The Challenge to Meteorologists in the Weather risk market

Differences in temperatures stirred this new market into motion – differences from the seasonal averages that generate either steady income for power utilities or perturb it.

The market's exponential growth from a few dozen contracts in its first year to a few hundred for the cooling season of 1999 alone, confirms its ability to meet a growing need – that of protecting revenue from the vagaries of weather. The spreading familiarity with these new financial securities explains the expanding interest in this market, yet unresolved meteorological and other problems restrain the market from reaching its full potential.

In its effort to put a price on weather securities, the market estimates future weather probabilities. To do so, it must deal with issues of data acquisition and accuracy, quantitative analysis, and seasonal weather forecasts.

Multi-decadal weather trends seen in the record at many sites and the uncertainties this generates are among the more frequently encountered quantitative problems. The market compensates for these uncertainties by keeping bid/ask spreads wide. Meteorologists might focus more on this issue to reduce these uncertainties and provide resolutions that could spur more market activity. This, in turn, would lead to more opportunities for meteorologists.

Other quantitative issues deserving meteorological attention include estimating precipitation probabilities, and estimating weather basis risk – the uncertainties in extrapolating the weather measured at one location to either another location or over a region. Moreover, as we have experienced in other commercial sectors, we encounter problems in tailoring forecasts to the particular needs of this market, and in explaining the value of seasonal forecasts to end-users of the information.