MEANING:

Weather derivatives are financial instruments that can be used by organizations or individuals as part of a risk management strategy to reduce risk associated with adverse or unexpected weather conditions. The difference from other derivatives is that the underlying asset (rain/temperature/snow) has no direct value to price the weather derivative.

There are 4 major players in the weather derivates market : MARKET MAKERS BROKERS INSURANCE AND REINSURANCE COMPANIES. END USERS such as Gas and power marketers and utilities etc

Weather Measures
Weather measures are considered underlying assets of the weather derivatives, as the price of a futures contract is an asset for an option on a commodity. The two most common weather measures are Heating Degree Days (HDD) or Cooling Degree Days (CDD) depending on the specifics of the contract.

Other measures are based on precipitation, which can be measured by the amount of rain over a given time period or on Snowfall, measured by the amount of snow (or sleet) over a given time period.

HDD and CDD

These weather measures are used to measure the demands that arise due to the departure of the average daily temperatures from a base level.

An HDD (or CDD) is the number of degrees the days average temperature is above (or below) a base temperature. They are calculated as follows:
Daily HDD = Max (0, base temperature daily average temperature) Daily CDD = Max (0, daily average temperature base temperature) Where, Base temperature is defined as, the pre-defined base temperature, and, Daily average temperature is measured as the average between the daily high and the daily low.

Weather Derivatives in India

Weather derivatives have been launched in India as well. Here the major customers will be the farming community. We dont see a huge potential for the derivatives by utility companies as India is a power shortage nation and we dont see the chances of excess power due to cooler summers or warmer winters.

Reasons
Farmers
Agriculture credit off-take in ninth plan Rs. 2,31,798 crores (grew @ 20% pa); Target for X plan Rs. 7,36,570 crores. 90% crop losses on account of weather related risks Rural Economy is highly weather dependent

 Commodity Traders
Weather related supply bottlenecks make dry-land commodities very volatile Intraday volatility of Guar, chilly touches 10-15% (daily trading at national exchanges touches Rs.1000 crore daily) Vegetable and fruit Mandis highly dependent on temperature (Delhi Mandi trade alone touches Rs.1000 crore annually) Trader income dependent on weather vagaries

 Industries like agro-input companies, food processing industry, companies, plantations, FMCG, Banks, Power sector etc. Not uncommon to find Agri-Input companies, whose sale dips by over 30-40% due to fluctuation in rainfall