CHICAGO – People across the region are digging out from one of the worst blizzards in recent memory. But at the Chicago Board of Trade, this blizzard may be a boon for business. Here, I look at a futures market based on snowfall that’s the first of its kind in the world.
The average annual snowfall at Chicago’s O’Hare International Airport is about 37 inches. Given that more than 20 inches fell this week, you can bet the year’s total will be much higher. For people responsible for the cleanup, those additional inches are adding up to many extra hours of work.
At a local factory on Chicago’s North Side, Raul Montesyoca says it usually takes him about an hour to clear the snow at a local factory on Chicago’s North Side. Not so today.
“Oh, I was here this morning for four hours,” he said, pushing a snow blower around the parking lot. It’s close to 3 p.m., and he’s come back, for another two hours of work.
Montesyoca is a small player in a snow removal business. But the entire industry is actually as large as $8 billion. So it’s natural that eventually it would spawn a new financial instrument: snow derivatives. (Curious about what a derivative actually is? There’s actually an entire market based on trading the weather. If you’re interested, check out the Weather Risk Management Association. As they like to say: “Weather is no risk for poor earnings”.)
Here’s how it works: Most major snow removal contracts are calculated by the season. A contractor is paid a set fee to clear all the snow that falls that winter – regardless of how deep it is. In the past, snow removal companies would simply have to end up cover the extra costs if more snow falls. But that’s not the case anymore, according the CME Group’s Tim Andriesen.
“Everybody says you can control everything but the weather. Well, we can’t control the weather, but we can help you mitigate the risk of weather on your business,” he said.
The CBOT is the world’s oldest – and largest – futures and options market exchange. Its floor is famous for a place where people trade on the future price of commodities like corn, pork bellies – even milk.
Two years ago, they created contracts based on the amount of snow that falls – it’s basically like an insurance policy. They’re not traded in a pit like older contracts – it’s all done electronically.
The CME offers the contracts based on the official airport snowfall tallies from O’Hare, Minneapolis/St. Paul, Detroit and Boston, as well as New York’s LaGuardia and in Central Park.
Andriesen explains how it works:
“If you’re an airline, and you have to cancel a bunch of flights, you’re forgoing a lot of revenue, so our products would allow people to hedge against that extra cost of having to deal with the weather,” he said.
The creator of this idea, Jeff Hodgson, came up with it while he was a broker at Merrill Lynch in Chicago. He had a client with a road salt business.
“As you can imagine, he had a need to hedge that weather exposure,” said Hodgson, who left Merrill Lynch to start the Chicago Weather Brokerage. “He [was] buying millions of dollars of salt and had no way of controlling that risk.”
These snow futures contracts are a tiny market compared to say, oil futures. But it’s really taken off – Hodgson has gone from doing $500,000 worth of contracts to around $3 million in a year of business.
And the blizzard of 2011 is like a huge commercial for this market.
“They realize the value,” he said. “People say, ‘Wow, this is a storm that I didn’t see coming. And I just lost a lot of money on my business or I could have made a lot of money’.”
Contracts can be purchased by the month, or for the entire snow season, which for them runs until March.
But not to worry – the business doesn’t end with winter. In the spring, the Chicago Weather Brokerage starts selling contracts based on rainfall.