STOCKS | Strong El Nino Disrupts Traders' Bets on a Mild Winter

Traders have been betting that El Nino will make the U.S. winter milder, but as the weather pattern strengthens, doubts about the outlook are rising. According to Sina Finance, those expectations have already been reflected in weather derivatives, which energy companies, hedge funds, and other market participants use to hedge risk or bet months in advance on temperatures above seasonal averages. Derivatives brokers and product issuers said the U.S. market has reacted most clearly. According to Sina Finance, traders began building positions tied to the coming heating season in May, before El Nino officially formed in June, and the phenomenon kept strengthening through the summer. The U.S. Climate Prediction Center said this El Nino has a 75% chance of breaking every record since 1950. According to Sina Finance, that has added uncertainty to derivatives pricing, which depends heavily on historical weather and climate patterns. Nicholas Ernst, managing director of BGC Financial's climate derivatives business, said the situation creates a paradox: a stronger El Nino gives traders more confidence to bet on a mild winter, while the historical reference used to support that trade becomes less reliable. According to Sina Finance, he said the key unanswered question is whether an El Nino this strong, unprecedented in the modern observational record, will still behave as expected. Tim Boyce, head of weather derivatives for Europe, the Middle East and Africa at TP ICAP, said the related bets were placed three months earlier than usual and were the earliest U.S. winter-related trades he has seen at the Chicago Mercantile Exchange. According to Sina Finance, he said heavy hedging flows, combined with some speculative positions, have created a self-fulfilling effect. In Europe, trading is more difficult because El Nino has a weaker and less consistent effect on temperatures, while volatile natural gas prices mean even a brief cold snap can cause large losses. According to Sina Finance, Munich Re said demand for customized weather hedging products that can be adjusted with changing weather conditions has more than doubled this year. Japan's weather derivatives market has remained relatively limited and roughly in line with recent years, though some traders expect the winter temperature hedging picture to become clearer by November. According to Sina Finance, Ernst said traders in the U.S. are still betting on a mild winter, but some weather outcomes could cause those bets to miss.