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Derivatives Help Businesses Weather Cold

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Derivatives Help Businesses Weather Cold

Business

Derivatives Help Businesses Weather Cold

Derivatives Help Businesses Weather Cold

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Citrus worker Audra Wilson packs oranges for customer orders Monday in Clermont, Fla. The fruit was picked before the freeze, but the grove owner estimates a 30 to 50 percent loss of the fruit still on the trees. John Raoux/AP hide caption

toggle caption John Raoux/AP

Citrus worker Audra Wilson packs oranges for customer orders Monday in Clermont, Fla. The fruit was picked before the freeze, but the grove owner estimates a 30 to 50 percent loss of the fruit still on the trees.

John Raoux/AP

From the northern plains to Miami, the first half of January brought bone-chilling wind and cold. The record low temperatures inflicted big financial losses on many industries.

Citrus growers, truckers, restaurant workers, dairy farmers, crawfish harvesters and others have seen their profit outlooks shrink because of weather-related higher costs and lower revenues.

The Commerce Department says one-third of all business activity in this country — from utilities to airlines to theme parks — has a direct stake in the weather.

The citrus industry in Florida is particularly tied to weather. The growers' trade association has not yet tallied the costs of this month's weather-related damage, but it says growers sustained a significant loss of fruit.

Weather is unpredictable and uncontrollable, so business owners have a long history of looking for ways to offset the economic impact of storms and harsh weather. Ship owners, sailors and merchants started spreading risks with the help of Lloyd's of London more than three centuries ago. The colonial entrepreneurs wanted insurance in case their ships didn't come in.

Citrus growers spray water on their trees to protect the fruit from subfreezing temperatures. Red Huber/Orlando Sentinel/AP hide caption

toggle caption Red Huber/Orlando Sentinel/AP

Citrus growers spray water on their trees to protect the fruit from subfreezing temperatures.

Red Huber/Orlando Sentinel/AP

In more recent times, business owners used relatively simple financial products such as flood insurance to protect property from soaking rains.

Now, they are turning to financial markets to give themselves a little more protection from Mother Nature. They are using so-called weather derivatives to reduce their weather-related losses. These were created by securities traders about 20 years ago. They are futures contracts and options that allow parties to effectively bet on the weather. On one side of the agreement, someone will profit if the weather is mild; on the other side, someone will gain if the weather is terrible.

For example, a theme park operator in Florida could hedge against cold days in January by using a weather futures contract to effectively set up a swap. Under the contract, one party gets paid if a certain number of days are colder than a set point — say, 40 degrees. The other party gets paid if it turns out to be warmer than expected.

These weather derivatives help the operator avoid the worst consequences of bad weather.

Of course, there are limits. Even the smartest financial wizards don't know how to create instruments big enough to protect against the kind of change that could happen as a result of global warming.

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