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. Last Updated: 07/27/2016

As Muscovites Shiver, RTS Bets on the Cold

It sounds, at first, like the fantasy of a free-market guru who has spent too long in the sun: trading shares in the Russian weather alongside Gazprom and pork belly futures.

But when the Russian Trading System announced plans last week -- at the height of Moscow's deep freeze -- to start trading weather futures, it wasn't intended as an attempt to relieve the chill with a little levity, but as a form of insurance for the country's heavily weather-dependent economy.

"Weather is one of the most important factors in the economy," RTS spokesman Ilya Yefimchuk said Monday, as the city's thermometers crept back up to minus 20 degrees Celsius. "It's clear from the example of Russia's recent freeze that these kinds of weather conditions can cause unexpected consequences."

He wasn't talking about the boom in radiator sales. For the second straight week, oil production is down 250,000 barrels per day on December's average of 9.65 million bpd, as temperatures dropped below minus 50 C in parts of Siberia, hampering extraction.

State-owned Gazprom and electricity monopoly Unified Energy Systems have struggled to supply energy-hungry consumers during the cold snap, with communal heating systems coming under strain and gas supplies to Western Europe falling in the process.

Meanwhile, Agriculture Minister Alexei Gordeyev warned Friday of crop failures due to the cold, and Moscow construction chief Vladimir Lesin said Saturday that 700,000 of the city's 1 million construction workers had been left idle by the freeze.

Though the extent of financial losses related to the cold snap is not yet clear, "weather futures contracts are one more instrument to let companies hedge against losses" from such weather, Yefimchuk said.

Still, the RTS announcement was greeted with more puzzlement than celebration, which one U.S. pioneer in weather trading said was no surprise.

"It's true a lot of people don't know about this yet," said Felix Carabello, associate director of weather products at the Chicago Mercantile Exchange, speaking from Chicago on Monday, where the temperature was minus 3 C.

Apart from buying traditional insurance to cover against catastrophic weather-related losses, "the financial community has accepted the idea that there's nothing that you could have done," Carabello said.

The Chicago exchange's booming weather market, however, would seem to prove otherwise. The exchange first offered weather products in 1999, and last year it traded 850,000 contracts -- up from 122,000 in 2004 -- valued at over $22 billion.

The weather market works by the same principle that lets people speculate in everything from grain prices to foreign exchange rates, and that even led the U.S. Defense Department in 2003 to suggest a futures market in terrorist attacks until outraged politicians objected that it would let terrorists turn a profit.

"Where there's risk for someone, there's the opportunity for someone else to take it on" with the possibility of making a profit, Carabello said.

Weather futures allow companies to hedge against unexpected weather fluctuations -- and let speculators profit from them -- the same way traditional commodities futures do, Carabello said.

For hedgers, traditional futures protect against unexpected price rises or slumps. A soybean processor who will need to buy soybeans in June and expects cash prices to rise, for example, can buy futures contracts for soybean delivery in July, locking in a current price. If the cash price has risen by June, the value of the futures contracts will have risen as well. The processor can sell them at a profit, offsetting the rise in the cash price.

Weather futures contracts on the Chicago Mercantile Exchange work in a similar way, affixing a value to days on which temperatures are higher or lower than a given baseline in 22 cities worldwide. A natural gas company in New York might hedge against the possibility of a warm winter by investing in warm winter days. If January turns out balmy, low heating use will mean lower profits, but the warm weather futures will pay off, offsetting the company's losses.

A weather speculator can pit his own temperature predictions against the market's, just as ordinary investors or commodity speculators do with price predictions.

The basic concept is simple enough, "but there are quite a few challenges" in offering weather products that attract investors, Carabello said.

RTS is working with the Federal Meteorological Service on the first of them, pinning down precisely what kinds of weather contracts will be offered for sale. Yefimchuk acknowledged that the process was a complex one.

"It's clear that temperature indicators should be involved, and they should obviously be connected to specific regions or specific cities," but many questions remain, Yefimchuk said.

The largest one is whether Russian companies and their investors will actually be interested in trading such products.

"In and of itself, the proposal is a fairly interesting one, since the volume of our extraction and all of our production indicators depend fairly significantly on where average temperatures are headed," said Gazprom spokesman Sergei Kupriyanov. "But the details are going to depend on what kind of product is ultimately offered."

Spokespeople from Sibneft and UES also said their potential interest would depend on precisely what RTS put on the market, though UES spokesman Andrei Trapeznikov stressed that as a monopoly, his company's highest risk-management priority was insuring against production failures, rather than financial setbacks.

UFG oil and gas analyst Stephen O'Sullivan said that although the timing of the RTS announcement was clearly meant to spark interest, investors were minimally concerned with how weather was affecting prices and were not showing any immediate interest in derivatives.

"Weather may be one of the factors driving up oil prices, but I don't think it's been a major factor," O'Sullivan said by telephone Tuesday.

Carabello said he was willing to share Chicago's expertise with the RTS during what was likely to be a steep learning curve.

"Listing products is one thing. Building a marketplace is something entirely different," Carabello said.