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Fri February 4, 2011
Banking on snowfall at the Chicago Board of Trade
Parts of the Midwest are still shoveling out after one of the worst blizzards in recent memory. For some people, they can't see the good in all that snowfall.
But at the Chicago Board of Trade, this blizzard may be a boon for business.
Investors are banking on a futures market based on snowfall that’s the first of its kind in the world.
The average annual snowfall at Chicago’s O’Hare airport is about 37 inches. Given that more than 20 inches fell in one day during the Blizzard of 2011, you can bet the year’s total will be much higher. For people responsible for the cleanup, those additional inches are adding up to many extra hours of work.
Raul Montesyoca says it usually takes him about an hour to clear the snow at a local factory on Chicago’s North Side.
Montesyoca is a small player in a snow removal business. The entire industry is actually as large as $8 billion. So it’s natural that eventually it would spawn a new financial instrument: snow derivatives.
Here’s how it works: Most major snow removal contracts are calculated by the season. A contractor is paid a set fee to clear all the snow that falls that winter - regardless of how deep it is.
In the past, snow removal companies would simply have to end up cover the extra costs if more snow falls. But that’s not the case anymore.
"Everybody says you can control everything but the weather. Well, we can’t control the weather, but we can help you mitigate the risk of weather on your business," says Tim Andriesen.
Andriesen runs the CME Group’s agricultural products and alternative investments. The company’s responsible for the Chicago Mercantile Exchange and the Chicago Board of Trade
The floor of the CBOT is famous for its markets where people trade on the future price of commodities like corn, pork bellies – even milk.
Two years ago, they created contracts based on the amount of snow that falls.
It’s basically like an insurance policy.
The CME offers them based on the official airport snowfall tallies from O’Hare, Minneapolis/St. Paul, Detroit and Boston, as well as New York’s LaGuardia and in Central Park.
Andriesen explains how it works:
If you’re an airline, and you have to cancel a bunch of flights, you’re forgoing a lot of revenue, so our products would allow people to hedge against that extra cost of having to deal with the weather.
The creator of this idea, Jeff Hodgson, came up with it while he was a broker at Merrill Lynch in Chicago.
He had a client with a road salt business, "and he had, as you can imagine, a need to hedge that weather exposure. He’s buying millions of dollars of salt and had no way of controlling that risk," says Hodgson.
So Hodgson left Merrill Lynch to start the Chicago Weather Brokerage.
These snow futures contracts are a tiny market compared to say, oil futures. But it’s really taken off – Hodgson has gone from doing half a million dollars of contracts to around $3 million. That’s six times as many in a year.
And the blizzard of 2011 is like a huge commercial for this market:
"Then, people will say, wow, this is a storm that I didn’t see coming. And I just lost a lot of money on my business or I could have made a lot of money."
Contracts can be purchased by the month, or for the entire snow season, which for them runs until March.
But not to worry – his business doesn’t end with winter.
In the spring, the Chicago Weather Brokerage starting selling contracts based on rainfall.
(This story was produced for Changing Gears - a new public media project looking at the reinvention of the Midwestern economy)