Thursday, January 8, 2009

Cold weather in Europe catching many by surprise

Following some milder weather in mid December, temperatures across much of Europe have been extremely cold from late December through January. London is in the midst of a stretch of several evenings with sub-zero temperatures (5 and counting), which has lead to an unusually high number of infrastructure related problems such as water pipe bursts and tank ruptures. It is not necessarily noteworthy that there are sub-zero temperatures in winter in the UK, it is just that a stretch of days where minimum temperatures drop to these levels is unusual. This stretch of cold days is significantly cooler than both last year as well as normal, so utility operators and/or weather risk managers who were planning energy load requirements off of either variable (LY or normal) were likely caught off-guard. The effects spill over into the energy markets, where incidentally, the timing of this weather event is not so great (UK natural gas is currently at a three year high). Aside from the financial and infrastructure implications, there are also obvious concerns which address the effects of the cold snap on human health and safety.

Despite the unpleasant conditions that are making life uncomfortable for many UK residents who are without water, power, or both, this sustained Arctic blast was not an unforeseeable event. The use of weather derivatives are one way to protect against this risk. Another is through the use of better long range seasonal outlooks. The chart below highlights the weather forecast for 24 UK markets made by Weather Trends International. Note that this was a long range temperature forecast for the UK, which we made several months in advance. The bars indicate the forecasted year over year temperature (by day), and the solid line shows the observations through 07 January 2009. The ‘hit rate’ for this period, which represents the number of days during the specified period where our long range forecast was directionally accurate, is 78%. Our forecast captured both the magnitude and the timing of this shift from warm to cool, which commenced right around the Christmas holiday.

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