How Weather Reporting Affects Petroleum Prices

It has already been an historic year in 2011 for weather disasters. The National Climatic Data Center (NCDC) is reporting that the economic cost from these events already surpasses $32 billion and the height of hurricane season is approaching. Typically, the year-to-date total is near $6 billion. The damages come from a combination of major weather events including severe weather outbreaks, winter storms and flooding.

These storms and weather scenarios impact natural gas and oil markets. Prices are obviously affected by pipeline system damage, but markets can also be affected simply by how the storms and subsequent damage are reported. Even something as simple as an altered forecast can create a swing in market prices.

Many energy traders and hedge funds anxiously await the weather computer models that forecast temperature and precipitation. Millions of dollars are made or lost depending on the timing of when the traders get the model data. If a trader is able to get the inside track that the Global Forecast System Model or (GFS) is about to run much warmer than a previous run, then that trader has a great advantage over others who are still awaiting the information.

Most days the markets fluctuate immediately after models are disseminated. Quite often, there will be “knee jerk” reactions when the models swing either much warmer or colder than before. Over time, as the models merge into better agreement, trading is less volatile and the markets tend to follow the trend and the swing is more or less averaged out. The accuracy of the models is not as important as the perception of them or the forecast by the users that have an effect on market prices for both oil and natural gas.

Meteorologist Dave Melita of Melita Weather Associates was among the first to forecast for energy trading entities in the early 1990s, and has seen first-hand how the timing of weather information is crucial. His particular specialty is seasonal forecasting for extended periods. Melita says, “Timing of weather forecasts is of critical importance over every time scale from intraday to several months lead time. This is because a weather forecast that consists of “new” information, or a markedly different temperature expectation compared to an earlier forecast, can and often does move energy markets substantially.”

This concept is even more pronounced when dealing with the release of storm forecasts. The trader who gets the report first will be able to move on their position in advance of their competition. In the short term, it may not matter if the weather report is accurate. The markets are going to react. For a hypothetical example: a hurricane is moving into the northern Gulf of Mexico. It has not made landfall yet, but the latest forecast calls for the storm to approach the Louisiana coastline. That scenario could affect natural gas and oil delivery as well as pipeline systems inland.

Hedge funds and traders are searching for any forecast data that will help strengthen their trading position and they are looking at computer models, talking to meteorologists and even watching the Weather Channel. They anxiously await the release of any new weather data. There is a high likelihood that prices are already on their way up as the markets close for the day. The evening run of the forecasting models indicate the storm is going to move off to the west and away from infrastructure, but the models are wrong.