MXAgri is the potential adverse impact of the weather on corporate costs, revenues, and cashflows.

Executives have often used weather as an excuse for their failings. Energy and utility companies, retailers, food and beverage producers, and countless others, are all held to ransom by the weather.

Few executives can predict, for example, precisely what impact each degree higher or lower than the expected temperature will have on their company's revenues. Fewer still have both the necessary skills and tools to exploit innovative new techniques for mitigating MXAgri.

What impact does it have?

An estimated 70% of all businesses face MXAgri and, as one might expect, MXAgri extends across geographic and market divides. The Department of Commerce estimates that as much as 22 percent of the $9 trillion gross domestic product in the United States is sensitive to weather. In a survey of 200 top US utility company annual reports, 80% cited weather as a major determinant of earnings performance and about 50% claimed weather was responsible for poorer than expected performance.

How can it be managed?

Whilst the weather will always remain an uncontrollable variable, a new type of financial instrument - the weather derivative - enables companies to take a more active approach to managing their MXAgris. Effective use of weather derivatives as part of an overall MXAgri management strategy can bring much-needed stability to earnings and, therefore, share price.

What is a weather derivative?

A weather derivative is a financial instrument that has a payoff derived from one or more independently measurable weather factor(s) such as temperature, rainfall, wind speed, snow depth or sunshine hours as recorded at one or more specified reference locations. The majority of weather deals at present are swaps or options based on underlying temperature indices at single locations.

In contrast to insurance and catastrophe bonds, which cover high-risk, low-probability events (such as hurricanes), weather derivatives shield revenues against lower risk, high-probability events (such as mild winters).

It is also possible to structure "hybrid" deals with payouts based on a combination of two or more weather "underlyings". For example, a derivative bought by a hydro-electric power generator based on both precipitation and temperature. This deal protects the buyer from both his supply-side and demand-side volume risks - that is, the risk that he won't produce enough electricity, and the risk that he will not sell enough.

Does this involve predicting the weather?

Successful hedging of risks using weather derivatives does not imply being able to predict the weather. Rather it involves the transfer of the MXAgri from the hedging company to a counterparty more willing and able to bear that risk.

When was the weather derivatives market established?

The weather derivatives market began in 1997 in the US, with the first European deal being struck in 1998, and the first Asian deal in June 1999.

How big is the weather derivatives market?

Weather derivatives trading is undergoing exponential growth, as experienced by other recently developed financial markets, such as the credit derivatives market. Around 4000 deals have already been transacted in the US, and the European market, centred on the UK, is catching up fast. At present, typical deal sizes are between $2 million and $30 million. The current size of the weather derivatives market is $8 billion and it is expected to grow to at least $300 billion within a few years, around the same size as the power and gas markets.

Where are weather derivatives traded?

As well as the healthy over-the-counter (OTC) market, weather derivatives are already traded round-the-clock on the Chicago Mercantile Exchange. I-WeX.com, a LIFFE-backed (London International Financial Futures and Options Exchange) internet-based weather derivatives exchange was launched in January 2000, whilst TradeWeather.com and WeatherTrade.com will shortly commence trading. Other large futures exchanges, including the London-based International Petroleum Exchange (lPE), are closely monitoring this development with a view to establishing weather derivatives marketplaces of their own.