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Bad Weather Impact on Supply Chain, Retail and Commodities

Over the past few months we have seen climate change that has brought about extreme weather all over the globe. Most currently, Thailand is still besieged by the worst flood since 1942 which started three months ago; the US battles with snowstorms that came a month earlier than expected and Alaska is just hit by a hurricane-like storm.

Gloomy weather ahead

Extreme weather patterns affects, in particular, all weather-driven commodities, supply chain and retail for the simple reason that weather is the most powerful force on earth.

The flood in Thailand has crippled car manufacturers like Honda and Toyota, halting operations and forcing them to move businesses elsewhere. Food supplies like rice and vegetables are also decreasing, as crops are hit by flood in Thailand and Vietnam pushing the prices up to cope with the demands from major rice importers such as Malaysia and Singapore.

Flooded river

Commodities are also impacted by bad weather – this is particularly true for crops such as coffee, corn and palm oil to name a few. The early snow in the US not only disrupted power and water supplies; it also drives natural gas commodity prices higher to fuel electricity generation and residential and industrial heating. While this could be a good thing to derivatives trading, local businesses are closed making workers temporarily lose their jobs and source of income to generate the economy. 

Snow covered cars

On the retail front, a 2003 study called “Weather, Stock Returns, and the Impact of Localized Trading Behavior” by Tim Loughran and Paul Schultz reported that weather can influence trader’s mood. Bad weather such as blizzard and snowstorm can decrease trading demand as these weather conditions make it impossibly hard for traders to get to and from work. As such, traders may simply not have the time to trade on such days. 

These erratic weather patterns are not bad news entirely. As unpredictable weather affecting businesses’ bottom lines, there are weather-related derivatives 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 Chicago Mercantile Exchange for example has introduced its first hurricane futures and options in March 2007. The derivatives are geared toward insurance companies, municipalities and energy companies that seek to transfer the risk of hurricanes to capital markets. Farmers can use these weather derivatives to hedge against poor harvests caused by drought or frost and a sports event managing company may wish to hedge the loss by entering into a weather derivative contract because if it rains the day of the sporting event, fewer tickets will be sold.

Traders who trade commodity derivatives based on fundamentals should include weather risk as part of their analysis. As weather patterns are unpredictable, trading smart in any weather-driven commodity derivatives may help reduce risks caused by climate change.

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