Weather Derivatives as a Financing Tool

Originally published in North American Wind Power, December 2004

Businesses that bear weather-related risks can use weather derivatives as a hedge against such risks.

Weather derivatives are starting to make an appearance in the project finance market. Energy finance professionals need to be familiar with these risk mitigation tools and the creative ways that they can be used. A large "monetization" transaction moving currently to market – and a debate about whether the derivatives should be regulated as insurance – will determine the extent to which they will become a standard tool in the future financing of energy projects.

A weather derivative is a transaction through which payments from one party to the other are made based on weather-related measurements, such as temperature, rain, snow or wind speed. Businesses that bear weather-related risks can use weather derivatives to transfer, share or otherwise hedge against such risks.