How do you manage warm weather?
Each winter begins with strong expectations of cold weather, which will drive a demand for more heating. In the energy industry, this demand is often measured by how many heating degree days (HDDs) a region has. Very cold weather in a region will have more HDDs than average and will generate more margin for propane distributors.
Edging through winter though, there is always a slight sense of uneasiness. For example, what happens if it’s a warm winter? Or, what happens if HDDs drop by 15 – 25%? How will that affect your bottom line?
These expectations and questions are typical for every winter, and they lead to one main question – “How do you manage warm weather?”
How do you manage warm weather?
Over the years we have heard these potential answers to that all-important question:
- Purchase less propane supply. But that raises the question of what to do if it actually is cold.
- Short the propane financial market. This translates into retailers selling a financial transaction in the hopes that propane prices will decline if it is a warm winter. The fact that North America is the global leader in exports of propane means that if it is cold in other continents, prices could remain high.
- Simply do not purchase any financial (or fixed price) protection for the winter period. Again, this also raises the concern of what you do if prices rise.
All these answers fail to address the main theme – weather. Or more correctly, temperature changes.
Weather derivatives protect against temperature changes
The only way to manage the impact of temperature changes on a propane distribution business is to protect against adverse changes in the weather. Financial weather tools can provide that type of protection.
Financial weather tools (weather derivatives) have been available to the energy markets since the end of the 1990s. Westlark Advisors has been an advocate for these tools for over a decade.
How do they work?
How do they work? These weather tools work just like a traditional propane hedge and allow a retailer to protect against an adverse change in temperatures.
The basic process requires a retailer to know these items:
- Historical HDDs for your region
- Estimated gross or net margin per HDD
- How much change in temperature are you looking to protect?
Westlark Advisors can help identify all three of those items for a retailer and then provide a solution that meets their needs.
Managing warm weather will stabilize your business
We started with the main question, “How do you manage warm weather?” in your propane business. Identifying tools that are directly tied to weather is the first step in successfully answering that question. The final part of the answer is a realization that managing warm weather is essentially stabilizing your business.
This means a weather financial tool is meant to keep your business earnings from seeing large fluctuations each year due to changes in the weather. One year a weather tool may provide a strong payout and help offset earnings lost from a warm winter. Another year that same tool may require a retailer to make a payment, but their retail business has seen strong earnings due to a cold winter. In both situations, the company has created a stable business.
If you are heading into this winter searching for the answer to how to deal with warm weather, contact the Westlark Advisors team and let us create the plan to fit your needs.
How do you manage warm weather?
By JD Buss
