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© Cargill Incorporated 2002
Weather Risk Management for Agriculture
Michigan State University
March 22, 2002
Cargill Risk Management
2Cargill Risk Management
Weather is a Business Risk
Recent Weather Related News Items:
• …”Bullish hopes that a recent bout of hot and dry weather would hurt the quality of the 2001 crops were thrown aside following reports of a rainy, cool weekend in key corn and wheat growing regions…..” WSJ, May 22, 2001
• …”Hot, dry weather in August damaged the nation's corn crop, dropping the estimated harvest to the lowest in four years….” St. Louis Dispatch, September 15, 2001
• “Weather Problems Result in Bad Year for Michigan Wine Grape Growers”….”even before the growing season began, more than half of the buds of damage-prone wine grape varieties were killed by harsh winter temperatures in December…..” Knight Ridder, October 20, 2001
The U.S. Department of Commerce estimates that up to $1 trillion of the $7 trillion U.S. economy is subject to weather risk.
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Weather is a Business Risk That Can be Covered
The market for weather risk management products was established in late 1997 to help energy companies hedge volumetric risk and smooth revenue streams. It is quickly migrating to new industries as participants become familiar with the applications and benefits of these products.
Volume of transactions since market inception is roughly $10 billion.
Weather risk management tools are used by companies for protection against “adverse” weather conditions.
Companies no longer have to bet on “good” weather.
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Weather Risk Management Products
Weather risk management products are structured as customized financial instruments that allow companies to hedge weather-related revenue or margin exposure.
Protection generally for a season (winter/summer) or multiple seasons.
Protection is typically based on an average weather index during a season or on a specific weather event occurring during the season.
Protection is typically capped to reduce cost.
Protection can be tailored for a specific location or can be based on a basket of multiple locations.
Protection may be imbedded or combined with other risk management tools or into physical commodity contracts.
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Weather Indices
Temperature over period of time Temperature Extreme Rainfall Snowfall Snow cover River flow Wind speed Storm Activity (intensity, frequency) Misery Indices (wind chill, heat index) Frost/Freeze (if four hours below 28° then …) Combination/Multiple Triggers (if snow and temp then …) Customized Indices (multiple city baskets)
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Weather Risks for Crop Yields
1) Excessive heat - persistent temperatures above certain thresholds are detrimental to crop.
2) Excessive cold – freeze/frost can harm planting and harvest. 3) Minimal precipitation - insufficient rainfall diminishes crop size. 4) Excessive precipitation – too much rainfall diminishes crop
quality.
Poor Yields Equal Poor Revenues………… Example -- For a 40 bu/ac drop in corn yield from expected:
$0.10/bu * 250,000 acre * 40 bu/ac = $1,000,000 deficit
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• Extreme degree day = max(High Temp-86,0)• Weather data from Lansing Station
Year Weather Event Time Period Index Actual Average
1996 Early Wet May-Jun Rain 11.88 6.411988 Early Dry May-Jun Rain 0.83 6.41
Hot Jun-Aug Extreme DD 343 72.51984 Dry Jun-Jul Rain 2.96 6.311976 Dry Aug Rain 0.58 3.221974 Dry Jul Rain 1.21 2.621965 Dry Jul Rain 0.5 2.62
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Weather Protection
• Advantages– Historical Payouts correlate well with low yield years– Individual products are inexpensive
• Disadvantages– Protection from all weather extremes has its cost
Structure 1 Structure 2 Structure 3
Index Rain Extreme DD Rain
Time Period 5/1-6/30 6/1-8/31 7/1-7/31
Threshold 3.5 inches 200 DDs 1.5 inches
Incremental Payment
10 cpb/inch 0.25 cpb/DDs 10 cpb/inch
Maximum Coverage
25 cpb 25 cpb 25 cpb
Premium 2.1 cpb 1.8 3.75 cpb
1988 max 1988 max 1965 max1965 1/4 max 1989 1/2 max
2001 1/3 max
1978 1/3 max1974 1/3 max1967 1/3 max
Noted Historical Payouts
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Yield Protection
• Advantages– Direct Volume Protection
• Disadvantages– Cost is higher due to higher risk
3 county average APH = 116.6
Threshold 112 112 107 102 bu/ac
Incremental payment 1.25 1 1.25 1.25 cpb/(bu/ac)
Maximum Coverage 25 25 25 25 cpb
Premium 6.25 5.625 4.5 3.55 cpb
4 Levels of Coverage
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Daily Weather Indices
• Advantages– Flexibility in structure, cost, and timing– Can be traded like any financial index– Immediate settlement– Can protect against short term quality issues as well as seasonal volume
protection for specialty crops
• Disadvantages– Developmental Stages….
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Contact us for more information:
Michael Grover, Mgr. Weather Risk Products
952-984-3235 [email protected]
Ryan Williams, Ph.d.Weather Risk Products
Cargill Risk Management
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Quotes of the Day“Everybody talks about the weather, but nobody does anything about it.” (Charles Dudley Warner,1897, Hartford Courant)
“Drought is part of the cycle, but when it comes you’re never ready for it.” (farmer of 33 years in Blue Springs, NE)
“We’re retailers, not meteorologists, and as long as weather affects our business, we have to do something about it.” (director of supply-chain strategy at Sears)
“I think the only thing we can do is pray for a very warm winter.” (chief economist, Center for Global Energy Studies)
“For too long, businesses have cited bad weather as an excuse for under-performance. This excuse is no longer valid.” (anonymous)
