1. Why will a weather derivative be useful for PNW
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1. Why will a weather derivative be useful for PNW?
2. What does Enron stand to gain by selling a weather derivative?
3. Should PNW purchase a weather derivative? Why or why not?
Earnings per share (EPS) is the portion of a company's profit allocated to each outstanding share of common stock. Earnings per share serves as an indicator of a company's profitability.
Capital intensive refers to a business process or an industry that requires large amounts of money and other financial resources to produce a good or service.In finance, the cost of equity is the return (often expressed as a rate of return) a firm theoretically pays to its equity investors, i.e., shareholders, to compensate for the risk they undertake by investing their capital.
A hedge is an investment position intended to offset potential losses or gains that may be incurred by a companion investment. In simple language, a hedge is used to reduce any substantial losses or gains suffered by an individual or an organization.
Cost of debt is the interest a company pays on its borrowings.
: Mary Watts , the chief financial officer of Pacific Northwest Electric.
Why will a weather derivative be useful for PNW?
1, weather derivative targets at power producers that was exposed to volume risk as a result of changes in weather. Volume related revenue - the deviation of actual acumulative degree days from an established threshold
Weather is biggest independent variable in power business
Watts analysis - seasonal demand is highly correlated with cumulative HDD
2000-01 is expected to be an unseasonably warm weather- less consumers (use of electricity) - huge impact on earning (devastating)
2, public utility - regulations permit them to pass along costs to consumers
Capital intensive firm
But there are already a variety of producers on the power grid where consumers can purchase power from. If they pass along costs to consumers , it would result in a loss market. Weather derivative can be an alternative way to compensate the loss in income associated with lost demand instead of increasing prices.
What does Enron stand to gain by selling a weather derivative?
1, Enron corporation is the world's leading integrated natural gas and electricity company
Discover a method for hedging its own weather risk - help other power producers to manage their own weather risk (customerized products) not just price risk but also volume related risk
2,Better meet customer demands(compared to two other options insurance and capital and commodities markets) exchange traded contracts need to be marked to market frequently - the hedge was pegged to a market index.
Should PNW purchase a weather derivative? Why or why not?
Gross margin per HDD is 40.30 ?
Limit : 20,000 * 400HDD= 8000,000
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