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Ugg Case Study Weather Derivatives Data

Weather risk management and hedging case studies

A selection of articles and papers providing case studies on how industries and end-users utilise weather risk management, weather derivatives and weather risk transfer techniques to hedge risk.

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Risk Management Issues for Small Farms with Local Food Systems 
Choices Magazine 2013

How United Grain Growers tamed Mother Nature in completing the deal of the decade 
CFO Magazine Jun 2000

Construction, Ingenuity and Derivatives: A Profile 
Risk Management Solutions

The Potential Role of Weather Markets for U.S. Agriculture 
Cooerative Extension Service

The Effects of Weather on Retail Sales 
Martha Starr-McCluer Jan 2000

Hedging Maize Yield with Weather Derivatives 
Geyser J.M and T.W.G Van de Venter Jan 2001

Hotel Marketing Strategy 
Evolution Markets LLC

NYC Brewery Co. Weather Hedge 
Evolution Markets LLC

Can Weather Derivative Contracts Help Mitigating Agricultural Risk? Microeconomic Policy Implications for Romania 
Aslihan Spaulding, Murali Kanakasabi, Jianqiang Hao and Jerry Skees

THI Application to Insuring Against Heat Stress in Dairy Cows 
Xiaohui Deng, Barry J. Barnett, Dmitry Vedenov, and Joe W. West Feb 2004

Weather derivatives as an instrument to hedge against the risk of high energy cost in greenhouse production 
Ernst Berg, Bernhard Schmitz, Michael Starp 2006

Weather Derivatives in the Presence of Index and Geographical Basis Risk: Hedging Dairy Profit Risk 
Gang Chen and Matthew C. Roberts Apr 2004

Monsoon Risk Securitisation: Monsoon Options on Select MET Subdivisions 
G. Kotreshwar and Rekha Arunkumar  Dec 2006

A Dynamic Programming Framework for Using Weather Derivatives to Manage Dairy Profit Risk 
Gang Chen and Matthew C. Roberts 2004

Managing Irrigation Risk with Inflow-Based Derivatives: The Case of Rio Mayo Irrigation District in Sonora, Mexico 
Akssell J. Leiva & Jerry R. Skees

Pricing Weather Insurance with a Random Strike Price: An Application to the Ontario Ice Wine Harvest 
Calum G. Turvey and Alfons Weersink Jul 2005

Impact of Climate Change on Golf Playable Days in the United States 
Weather Bill Feb 2007

Weather & Film Box Office Revenue: The impact of precipitation and temperature on UK film box office revenue 
Weather Bill Dec 2007

Flight Disruptions and Weather: An assessment of weather's effect on United States airlines and airports 
Weather Bill Apr 2008

itravel2000 "Let it Snow!"  
Weather Bill

Protecting Profits in the Snow & Ice Removal Industry  
Weather Bill Feb 2009

Flagstaff Nordic Center Ski Season Guarantee 
Weather Bill

Protecting Revenue and Growing Sales in the Oil Heat, Propane & Natural Gas Industries 
Weather Bill Jan 2009

PGA Championship: Greater Hickory Classic at Rock Barn - Golf Tournament 
Weather Bill

PGA Event: BMW Championship - Golf Tournament 
Weather Bill

Presentation on theme: "L21 Enterprise Risk Management- A Case Study"— Presentation transcript:

1 L21 Enterprise Risk Management- A Case Study
Objective: UGG Case-describe and illustrate enterprise risk management (ERM)L21-Spring 2011 Module 1

2 Enterprise Risk Management
Traditional approach: being questioned in the 1990sManage each type of risk separately (silo approach) within separate departmentse.g. pure risk manager & financial risk managerEnterprise risk management approach:Manage all risks in a unified frameworkFocus more on overall firm riskSome firms have established a new position: chief risk officer (CRO)L21-Spring 2011 Module 1

3 Enterprise Risk Management
Arguments for ERM:Process provides managers with a better understanding of the firm’s full range of risksMany of the reasons for managing risk suggest looking at an aggregate performance measure (e.g., cash flows)Arguments against ERMToo time consuming to implementLack of uniform metricsCultural incompatibilityInadequate IT systemsL21-Spring 2011 Module 1

4 United Grain Growers Case
UGG was one of the first to use ERMBackground on UGG:Operates in western Canada, a public company and the 3rd largest provider of grain handling servicesProvides commercial services to farmers and tries to differentiate itself from competitors by developing brand name products and by providing superior servicesMain business: grain handling service; crop production services; livestock service; business communicationsCapital expenditure program: replace old grain silosRecently increased financial leverageL21-Spring 2011 Module 1

5 EBIT for UGG’s Business Segments Earnings before Interest and Taxes =Gross margin-Expenses excluding depreciation-DepreciationL21-Spring 2011 Module 1

6 Consolidated Financial Highlights
In 1999, EBITDA (earnings before interest, taxes, depreciation, and amortization) declined substantially relative to prior years.Total debt to net assets=37% , total assets financed through debt increased to 37% with the issuance of another $50 million in long-term debtReturn on equity (net earnings to book value of equity)=1.17%L21-Spring 2011 Module 1

7 UGG ERM Process Formed a RM Committee Brainstorming session
CEO, RM, CFO, Treasurer, Compliance manager (for commodity trading), Manager of Audit ServicesBrainstorming sessionWillis Corporation (insurance broker), RM committee, other employeesIdentified 47 main risksThe top 6 risks were chosen for further investigation:Environmental liabilityEffects of weather on grain volumeCounter-party riskCredit riskCommodity price and basis riskInventory riskL21-Spring 2011 Module 1

8 UGG ERM Process - Gather data - Estimate loss distribution
Willis tasks:- Gather data- Estimate loss distributionquantify impacts of each source of risk on measure of UGG’s performance, including ROE and EBIT- Estimate correlations among 6 risk exposures quantify impacts of the 6 sources of risk in combination on UGG’s performanceL21-Spring 2011 Module 1

9 Focus on Weather RiskKen Risko, statistician for Willis Risk Solutions, found weather was the most important source of riskWeather (temperature & precipitation) affects Crop yieldswhich affects UGG’s grain volumewhich affects UGG’s gross profitImplementing regression analysis using data fromL21-Spring 2011 Module 1

10 Choice 1 --RetentionDisadvantages ?L21-Spring 2011 Module 1

11 Choice 2--Weather Derivatives
L21-Spring 2011 Module 1

12 Weather DerivativesSold in the OTC market by Enron, Goldman Sachs etc, and CMEThe underlying variable determining payoffs can be average temperature, rainfall, a heat index or a combination. The payoff structure could be a put option, call option etc.L21-Spring 2011 Module 1

13 Weather DerivativesL21-Spring 2011 Module 1

14 Weather Derivatives Unhedged Profits UGG’s Payoff Weather Index
A weighted average of various temperatureand precipitation measures in western CanadaL21-Spring 2011 Module 1

15 What Derivative Contract will provide a hedge?
If hedged, what is the payout structure like?L21-Spring 2011 Module 1

16 Disadvantages of Weather Derivatives
L21-Spring 2011 Module 1

17 What did UGG Do? Choice 3-Insurace
Purchased multi-year insurance contractBundled P&C coverages with grain volume coverage (e.g. boiler and machinery policy and environmental impairment liability)Grain volume coverage based on industry shipmentsWhy not UGG’s own grain shipments?L21-Spring 2011 Module 1

18 Grain Volume CoverageAvgShpmnts = Average industry shipments in past five years (in tons)Shpmntst = industry shipments in year tIf Shpmntst < AvgShpmnts, then a loss occursMagnitude of loss = $25*15%* ( AvgShpmnts – Shpmntst )$25UGG’s gross margin on per ton on grain shipment15%marketshare of UGGCoverage depends on loss subject to retentions and policy limitsL21-Spring 2011 Module 1

19 Bundling of Coverages Illustration of how coverage was bundled
L21-Spring 2011 Module 1

20 Transaction CostsBundling approach  Bundle multiple risk exposures into one contractUnbundling approach  hedge each exposure with a separate contract1st point: if there are fixed costs per contract, then unbundling approach might be more costly2nd point: Unbundling approach will result in unnecessary coverage, which increases costs that are proportional to the amount of coverage3rd point: Unbundling approach is more complex, which can make it more costly to supplyL21-Spring 2011 Module 1

21 Unnecessary Coverage Argument
Illustrate unnecessary coverage with unbundling approach with an exampleTwo exposures: Property LossLiability LossFirm does not want total loss to exceed $40 millionOption 1:Purchase coverage on each loss with a deductible of $20 millionOption 2: Purchase coverage on total loss with adeductible of $40 millionL21-Spring 2011 Module 1

22 Unnecessary Coverage Argument
Which one may be more costly?Problems for Bundled Policies?L21-Spring 2011 Module 1

23 Disadvantages of Insurance
L21-Spring 2011 Module 1

24 Accomplishments & Lessons
L21-Spring 2011 Module 1

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