Knowing It’s Going To Rain Is Better Than Guessing

By Gregory S. Davis | July 24, 2008 AAA

Weather is big business, not only for insurers that provide protection from the aftermath of a storm, but also for services that can forecast or offer protection against unforeseen occurrences. On July 6, General Electric's (NYSE:GE) subsidiary, NBC, agreed to pay an estimated $3.5 billion to buy the Weather Channel, which also includes Weather.com. Accurate weather predictions have value not only for planning weddings and picnics, but also for investors and the business world. Let's take a look at how weather forecasts impact business activity.

Weather Forecasting Service Provider
Weather Trends International was recently profiled on the ABC network for the weather forecasting services it provides to well-known clients, including retailer Wal-Mart (NYSE:WMT), clothing manufacturer VF Corp. (NYSE:VFC) and the investment banking firm Citigroup (NYSE:C). Weather intelligence allows companies to time marketing events and product offerings, and to better estimate future orders based on variations in temperature, rainfall and other factors. For this service, the companies pay an undisclosed fee. The return on investment has turned Weather Trends' users into loyal clients. Individuals can also use Weather Trends' free service to forecast weather conditions one year ahead for events such as weddings or vacations.

Banking on the Weather
Weather derivatives are another reason why predicting the weather has become a business activity. These financial instruments work like an insurance policy against poor market conditions. For example, suppose that a gas utility company pays a premium to a weather derivatives broker like TFS Energy LLC to protect itself from financial losses due to an unusually warm winter. If the weather proves to be warmer than a predetermined benchmark, the utility receives a payment based on the value of the contract purchased. If the weather turns out to be normal, the derivatives broker keeps the premium. In this case, the utility company protects itself by ensuring a certain level of income over the winter - if it's warm, the income will come from the derivative, if it's cold, it will come from customers. (To learn more, read Introduction To Weather Derivatives.)

The $32 billion weather derivatives market is driven by banks, utilities and hedge funds. In June, the Weather Risk Management Association out of Washington,D.C., reported a growing use of weather derivatives from India, Latin America and Southeast Asia. The World Bank is also proposing to use weather derivatives to reduce the threat of drought in developing countries. If a tragic event occurred, the World Banks client country would receive a payout from the bank. The Chicago Mercantile Exchange (Nasdaq:CME) is home to the majority of the weather derivatives traded. Banks with weather trading operations include Merrill Lynch (NYSE:MER) and Credit Suisse Group (NYSE:CS).

Farmer's Almanac
A favorite read among commodities traders who want to get a leg up on future weather conditions is the Farmer's Almanac. Weather forecasts for the year are critical to farmers, and futures traders and investors who are eager to determine how an unusually wet or dry season will affect crop prices may look for answers here.

Conclusion
Predicting the weather is not an exact science; in fact, none of the forecasting services mentioned predicted the recent flooding in the Midwestern U.S., but business interest in the weather should continue to grow. Even without the 100% guarantee weather forecasting service buyers would prefer, it appears that walking into a dark room with a flashlight is better than walking in blindfolded.

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