DEFINITION of 'Cooling Degree Day - CDD'

A cooling degree day (CDD) is a measurement designed to quantify the demand for energy needed to cool a building. It is the number of degrees that a day's average temperature is above 65o Fahrenheit (18o Celsius), which is the temperature above which buildings need to be cooled. The price of weather derivatives traded in the summer is based on an index made up of monthly CDD values. The settlement price for a weather futures contract is calculated by summing CDD values for a month and multiplying that sum by \$20.

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BREAKING DOWN 'Cooling Degree Day - CDD'

While CDD can describe the overall need for cooling as part of the planning for residential or commercial buildings, it is critical for the pricing of weather futures. In turn, that creates a risk management tool that utility, agriculture, construction and other firms can use to hedge their activities that depend on weather, such as energy needs, growing season, and outdoor work time.

How to Calculate Cooling Degree Day (CDD)

There are several ways to calculate CDD. The more detailed a record of temperature data, the more accurately the CDD can be calculated.

1. Subtract 65 from the average of a day's high and low temperatures. For example, if the day's average temperature is 75o F, its CDD is 10. If that day's average is below 65, the result is set to zero. If every day in a 30-day month had an average temperature of 75o F, the month's HDD value would be 300 (10 x 30). The nominal settlement value for that month's weather derivative contract would therefore be \$6,000 (300 x \$20).

2. Subtract 65 from each half-hourly temperature reading, with the provision that negative values be set to zero, sum the result and divide by 48 (48 half-hours in a day). Then sum that value over 30 (for a 30-day month) and multiply by \$20. If a given day's value is less than or equal to zero, that day has zero CDD. But if the value is positive, that number represents the CDD on that day.

For all methods, if the value for any given day is less than or equal to zero, that day has zero CDD. But if the value is positive, that number represents the CDD number of that day.

A similar measurement, heating degree day (HDD), reflects the amount of energy needed to heat a home or business.

One caveat is that cooling degree days are extremely localized. Cooling needs vary greatly depending on the geographical region. Furthermore, the average CDD in one building may not have the same impact as it does on the building next door due to differences in construction, orientation relative to other buildings, insulation, sun exposure, and the nature of the building's usage.

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