Risk management in troubled times: weather hedging to protect profits in power and gas

European power and gas markets are facing a perfect storm of competition from renewable energy, depressed prices, excess capacity that leaves gas-fired assets idle or moth-balled, and a mild winter that further reduced demand for both the heating and power businesses. Revenue, profitability and share prices of gas and power utilities are in decline.

Risk management is key to navigating rough waters and this year's Swiss Re Corporate Solutions Weather & Energy Conference provided a platform to exchange views on the way forward. Several themes emerged: credit rating agencies are fully aware of the need to protect the remaining margins and see the weather as one of the largest unhedged risk factors; the leading utilities continue actively to manage their weather risk; and there is a range of new product developments especially related to renewable energy addressing for example the risk of off-shore project downtime.

Over 40 experts from the energy industry and the financial sector gathered in Hamburg on 26 June 2014 to discuss the state of their industry as part of Swiss Re Corporate Solutions fourth Annual Weather & Energy Conference.

To illustrate how weather can affect a business, Karin Volgers from Ballast Nedam spoke about an innovative use of a financial product to compensate the company's offshore contracting business for work time lost when seas and wind are too high.

Analysts from the debt and equity side then commented on the investor perspective, acknowledging that weather is a surprisingly undermanaged risk. "Volatility is the enemy of credit" pointed out Tuomas Erik Ekholm of Standard & Poor's. A firm's efforts to hedge weather risk are therefore key evidence of sound risk management.

Given the limits to cost cutting, operational efficiency and the reduction of debt levels to repair profit margins, weather surprises may become unacceptable to investors.

Leading utilities EON, RWE and EDF spoke in the afternoon about how they protect themselves against weather and commodity price risk using pure temperature hedging or products which combine protection against commodity price and temperature risks.

"Weather has a bigger impact on earnings than any other variable" emphasized Scott Putnam from EDF Trading & Markets. Taking the resulting volatilities out will therefore be key for energy and gas suppliers in the years ahead. Tailor-made solutions to hedge commodity price and weather risks are needed to do this. Providing these solutions requires know-how and a solid balance sheet to either take the risk or place it in the market. Swiss Re Corporate Solutions has both.

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