ANALYSIS - Frigid Winter Sparks Japan Weather Derivatives
Date: 14-Mar-06
Country: JAPAN
Author: Ikuko Kao
The Japanese market for weather products - over-the-counter contracts based on temperatures, snowfall or other conditions in a city or region - grew a third to about 80 billion yen ($680 million) in the year to April, Mizuho Corporate Bank estimates.
That pales in comparison to the $36 billion ploughed into the Chicago Mercantile Exchange's (CME) futures contracts last year, a 15-fold rise from the year before, fuelled by speculative fund activity and a flush of hedging demand.
"It's true that abnormal weather conditions help weather derivatives get a higher profile and the market grow," said Jun Kase, vice president of the derivatives business unit at Mizuho.
The biggest players have been power and gas firms who incur added costs when forced to meet higher demand during unusually cold winters or hot summers, but interest is also growing from retail shops, farmers, airport operators and travel agencies.
Japan suffered the coldest December since the mid-1980s and in some areas saw its heaviest snowfall on record, driving up kerosene prices for home heaters, forcing power providers to buy costly oil, hitting farm output and disrupting transportation.
But severe weather conditions that appear once every several decades cannot foster the market alone.
"The market needs an exchange to let big foreign funds in," says Kase.
The Tokyo Financial Exchange (TFX), which lists foreign exchange futures and swaps, had planned to introduce weather contracts in December, but missed that deadline on undisclosed technical reasons. An exchange spokesman declined to give a new target.
A more liquid market would encourage more participation from hedgers such as Tokyo Electric Power Co. (TEPCO) and banks such as Goldman Sachs, which industry sources say has recently hired a new trader to specialise in the area.
Active players now include Japanese banks such as Mizuho and Sumitomo Mitsui Banking Corp., a 100 percent unit of Sumitomo Mitsui Financial Group., as well as Natsource Japan, a unit of Mitsubishi Corp.
SNOW AND TRADE
The modern market for weather derivatives was born about 10 years ago in the United States, with innovative but ultimately failed energy trader Enron in the vanguard.
Japan, the world's second-largest economy and third-biggest energy consumer, followed several years later with insurer Mitsui Sumitomo selling a contract to a retail ski shop to hedge against low snowfall that could hit its sales.
Banks and traders say there is potentially huge appetite for weather hedging in Japan, where winter temperatures in northernmost Hokkaido can fall as low as 20 Celsius below zero and summers can soar to 40 Celsius (104F) in the capital Tokyo, costing companies billions of yen.
It also has advanced financial systems and savvy corporations which may be ready to hedge their exposure in an era when some environmentalists warn extreme weather may become more common.
But thus far liquidity has been limited, as insurance companies sell weather derivatives to customers without offsetting those risks in the open market.
Mitsui Sumitomo says sales have increased by half so far this year from 2005, with inquiries from transporters and cities on the rise after local governments had to boost tax money to clean up snow from roads and reach isolated villages.
"It is quite possible that sales of snow derivatives products will increase next year," a spokeswoman for Mitsui Sumitomo said.
Traders would like to see more of that business channelled into the market, which could then lure liquidity from speculators and activity from bigger banks and energy companies.
Small users tend to buy as small as a 1 million-yen lot insurance. Big utilities typically prefer 1 billion-yen lot derivative contracts, which use temperatures as a parameter and only trade over-the-counter, industry officials said.
Some dealers are sceptical of how long the new enthusiasm wi