Enron Corporation's Weather Derivatives (a)

12 Pages Posted: 21 Oct 2008

See all articles by Robert F. Bruner

Robert F. Bruner

University of Virginia - Darden School of Business

Samuel E. Bodily

University of Virginia - Darden School of Business

Multiple version iconThere are 2 versions of this paper

Abstract

New options on weather from Enron are described, in particular floors, swaps, and caps on heating degree days. An electric utility is considering whether to purchase a weather derivative to offset the risk of low volume of kilowatt hours. After understanding the nature and purpose of the contract, students will structure the option in preparation for valuing it. A teaching note is available to registered faculty, along with a video supplement to enhance student learning.

Excerpt

UVA-F-1299

Rev. Feb. 8, 2011

ENRON CORPORATION'S WEATHER DERIVATIVES (A)

Everybody talks about the weather, but nobody does anything about it.

In October 2000, Mary Watts, the chief financial officer of Pacific Northwest Electric (PNW), a utility servicing the Pacific Northwest region of the United States, reviewed the financial plan for PNW's 2000–01 forthcoming winter season. Winter temperatures affected the firm's revenues: the colder the season, the greater the electricity usage. She recalled that the last few years had offered a warmer-than-average winter climate, resulting in adverse financial results for PNW. The weather, combined with rapid deregulation in PNW's market area, meant that the firm reported substantially no EPS growth from 1995 to 1999, in an otherwise buoyant economic setting. PNW's stock price had suffered accordingly. On her desk was a report from a weather-advisory service predicting another unseasonably warm winter.

Watts remembered a recent conversation with Mike James, a representative of Enron Corporation. James had presented a new “weather-derivative” product from Enron that he claimed could minimize PNW's weather-related volume risk. Watts wondered how these derivatives worked, and how they might be used to help restore PNW's credibility in the capital markets. Should she consider purchasing Enron's weather-protection products for the upcoming winter season? She would need to decide soon about the use of these derivatives if she wanted to put in place a hedge for the winter months ahead.

. . .

Keywords: hedging, option pricing, risk analysis, risk management, simulation

Suggested Citation

Bruner, Robert F. and Bodily, Samuel E., Enron Corporation's Weather Derivatives (a). Darden Case No. UVA-F-1299. Available at SSRN: https://ssrn.com/abstract=909681

Robert F. Bruner (Contact Author)

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-924-3823 (Phone)
434-924-0714 (Fax)

HOME PAGE: http://faculty.darden.edu/brunerb/

Samuel E. Bodily

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-924-4813 (Phone)
434-293-7677 (Fax)

HOME PAGE: http://www.darden.virginia.edu/faculty/bodily.htm

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