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New financial hedge for weathering the weather

New financial hedge for weathering the weather
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First Published: Thu, Jun 07 2007. 12 45 AM IST
Updated: Thu, Jun 07 2007. 12 45 AM IST
San Francisco: A San Francisco start-up is touting a new kind of financial hedge aimed at helping small businesses weather the weather.
WeatherBill, a venture capital-backed firm started by two former Google employees, sells what are called weather derivatives—contracts that pay in cash if the weather hits a selected level of heat, cold, rain or drought.
Weather derivatives have been available to large companies such as electric utilities for a decade. But WeatherBill is making them available over the Internet to smaller companies that are affected by the weather, such as golf courses, restaurants and even hair salons. For instance, a San Francisco golf course trying to compensate for slow business on rainy autumn days could buy a contract that would pay $500 for each day with more than half an inch of rain from 1 October to 30 November. WeatherBill quotes a price of $1,451.74 for such a contract.
“We can sell a weather contract for $1 or $100 million," said chief executive officer, David Friedberg, who founded the company with chief technology officer, Siraj Khaliq. “We've used technology to let us address the needs of businesses of any size." In reality, WeatherBill's services will initially be limited to businesses with a net worth of $1 million or more. That rules out small mom-and-pop firms.
And some observers caution that weather derivatives are too complicated and risky for small businesses. They note that weather derivatives were pioneered by Enron as a tiny part of its business during the go-go days before its collapse.
“It's basically placing a bet, and you might as well go to the Preakness," said Rick Vassar, a Virginia risk management consultant and author of Hide! Here Comes the Insurance Guy.
WeatherBill isn't the first company selling tools for businesses to protect themselves from bad weather. Insurance companies have traditionally offered policies covering catastrophic weather or major crop failures. They also offered policies covering cancellation of special events due to weather.
But WeatherBill's contracts go beyond catastrophes like hurricanes, to address more-modest weather challenges such as a somewhat rainy spring or cool summer. And unlike insurance, WeatherBill doesn't require businesses to show proof of actual losses to get a payout.
Spencer Malay Hair, an Atlanta salon and day spa that opened less than a year ago, is a WeatherBill client and an example of how weather derivatives work for a small business. The salon's owners rely on walk-in customers from a nearby movie theater to build clientele. But they found their walk-ins dropped dramatically on sunny days when people stayed away from the movies.
Searching on the Web for weather forecast information, co-owner Ray Luciano stumbled upon WeatherBill. He and partner Spencer Malay decided to spend $2,000 for a contract that would pay them $10,000 if the weather was completely dry over a particular two-day weekend. The skies did indeed stay dry, and the salon reaped $10,000. Luciano and Malay bought a similar contract for another weekend and reaped another $10,000.
They plan to continue buying a weather contract every few months until their salon is busy enough that they no longer need walk-in clients. “If it had rained, we would have lost $2,000 but we would have more than made up for it with the new clients we would have gotten," Luciano said. “This helps us protect ourselves if the weather doesn't go the way we want it to." Not all of WeatherBill's clients, receive the dramatic payoff that Spencer Malay Hair did.
The challenge for weather contract buyers is weighing the likelihood of bad weather against the cost of protection. “You need to be really, really informed," Vassar said. “A lot of small business people don't have the time or expertise to do this financial modeling."
WeatherBill faces its own set of challenges. To turn a profit, the company must rely on databases of historical weather information and complex mathematical formulas aimed at calculating the likelihood that a given time period will be wet, dry, cold or hot. And it's got to do this at a time when global warming is calling much historical weather data into question.
The company also must find enough customers to balance its own risk—offsetting payments to some clients with revenues from others who didn't win a payout. “Their challenge is to build a diversified book, so their risk is spread across different kinds of weather conditions, different geographical areas and different time periods," said Scott Mathews, president of WeatherEX LLC, a commodity trading advisory firm. “If they have that, they won't be inundated by rain people or drought people."
WeatherBill has some deep-pocketed help. It has venture capital investment from New Enterprise Associates and Index Ventures. Nephila Capital, a $3 billion reinsurance company, also owns a minority stake in WeatherBill and provides reinsurance for the firm.
Friedberg said he got the idea for WeatherBill about two years ago when he was still working in Google's corporate acquisitions division and Khaliq was an engineer there. Friedberg lived across the street from a bicycle shop and noticed that its business plummeted on rainy days. “I thought it would be cool to do something to help protect these businesses whose revenues were so dependent on the weather," he said.
At that point, Friedberg had never heard of weather derivatives. But derivatives had been around since the late 1990s. Electric deregulation, which spread across the country in the 1990s, meant that utilities were no longer able to pass all their costs on to consumers. They began looking for ways to control expenses such as unexpected spikes in the cost of energy due to weather.
WeatherBill aims to reach smaller businesses by using the Internet to streamline the process, making it as simple to price a weather contract as it is to buy something on E-Bay.
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First Published: Thu, Jun 07 2007. 12 45 AM IST
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