Energy and power traders can increase profits from weather uncertainties by monetizing Planette’s Degree Day forecasts.
Here’s a walkthrough using HDD futures traded on CME.
We'll use New York HDD monthly Futures for the winter months of January, February and November and December of 2023. This way we cover two winters. CME uses HDD figures published by the weather station at LaGuardia Airport¹. We consider positions placed 3 months in advance for computing the payoffs. First, we'll show how the market arrives at the price for a Future and then show how Planette’s forecasts will give energy and power traders an edge.
Payoffs
CME Degree Days contracts are priced at $20 per degree day. The following figure shows the New York monthly HDD 3-months out Future prices.
Table 1 compares the historical New York monthly HDD Futures index, Planette’s prediction 3 months ahead as well as the actual HDD values for the months of interest in 2023.
Month associated with the Future | Index 3 months out | Index 2 months out | Index 1 month out | Index at settlement | Planette's HDD Prediction (3 months ahead) |
|---|---|---|---|---|---|
1 | 745 | 785 | 810 | 665 | 748 |
2 | 960 | 799 | 665 | 673 | 615 |
11 | 488 | 472 | 481 | 515 | 504 |
12 | 725 | 488 | 506 | 611 | 684 |
Table 1
Letting It Ride
If you took positions 3 months ahead based on Planette’s prediction and didn’t adjust those positions until settlement, your payoffs on a single contract would have been $6,960:
Month | Position | Payoff ($) |
|---|---|---|
1 | Long | -1600 |
2 | Short | 5740 |
11 | Long | 540 |
12 | Short | 2280 |
Total | 6960 |
Table 2
Table 2 demonstrates how using Planette’s forecasts would make you money, and how losses on some positions should be expected given the inherent probabilistic nature of the forecast.
The payoffs depend not only on how right Planette’s forecasts were, but also how wrong the market was.
Adjusting Positions
It’s normal to adjust positions. If you adjusted your positions once every month, the payoffs would be even greater. Take the example of January.
At first, 3 months out, you would have taken a long position because the market price of 745 was lower than Planette’s prediction of 748.
But the next month, you would have closed the position as the market price went above 748 to 785. You would have made (785-745) x $20 = $800/contract in a month
But then you would have additionally taken a short position at 785 and maintained it next month (because the index was at 810) and made (785-665) x $20 = $2,400/contract in two months.
Overall, you would have made $3,200 instead of losing $1,600 without adjusting your positions.
Table 3 shows the total payoffs for each month if you adjusted your positions along the way.
All figures in $ (Blue represents the result of a long position,
and orange represents the result of a short position)
Month | Payoff 2 mo out | Payoff 1 mo out | Payoff at settlement | Total Payoff ($) |
|---|---|---|---|---|
1 | 800 | 0 | 2400 | 3200 |
2 | 0 | 0 | 5740 | 5740 |
11 | 0 | 0 | 540 | 540 |
12 | 4740 | 0 | 2460 | 7200 |
Total | 16680 |
Table 3
The Table 3 example also underscores the fact that returns are related to volatility rather than absolute price as observed by McKinsey².
Climate change is only going to increase weather volatility.
If you’re ready to increase your payoffs by adding our degree days dataset to your workflow, sign up for an account today. If you have more questions, schedule a call.
