled or delayed of

which 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 of

hedging 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 officer

at Speedwell Weather


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Investment buyers of weather derivatives will tend

to be standard investors such as pension funds and

asset managers looking for a non-correlated asset

class. 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 also

look at the non-exchange traded , insurance market.

He says: This market is still very premature and

opaque, a key reason why hedge funds like it. The

bespoke insurance market is bigger and more attrac-tive in terms of potential margins to be earned but

also requires a specific skill set rarely available.

Market participants assume that a lot of the hedge

fund money goes into the bespoke deals, though

there are hedge funds actively trading through CME

contracts.

There are a number of specific weather funds

investing in the derivatives market. Brewer runs the

Cumulus Climate fund, which launched in February,

and has a technical, quantitative-driven approach.

The fund is a long-short equity fund which seeks to

profit from the financial impacts of climate change.

It has not been running long enough to deliver mean-

ingful performance statistics, but Brewer says that it

has been run on a formal 'paper trading' basis for 16

months and delivered annualised returns of over

15% to end-December despite considerable volatility.

It targets 15-20% returns on 10% volatility.

The Nimbus fund, based in Bermuda and run by

Nephila has also proved popular. The Nephila spider

can apparently predict hurricanes, spinning its web

close to the ground when a hurricane is approaching

and high up in the shrubs and trees when the weath-er is nice. The group has recently signed an agreement

to provide risk capacity and collateral to WeatherBill

to support weather contracts sold to customers.

There are also a number of more mainstream

weather-related investments launched in the retail

market such as the Schroders Climate Change fund

and the Virgin Climate Change fund. This demon-

strates that demand is there among retail investors for

this type of product, but so far these have been

entirely equity-based.

So how big is the weather derivatives market likely

to become? Doherty says: The Enron idea that

weather derivatives will be as big as FX is not realis-tic. Weather risk is important, but the market will

grow quietly. It will be resilient but unexciting. There

is a flexible and deep pool of capital and so far the

ability of the market to adapt and step up to the plate

has been surprising. Hel believes there is ample

capacity in the market and it won't be constrained by

a lack of capital.

Gisiger says that at the moment corporate buyers

are restricted by the assumption that weather is sim-

ply a hazard of day-to-day business and therefore

does not need to be hedged in the same way as other

risks, though he believes more companies are becom-

ing aware of the options for hedging their weather

exposures.

Brewer concludes: A lot of people said in the early

days that this could be the biggest business on the

planet. That's not something we would argue. This is

a specialist market for companies concerned about

the weather. It will grow, but we are not about to see

a doubling of volumes every year. That said, more

companies are becoming aware of the possibilities

and we are seeing more catastrophic weather condi-

tions.

For the market to take off, there would have to be

increased shareholder pressure on corporates to

hedge out weather risk, plus an increased number of

investment buyers seeking uncorrelated returns. Asyet, there is little shareholder pressure, but corporate

are becoming aware of the potential of the weather

derivatives market and a growing number of buyers

are looking for new, alternative asset classes to hedge

out risk. Increased unpredictability of weather

conditions is also likely to stimulate demand. The

market is unlikely to see the sort of bullish partici-

pants it had in Enron, but should see steady growth

over 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 currently

exists for the weather derivatives markets.The index grew out of demand

from multi-asset clients for new uncorrelated assets. Ilija Murisic, Executive

Director, Hybrid Derivatives Trading at UBS says:In 2007, the equity and

commodity markets had rallied and investors were looking for asset classes

that were truly uncorrelated.We started to look at weather derivatives and

thought 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 the

Heating Degree Day (HDD) and Cooling Degree Day (CDD) weather

futures contracts traded on the CME.The index is currently composed of

weather 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 of

the 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 the

medium term.

The UBS-GWI Governance committee meets annually in September to revis-

it the weightings of the index and its sub-indices family (currently composed

of four US regions:Northeast, Midwest,West and South).

Since launching this index, UBS has moved into similar areas, launching carbon

trading, energy, commodities and freight indices. Murisic believes there is

good 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 index

itself is designed to be very simply and trade like the S&P index. Investors

don't need to look at seasonal variations.The index performance has moved

from around 100 at launch to around 250 today.

Investors have been varied. Murisic says:We have had a lot of interest from

insurance companies. Many of our investors come from Europe, particularly

Scandinavia and from Asia. Hedge funds have not been a big buyer, but there

has been a lot of interest from wealthy private individuals.Asset managers

and pension funds use the asset class to diversify - they have an allocation to

alternatives and they put some of it into weather. In general, he believes that

interest has not come from specialist weather funds and weather investors,

but more from normal investors looking for diversification.


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0 Brsen Fredag den 27. apFINANS

Klima

SIMON R.NIELSEN

ONDON Klimaforan-inger er for alvor rykket

toppen af dagsordenen in globale finansielle sek-r. I lbet af denne uge bli-

er det langt nemmere atdkke risikoen eller ud-

af verdens frste indeks, derdirekte er bundet op p un-derliggende forandringer iklimaet.

Det er storbanken UBS,der str bag det nye Global

Warming Index, som rentteknisk er baseret p eksi-sterende finansielle instru-menter p rvarebrsen iChicago Her kan man alle-

Det er imidlertid frstegang, at de mange mulighe-der samles i et indeks, derdirekte kan afspejle de om-skiftelige vejrfnomenerog udsving i temperaturen,

som menes at berre denglobale opvarmning.Helt enkelt vil Global

Warming Index stige, hvistemperaturen stiger

andringer, og som samtidighar en unik egenskab i ogmed indeksets udvikling erhelt uafhngig af bevgel-serne p aktie- og obligati-onsmarkedet.

I de senere r er marke-det for vejr-kontrakter ste-get betragteligt p ChicagoMercantile Exchange. I re-ne 2005 udgjorde vrdienaf handlede kontrakter53,4mia. kr. Sidste r steg mar-kedet til nsten 250 mia.kr., viser en analyse fra Pri-cewaterhouse iflge Finan-cial Times.

Global opvarmning harskabt mere volatilitet i tem-peraturer og vejrforhold,hvilket har medfrt str-re likviditet i handlen med

vejr-derivater, siger direk-tren forhandel medhybri-de derivater, Ilija Murisic,til Financial Times.

Tidligere i r har finans-huset Lehman Brothersudsendt en meget omfat-tende rapport om de er-hvervsmssige og finan-sielle konsekvenser af denglobale opvarmning. Fi-nansmarkedets store inte-resse for kl imaforandringer

blev foralvor vakt tillive,daden tidligere verdensbank-konom Nicholas Stern p

vegne af den britiske rege-ring konkluderede at der

Global opvarmningndtager

finansmarkedet

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

Bonus

AF SIMON R.NIELSEN

LONDON Selv om hedge-fond-industrien genereltmder stigende kritik forhje omkostningerog forla-

ve afkast, fejler evnen til atforgylde personerne bag ik-ke noget.

Undersgelsen af bonus- betalinger i 2006 er foreta-get af investeringsmagasinet

Alpha Magazine, derkan be-rette at hele trepersonerhar

brudt den magiske grnsep 1 mia.dollar. Godtnok erdenamerikanskevaluta svagfor tiden, men de spekulati-

ve og avancerede fonde hareftertrykkeligt og endnu en-gang bevist, at de bedst for-mr at aflnne stjernerne iden finansiellesektor.

S her bringer vi en lillelnstatistik, som opgrelsentager sig ud iflge FinancialTimes.

Jim Simon fra Renaissan-ce Technologies tjente 9,4mia.kr.

Ken Griffin fra Citadel In- vestment Group tjente 7,7mia.kr.

Eddie Lampertfra ESLIn-vestments tjente 7,2mia. kr.Sidster formede bare to

personerat runde denmagi-skemilliardmlti dollars

I dan. I gennemsnit erfordobletp tor.

Bag de enorme lngemmer sig en mereturel historie om entilstrmning af ny kda isr pensionskaandre institutionellestorer jagter det lille kast i forhold til maderer s afgrende.

Samtidig kan hedgefonde tilbyde ehjere grad af besi drlige tider, da destning til tradition

vesteringsfonde benyaf derivatmarkedet fodkkeog optimereafrisiko i portefljen.

Uanset baggrundestore lnninger blivsom endnu et eksemden grdighed, som fagforeninger og flerekere hvder florererhedgefonde og kapde,der beskyldesfor ate selskaber og skmens deforgylder siginvestorerne.

Blandt investorer ifonde er der en strstelse for lnningertrods alt er bundet

fondenes afkast.Typisk har hedgefomkostninger efter kaldte2-20-princip.ster 2 pct omreti fa

Hedgefondeudbetaler bonus

Banker

DAVID BENTOW

ksten i de islandske ban-r, der de seneste r harret nrmest eksplosiv,ved at stilne lidt af. For

aupthing Bank steg bund-njen i frste kvartal med9 pct. i forhold til sammeriode sidste r, til 20,3

ia. islandske kronur (2,1ia.danske kr.), mensegen-

kapitalforrentningen blevp 27,6 pct. mod 42 pct. forhele2006.

Frste kvartal sidste rvarfantastisk, og regnskabetsidster varbl.a.ogs pvir-ketaf salgetaf aktieri Exista,men eksklusive engangspo-ster var egenkapitalforrent-ningen p 28 pct. i 2006,detvil sige p samme niveausomfrstekvartal i r,siger

koncernchef Hreidar MrSigurdssontil Brsen.

Meget tilfreds

Han er i vrigt meget til-freds med udviklingen iKaupthings strste datter-

bank,danske FIH Erhvervs-bank.

Sidenvi blev ejereaf FIHi 2004, er bde antallet afansatte og bundlinjen blevet

fordoblet, og det er lykkedesat tiltrkke nogle srdelesattraktive medarbejdere,siger Sigurdsson.

P trods af det islandskeejerskab harFIH beholdt siteget navn og identitet. S-dan vil det formentlig fort-stte.

Indtil nu har vi anset detfor vigtigt at holde den se-parate identitet, bl.a. fordi

FIH-navnet er meget kendtog respekteret p de euro-piske obligationsmarke-der, hvor de henter kapital.Og i England bruger vi og-s fortsat Singer & Fried-lander-navnet, siger Hrei-darMr Sigurdsson,der dogdirekte adspurgt siger, atdet ikke er utnkeligt, atFIHp ettidspunkt vilskiftenavntil Kaupthing.Ogs investeringsbanken

Straumur-Burdaras kommedregnskabi gr, samtidigmed at det blev meddelt, atder vil blive bnet et kontori Stockholm. Investerings-

bankens bundlinje faldt ifrste kvartal til 69,2 mio.euro(516 mio.kr.) mod217,5mio. euro i frstekvartalsid-ste r. 2006-tallene var dogpvirket af et salg af en ak-tiepost p 21,1 pct.i Islands-

banki, deri daghedder Glit-nir.

Fantastisk r

Begyndelsen af 2006 varhelt fantastisk p aktiemar-kederne, og det afspejledesig i vores resultat. Men i rhar vi fortsat kunne notere

vkst i bde nettorente- oggebyrindtgterne, og voresegenkapitalforrentning p

19,9 pct.svarertil voresml-stning om 15 pct. rligt til-lagt den risikofrie rente,siger koncernchef FidrikJhannsson til Brsen.

Han vil dog ikke love, atbanken opfylder mlstnin-gen for egenkapitalforrent-ningen for hele 2007, fordiinvesteringsbanken fortsatekspanderer kraftigt.Vi nsker at vre den le-

dende investeringsbNorden, og vi foretagsat nyansttelser, Danmark, hvor vi kare markant fremgangres corporate finan

viteter, og en god udinden for vores ejerdgivning og lneforger, sigerJohannsso

david.bentow@b

Vksten forislandske bankerbremser op

Koncernmio.EUR

Nettorenteindt.Gebyr- & provis.indt.Rente- & gebyrindt.

KursreguleringerOmkst.& afskrivn.Tab og henst.Resultatfr skatPerioderesultat

UdlnIndlnEgenkapitalBalancesum

Egenkap.forr., pct.Udln/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

5,527,040,4

62,78,63,0

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-BurdarsKoncernmio.ISK

Nettorenteindt.Gebyr- & provis.indt.Rente- & gebyrindt.

KursreguleringerOmkst.& afskrivn.Tab og henst.Resultatfr skatPerioderesultat

UdlnIndlnEgenkapitalBalancesum

EK-forr. f.skat, pct.EK-forr. e. skat,pct.Indtj./omkst. kr.Udln/egenkapitalResultatpr.aktie, ISKAntal ansatte,gns.

Adm. direktr: Hreidar Mr SiBestyrelsesformand: Sigurdur Eiwww.kaupthing.com

1. kvt.2007

16.26512.33728.602

13.45617.7071.423

24.93020.694

2.559.121892.170313.900

4.198.385

7,76,4

2,308,1526,7

2.805

+37%

Udln

+6%

Resultat

+50%

Indt.

Kaupthing Bank

o islandske ban-er er kommet

med kvartalsregn-kaber, der viserdt lavere vkstnd hidtil


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

Beating The TSX

Global Warming AndYour Portfolio

David 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 worlds 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 earths 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 2.3C over the last 61years (Figure 2 shown on the next page).

World data also show a distinct warming trend. Figure

3 (shown on the next page) gives results for three climateparameters. From these and other data, the IPCC predictstemperature rises of 1.1-6.4C 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, agriculture

will 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, from

1976-2008.
http://www.canadianmoneysaver.ca/http://www.canadianmoneysaver.ca/http://www.canadianmoneysaver.ca/http://www.almanac.com/weatherhistory/locations/index.phphttp://www.almanac.com/weatherhistory/locations/index.phphttp://www.msc-smc.ec.gc.ca/ccrm/bulletin/national_e.cfmhttp://www.msc-smc.ec.gc.ca/ccrm/bulletin/national_e.cfmhttp://www.canadianmoneysaver.ca/http://www.msc-smc.ec.gc.ca/ccrm/bulletin/national_e.cfmhttp://www.msc-smc.ec.gc.ca/ccrm/bulletin/national_e.cfmhttp://www.almanac.com/weatherhistory/locations/index.phphttp://www.almanac.com/weatherhistory/locations/index.php


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Figure 3 - Changes in (a) global average surface temperature; (b) global average

sea level rise from tide gauge (blue) and satellite (red) data and (c) northern

hemisphere snow cover for March-April. All changes are relative to corresponding

averages for the period from 1961-1990. Source: 2007 Intergovernmental Panel on

Climate 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

worlds energy infrastructure awayfrom fossil fuels will be a humanactivity for many years and there isa universal call for more researchand development. Undoubtedly,numerous investment opportunities

will arise from this work. Lets look

at some ways the individual investorcan participate.First, let me say that the mention

of 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 was

surprised 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 Global

Warming 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 base

temperatures. There are also specific Canadianfutures, one being the Canadian MonthlyWeather Heating Degree Day (HDD) index thatis geared to how much below 18C 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, solar

energy, 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
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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 20.5

Johnson Controls JCI (US) Automotive control, energy management 35.05 1.50 15.5

Waste Management WMI (US) Waste management, recycling 35.76 3.10 16.9

Alcoa AA (US) Aluminum, automobile parts 36.26 1.90 13.9

Caterpillar CAT (US) Earth moving equipment 85.28 1.70 16.0

DuPont DD (US) Chemical, agriculture, biotechnology 52.02 3.20 15.9

FPL Group FPL (US) Electric utility, fiber optic network 66.44 2.60 20.5

Archer Daniels ADM (US) Agricultural processing, ethanol 46.47 1.10 18.3

John Deere DE (US) Agricultural equipment 92.68 1.10 20.8

Siemens A G SI (ADR) Industrial automation, building tech 113.95 2.10 11.0

Magna Intl. MG.A (CAN) Automotive systems 72.01 2.00 12.0

ITC Holdings Corp. ITC (US) Electricity transmission infrastructure 56.38 2.10 32.9

Dow Chemical DOW (US) Chemical, plastic, agricultural products 39.98 4.30 10.5

Honeywell Intl. HON (US) Diversified tech. and manufacturing 60.99 1.90 18.2

Trinity Industries TRN (US) Rail services, highway construction 27.10 1.10 7.0

Source: Alt Energy Stocks (http://www.altenergystocks.com)

late in 2007 at a price of$20.00 (CAD) and as of

April 18, 2008 had ad-vanced to $25.75 (CAD)

with a dividend yield of0.84%.

Another ETF operating

in 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, 2008

was 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 utilities

and 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 of

April 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 investors needs.

Individual stocks - If, upon inspection, the above ETFsseem a little too risky and volatile for your taste, you may

wish 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 profit

while 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, [email protected]
http://www.canadianmoneysaver.ca/http://www.canadianmoneysaver.ca/http://www.canadianmoneysaver.ca/http://www.altenergystocks.com/http://www.altenergystocks.com/ar-chives/2007/11/our_blue_chip_alternative_energy_stock_list.htmlhttp://www.altenergystocks.com/ar-chives/2007/11/our_blue_chip_alternative_energy_stock_list.htmlhttp://www.altenergystocks.com/ar-chives/2007/11/our_blue_chip_alternative_energy_stock_list.htmlhttp://www.socialinvestment.ca/mutualfunds.htmmailto:[email protected]://www.canadianmoneysaver.ca/mailto:[email protected]://www.socialinvestment.ca/mutualfunds.htmhttp://www.altenergystocks.com/ar-chives/2007/11/our_blue_chip_alternative_energy_stock_list.htmlhttp://www.altenergystocks.com/ar-chives/2007/11/our_blue_chip_alternative_energy_stock_list.htmlhttp://www.altenergystocks.com/ar-chives/2007/11/our_blue_chip_alternative_energy_stock_list.htmlhttp://www.altenergystocks.com/ar-chives/2007/11/our_blue_chip_alternative_energy_stock_list.htmlhttp://www.altenergystocks.com/


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