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The Five-Year Forecast

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In 1893, a Category 3 hurricane did in fact hit the funnel. Water levels rose thirteen feet in a single hour, then kept on climbing until they hit a maximum of 25 feet. If that happened today, transportation would grind to a halt, with both the FDR and the West Side Highway, much of the subway, and all traffic tunnels submerged. All airports would be shut, and, according to one study, upriver water-treatment systems would be contaminated by ocean saltwater.

Perhaps most remarkable, Manhattan would be split into two islands at Canal Street, which is low and would be completely flooded. “The financial district would be entirely cut off,” as one group of Columbia University engineers concluded when it assessed the impact of a direct-hit hurricane. Even higher land uptown would not escape the damage: One computer model of a hurricane estimated that water would surge eighteen feet at West 96th Street.

By the time the storm subsided, the overall cost to New York would be at least $100 billion—100 times more than the cost of the average storm damage we get in a year now. Even Hurricane Floyd, which swept ashore in September 1999 and was considered a big deal at the time, caused a mere $1 billion in damage.

The only thing that could truly prevent this damage are those gates that Bowman has proposed. But marshaling the political will—to say nothing of the billions of dollars—to build them could be difficult. The initial meeting Bowman had with Port Authority officials back in 2001 seemed promising. “They agreed it was a big issue,” he recalls.

The next week, however, was 9/11. Bowman shrugs. “And you know what happened next.”

A $16 billion bet on a warmer winter.

“One third of our gross domestic product,” declares Colt Heppe, an executive vice-president of ICAP, a new kind of trading desk, “is affected by the weather.” The white-haired, bearlike broker is peering over the shoulder of Peter Rosen, one of his twentysomething traders, as Rosen frantically works a deal via instant messaging. Connecticut-based Tudor Investment Corporation is asking about buying a “weather option”—a financial bet based on the ebb and flow of the weather. Is it going to get warmer? Colder? If your business suffers pain when the mercury unexpectedly plunges or soars, Heppe’s there to offer intriguing financial instruments to hedge the risks.

“Predicting weather is still such a totally inexact science. Kind of like economics,” Heppe jokes. “And that’s why we exist.”

The idea of weather futures has been around for decades, but it developed into an actual market only about ten years ago. The concept is fairly simple. Heppe divides the year into two five-month seasons—a November-to-March winter and a May-to-September summer (April and October act as “shoulder” months bridging the seasons). He figures out the average temperature expected each day for fifteen American cities based on the year-round measurements taken at their airports, and by studying the daily weather predictions issued by U.S. government and European meteorologists.

Then he sells options or puts based on how much people think the actual temperature will deviate from that mean. You could, for example, buy an instrument that pays you a set amount for each degree, per day, that the temperature dips below the expected mean. If it stays warm, you lose; if a cold snap arrives, you win. It is, in essence, a form of weather-based insurance.

“Let’s say you have a coat factory, like Burlington Coat Factory,” Heppe says. “What happens if midway through the winter it’s an El Niño year and it’s very warm, and people do not purchase as many coats?” If it had purchased a put, it could have hedged its risk. In a warm winter, its weather future pays out and diminishes its coat-selling losses; in a cold winter, it loses the money on its future but makes it up on extra coat sales. “It’s just like any natural hedge,” he adds.

Heppe began selling weather futures ten years ago, and his main clients are energy firms, insurance companies, hedge funds, and investment banks, as well as some firms with explicit weather-related risk like ski lodges and resorts. The industry is small—only about $16 billion a year—because the idea still seems a bit weird.

“If you’ve got a business that sells $100 million a year, and you get up at the annual meeting and say, ‘Hey, we should spend $10 million hedging against the risk of the weather,’ it’s hard to convince people,” Heppe admits. “It’s still a niche market. You have to educate people.” But weather, he believes, is becoming a bigger area of public discussion, with the average executive increasingly well informed about it. “Technology is telling us there are recurring patterns we can spot,” he says. “There’s far more data than ever before.” And the weather market isn’t susceptible to being manipulated by powerful financial instruments, because the weather ultimately runs the show—and nobody can control the weather. “You don’t have somebody coming in and single- handedly driving the price of a commodity down to $100,” he says with a laugh.


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