Derivatives Market Trends
Overall, weather-based derivatives have little trading volume currently, although recent innovations could restore this market. At this time, companies no longer prefer weather-based derivatives to hedge against loss of earnings due to unfortunate weather. Conversely, the energy derivative market is growing.
Despite thorough research, only limited sources could be found for both the derivatives. However, the trends project an in-depth picture of the present and the future market potential of the derivatives. A deep dive on the research is presented below.
Weather-based derivatives trends
1. In 2017, the Chicago Mercantile Exchange (CME) stopped offering snow-based derivatives, owing to the fact that there was little to no trading volume of the contract. The exchange delisted them along with all other products that were not attracting traders.
2. According to Jean Boeing, the head of weather derivatives at EDF Trading in Britain, weather risk management is strategically important in Europe. However, the weather-based derivative market is still in the initial stages and the profitability of this segment is meager at the moment.
3. In Germany, the surge in awareness regarding climate change is drawing attention from the large utilities, like EEX, towards the business of hedging against the risks around gas, power and water supplies due to the uneven pattern of wind, sunshine, and rainfall. For example, in Germany wind energy contributes to 12% of total power generation and hence the power production in this segment involves risks of gain or loss owing to the calm or turbulent wind conditions.
4. Catastrophe bonds or cat bonds — which provide risk coverage against wildfires, solar flares, hurricanes and other natural calamities — are gaining popularity at the moment, although these bonds have been in the market for more than a decade. Investment in these bonds is profitable; of the 300 recent investments in the cat bonds only 10 cases have resulted in losses by September 2017. According to Wall Street Journal, cat bonds which covered hurricane risks and amounted to $26 million have recently been purchased in Florida.
5. According to Aon Benfield’s 2016 Global Insurance Market Opportunities report, "data and analytics can stimulate a new wave of innovation for the insurance industry." The insurance companies are using predictive analytics to better price weather-based derivatives and customize the risk coverage as per business requirements. These predictive weather-based derivatives are useful for agriculture, breweries, airlines and many other weather-dependent industries.
Energy Derivatives trends
1. According to CME group, owing to the uncertainty in the international oil prices there is demand in the energy-derivative segment, which is attracting huge trade volumes. The CME group draws 85% of its revenue from transaction based processes of which energy-derivatives play an important part. CME's energy derivative revenues increased by more than 35% over the last two years.
2. According to Risk.net, the commodity derivative market (including the energy-derivative market) has been in recovery mode after experiencing uncertainty for the past few years. To be more precise, the derivative market for energy — including oil, petroleum, LPG, among many others — has been drawing greater attention in the recent months.
3. This surge in the energy-derivative market has also given rise to non-banks that are fast developing their innovative market strategies to offer better market plans to their potential clients specifically in the Greek and Italian energy markets.
4. The active players in the hedge market include large banks like Citi Group, brokers, and energy traders which make up a large portion of the energy-derivative market. However, there are smaller banks as well which take more risks in developing their derivative products than the larger banks.
5. According to a recent survey by PwC, most corporates need customized or tailor-made energy-derivatives to suit their needs ("on bespoke terms"), so the future of the energy-derivative market is more dependent on the over-the-counter (OTC) trade rather than the standardized market. However, standardization is necessary for the development of the energy-derivative market. Thus, more tailor-made or bespoken products are likely to emerge in the future to cater the needs of the diverse "hedge seekers" mitigating their energy risks.
To wrap it up, the weather-based derivative segment is in demand in weather dependent industries including agriculture, breweries, and airlines; however this segment has lost trading value over the past few years. Insurance companies are using cutting edge data and analytics to customize their derivatives, with the hope that increased innovation will restore market value to the weather-based derivative segment. The energy-derivative segment, which was uncertain in the past few years, is now attracting huge trading volume. However, the majority of the demand for energy-products is through OTC trading and in bespoken terms, to suit the corporate needs.