Download - Uncertainty in forecasts
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Uncertainty in forecasts Uncertainty in forecasts Uncertainty in forecasts Uncertainty in forecasts
• When very high temperatures are forecast, there may be a rise in electricity prices.
• The electricity retailer then needs to purchase electricity (albeit at a high price).
• This is because, if the forecast proves to be correct, prices may “spike” to extremely high (almost unaffordable) levels.
• When very high temperatures are forecast, there may be a rise in electricity prices.
• The electricity retailer then needs to purchase electricity (albeit at a high price).
• This is because, if the forecast proves to be correct, prices may “spike” to extremely high (almost unaffordable) levels.
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Impact of Forecast Accuracy Impact of Forecast Accuracy Impact of Forecast Accuracy Impact of Forecast Accuracy
• If the forecast proves to be an “over-estimate”, however, prices will fall back.
• For this reason, it is important to take into account forecast verification data in determining the risk.
• If the forecast proves to be an “over-estimate”, however, prices will fall back.
• For this reason, it is important to take into account forecast verification data in determining the risk.
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Using Forecast Verification DataUsing Forecast Verification DataUsing Forecast Verification DataUsing Forecast Verification Data
• Suppose we define a 38 deg C call option (assuming a temperature of at least 38 deg C has been forecast).
• Location: Melbourne.• Strike: 38 deg C. • Notional: $100 per deg C (above 38 deg C).• If, at expiry (tomorrow), the maximum temperature is
greater than 38 deg C, the seller of the option pays the buyer $100 for each 1 deg C above 38 deg C.
• Suppose we define a 38 deg C call option (assuming a temperature of at least 38 deg C has been forecast).
• Location: Melbourne.• Strike: 38 deg C. • Notional: $100 per deg C (above 38 deg C).• If, at expiry (tomorrow), the maximum temperature is
greater than 38 deg C, the seller of the option pays the buyer $100 for each 1 deg C above 38 deg C.
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Pay-off Chart: 38 deg C Call OptionPay-off Chart: 38 deg C Call OptionPay-off Chart: 38 deg C Call OptionPay-off Chart: 38 deg C Call Option
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Determining the Price of theDetermining the Price of the38 deg C Call Option38 deg C Call Option
Determining the Price of theDetermining the Price of the38 deg C Call Option38 deg C Call Option
• Between 1960 and 2000, there were 114 forecasts of at least 38 deg C.
• The historical distribution of the outcomes are examined.
• Between 1960 and 2000, there were 114 forecasts of at least 38 deg C.
• The historical distribution of the outcomes are examined.
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Historical Distribution of OutcomesHistorical Distribution of OutcomesHistorical Distribution of OutcomesHistorical Distribution of Outcomes
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Evaluating the 38 deg C Evaluating the 38 deg C Call Option (Part 1)Call Option (Part 1)
Evaluating the 38 deg C Evaluating the 38 deg C Call Option (Part 1)Call Option (Part 1)
• 1 case of 44 deg C yields $(44-38)x1x100=$600• 2 cases of 43 deg C yields $(43-38)x2x100=$1000• 6 cases of 42 deg C yields $(42-38)x6x100=$2400• 13 cases of 41 deg C yields $(41-38)x13x100=$3900• 15 cases of 40 deg C yields $(40-38)x15x100=$3000• 16 cases of 39 deg C yields $(39-38)x16x100=$1600
Total 53 cases Total $12500
cont….
• 1 case of 44 deg C yields $(44-38)x1x100=$600• 2 cases of 43 deg C yields $(43-38)x2x100=$1000• 6 cases of 42 deg C yields $(42-38)x6x100=$2400• 13 cases of 41 deg C yields $(41-38)x13x100=$3900• 15 cases of 40 deg C yields $(40-38)x15x100=$3000• 16 cases of 39 deg C yields $(39-38)x16x100=$1600
Total 53 cases Total $12500
cont….
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Evaluating the 38 deg C Evaluating the 38 deg C Call Option (Part 2)Call Option (Part 2)
Evaluating the 38 deg C Evaluating the 38 deg C Call Option (Part 2)Call Option (Part 2)
The other 61 cases (15+7+14+5+1+7+3+1+2+2+0+1+0+2+1), associated with a temperature of 38 deg C or below, yield nothing.
So, the total is $12500
This represents an average contribution of $110 per case ($12500/[61 cases (38 deg C or below)+53 cases (above 38 deg C) ]), which is the
price of our option.
The other 61 cases (15+7+14+5+1+7+3+1+2+2+0+1+0+2+1), associated with a temperature of 38 deg C or below, yield nothing.
So, the total is $12500
This represents an average contribution of $110 per case ($12500/[61 cases (38 deg C or below)+53 cases (above 38 deg C) ]), which is the
price of our option.
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Ensemble ForecastingEnsemble ForecastingEnsemble ForecastingEnsemble Forecasting
• Another approach to obtaining a measure of forecast uncertainty, is to use ensemble weather forecasts
• The past decade has seen the implementation of these operational ensemble weather forecasts.
• Ensemble weather forecasts are derived by imposing a range of perturbations on the initial analysis.
• Uncertainty associated with the forecasts may be derived by analysing the probability distributions of the outcomes.
• Another approach to obtaining a measure of forecast uncertainty, is to use ensemble weather forecasts
• The past decade has seen the implementation of these operational ensemble weather forecasts.
• Ensemble weather forecasts are derived by imposing a range of perturbations on the initial analysis.
• Uncertainty associated with the forecasts may be derived by analysing the probability distributions of the outcomes.
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Some Important IssuesSome Important IssuesSome Important IssuesSome Important Issues
• Quality of weather and climate data.• Changes in the characteristics of observation sites.• Security of data collection processes.• Privatisation of weather forecasting services.• Value of data.• Climate change.
• Quality of weather and climate data.• Changes in the characteristics of observation sites.• Security of data collection processes.• Privatisation of weather forecasting services.• Value of data.• Climate change.
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Weather Derivative Applications Weather Derivative Applications Weather Derivative Applications Weather Derivative Applications • Several Case Studies in the Australia Market will be
analysed including:
• Several Case Studies in the Australia Market will be
analysed including:
Weather Derivatives
Theme Park
Mining
Power
GasAgricultural
Clothing Brewing
Ice Cream
Air ConditioningSoft Drink Sectors
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Applications: Power (1)Applications: Power (1)
• "Earnings from Australian operations were lower primarily because of abnormally warm winter temperatures in Victoria that affected both electric and gas operations.” A utilities company in Texas, November 1999
• Demand for electric power is volatile, dependent upon numerous unpredictable factors, including the weather. New risk management tools can help power generators mitigate the impact of extreme weather conditions.
• "Earnings from Australian operations were lower primarily because of abnormally warm winter temperatures in Victoria that affected both electric and gas operations.” A utilities company in Texas, November 1999
• Demand for electric power is volatile, dependent upon numerous unpredictable factors, including the weather. New risk management tools can help power generators mitigate the impact of extreme weather conditions.
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Applications: Power E.g. 1 (2)Applications: Power E.g. 1 (2)
• A power generator can hedge its power price risk with a financial swap. However, it will incur an opportunity loss against the RRP (pool) price if temperatures in South Australia rise above normal during the peak cooling season (December - March).
• A power generator can hedge its power price risk with a financial swap. However, it will incur an opportunity loss against the RRP (pool) price if temperatures in South Australia rise above normal during the peak cooling season (December - March).
•Source:EnronOnline
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Applications: Power E.g. 1 (3)Applications: Power E.g. 1 (3)
• Under such conditions, a generator would like to receive a higher price for its power, which it will already have hedged through an electricity swap.
• Under such conditions, a generator would like to receive a higher price for its power, which it will already have hedged through an electricity swap.
•Source:EnronOnline
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Applications: Power E.g. 2 (4)Applications: Power E.g. 2 (4)
• A weather-indexed commodity swap can be structured to protect against such opportunity losses inherent in hedging programs.
• A weather-indexed commodity swap can be structured to protect against such opportunity losses inherent in hedging programs.
•Source:EnronOnline
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Applications: Power E.g. 2 (5)Applications: Power E.g. 2 (5)• The South Australian generator agrees to sell 60MW of
flat power at a price of $50/MW for the month of February 2001. Having analyzed historical weather conditions, both parties agree on a trigger number of 110 cooling degree days for February. CDDs are calculated as the cumulative number of CDDs for the month of February.
• The South Australian generator agrees to sell 60MW of flat power at a price of $50/MW for the month of February 2001. Having analyzed historical weather conditions, both parties agree on a trigger number of 110 cooling degree days for February. CDDs are calculated as the cumulative number of CDDs for the month of February.
•Source:EnronOnline
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Applications: Power E.g. 2 (6)Applications: Power E.g. 2 (6)• Should the underlying weather conditions be warmer
than the trigger, the power producer will be assured of receiving a higher price for its power. For every CDD per day above 110, to a limit of 200, the power company will be paid AU$0.10c/MW over the base price.
• Should the underlying weather conditions be warmer than the trigger, the power producer will be assured of receiving a higher price for its power. For every CDD per day above 110, to a limit of 200, the power company will be paid AU$0.10c/MW over the base price.
•Source:EnronOnline
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Applications: Power E.g. 2 (7)Applications: Power E.g. 2 (7)• If the cumulative number of CDDs for February equals
125, the power company would receive AU$51.50/MW(AU$50 + AUD$0.10 x (125 - 110)). If the weather proves to be cooler than the strike of 400 CDDs, the generator will still be assured of a price of $50 per MW from the weather-indexed commodity swap.
• If the cumulative number of CDDs for February equals 125, the power company would receive AU$51.50/MW(AU$50 + AUD$0.10 x (125 - 110)). If the weather proves to be cooler than the strike of 400 CDDs, the generator will still be assured of a price of $50 per MW from the weather-indexed commodity swap.
•Source:EnronOnline
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The increasing focus on weather riskThe increasing focus on weather riskThe increasing focus on weather riskThe increasing focus on weather risk
• 3,937 contracts transacted in last 12 months (up 43% compared to previous year).
• Notional value of over $4.3 billion dollars (up 72%).• Market dominated by US (2,712 contracts), but growth in
the past year is especially so in Europe and Asia. • Australian market accounts for 15 contracts worth over $25
million (6 contracts worth over $2 million, previously).
Source: Weather Risk Management Association Annual Survey (2002)
• 3,937 contracts transacted in last 12 months (up 43% compared to previous year).
• Notional value of over $4.3 billion dollars (up 72%).• Market dominated by US (2,712 contracts), but growth in
the past year is especially so in Europe and Asia. • Australian market accounts for 15 contracts worth over $25
million (6 contracts worth over $2 million, previously).
Source: Weather Risk Management Association Annual Survey (2002)
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Survey Design and Survey Design and Implementation (1)Implementation (1)Survey Design and Survey Design and Implementation (1)Implementation (1)
• Presurvey (sent in February)
– Sent to All WRMA members
– Will you participate? 20 companies responded in 2002 (19 in 2001)
• Survey (sent in April)
• Establish size of market between April 2001 and March 2002 (Latest statistics)
• 5 Pages in total (2 pages returned to PwC)
• General information about company
• Information on Contracts
– Responses confidential and destroyed once tabulated
•Source: Weather Risk Management Association Annual Survey (2002)