What Does Cooling Degree Day Mean?
A cooling degree day (CDD) is a measurement designed to quantify the demand for energy needed to cool buildings. It is the number of degrees that a day's average temperature is above 65o Fahrenheit (18o Celsius). Studies have shown that when the outside temperature reaches that level, people inside no longer want the building heated, but instead begin to consider cooling the building.
This measure has relevance to the price of weather derivatives traded on the basis of 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.
- Cooling Degree Day is a measure that helps to simplify the cost of projected energy consumption.
- It is based on the number of days where the temperature is above 65 degrees Fahrenheit, and the number of degrees above 65.
- Taking an average of the number of degrees and days above 65 helps organizations that have a need to hedge against energy costs.
Understanding 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 derivatives. These instruments create a risk management tool that utility, agriculture, construction, and other firms can use to hedge their activities affected by outdoor climate whether it be energy demand, growing season, or 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. Here are examples of two ways that are often used.
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).
A Utility company might recognize that they the price they are paying energy producers will be cost-prohibitive if they need to provide more energy than they expected. Using the information from the previous example, they could take weather data from previous years and current seasons to estimate their risk. Weather derivative (futures) contracts could then be purchased to protect against significant losses if the company expected higher temperatures. These same could likewise be sold if the company expected significantly lower temperatures.
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.