Weather Risk

Weather Market in India

Weather Risk Management Services Pvt. Ltd.

Agenda
Background Examples of Weather Insurance in India Issues Initiatives

Weather Risk

Weather Markets The Need

Farmers
Agriculture credit off-take in ninth plan Rs. 2,31,798 crores (grew @ 20% pa); Target for X plan Rs. 7,36,570 crores 90% crop losses on account of weather related risks Rural Economy is highly weather dependent Limited success of area yield based crop insurance Weather related supply bottlenecks make dry-land commodities very volatile
Intraday volatility of Guar, chilly touches 10-15% (daily trading at national exchanges touches Rs.1000 crore daily)

Commodity Traders

Vegetable and fruit Mandis highly dependent on temperature (Delhi Mandi trade alone touches Rs.1000 crore annually) Trader income dependent on weather vagaries

Industries like agro-input companies, food processing industry, companies, plantations, FMCG, Banks, Power sector etc
Not uncommon to find Agri-Input companies, whose sale dips by over 30-40% due to fluctuation in rainfall

Weather Risk

Weather Markets The Need

Weather Risk

Weather Markets The Need

EID Parry sales, net down 86 pc on monsoon failure. - The Hindu, Jan 17, 2003 The Company's business is seasonal in nature and the performance can be impacted by weather conditions - Notes to Accounts, Syngenta (I) Ltd. Monsanto India continued its strong profit growth on the back of positive all-round business performance aided by a good monsoon. - Annual Report 2003-04, Monsanto Ltd The delayed monsoon has hit the fertilizer stocks badly. - Analyst, Hindu Business Line Over 1000 farmers commit suicide in vidarbha and Telangana in last two years TOI An average drought costs upto Rs 4 bn to the state exchequer,Gujarat earthquake resulted in direct damages of about Rs.153 billion -NDMC

Weather Risk

Agri Risk Management Current Scenario

Crop Insurance

Delay in Claim Settlement High Cost of Risk Transfer, Inefficient allocation of public resources Lop-sided claim settlement mechanism with high possibility of subjective bias
Premium to claim 1:5 Reserves in the order of Rs.8000-10000 crores required

Less than 2% farmers taking insurance on a voluntary basis About 12% of loanee farmers taking insurance Doesnt address the risk management requirements of non-farmers In absence of meaningful risk management product --Agriculture production is sub-optimized
Inefficient distribution of agricultural inputs Large tracts of land unused/ used for non-commercial crops To a large extent the risk is weather dependent

Weather Risk

Why Weather Market

Agricultural loss in many parts of the country is weather dependent Weather Insurance/Derivatives can fill in the gap
Loss can be monitored real time Cost of risk transfer can be reduced through weather trading

Weather (esp. rainfall) is the common commodity across diverse agri-products, industries
Explains up-to large variation in prices for commodities in the dry land Entities on both the long and short side

Weather Risk

Why Weather Market

A diverse set of participants exchanging risks shall reduce cost of risk transfer
Volatility is comparable to other commodities such as Gold, agricommodities Attracts speculators and trading community

Synergies with Energy Market

Power deregulation would further strengthen the synergies

India has the potential to emerge as the largest weather market

An Indian Company/Exchange can lead the world market

Weather Risk

Weather Market: Instruments

Weather Insurance
Assurance against losses due to a specified weather event
Loss compensation based on a pre-agreed formula

Weather Derivatives
Option Futures

Bonds
Bond with payments triggered/calculated on basis of a weather event

Weather Risk

India is looking for such Instruments

Financial solutions to go along with technical solutions Informal rainfall markets exist Weather Insurance
Leveraging inherent diversification and non uniform impact of weather events

Launched in 2003, approved by IRDA

Weather futures and option trading to be allowed soon

Commodity futures market reformed in 2000
Since then an exponential growth in future trading witnessed Synergies with power, carbon markets

Weather bonds being contemplated by Institutions

Weather Risk

Why Weather Market

Commodity/ Index/Scrip
Forex Derivatives Interest rate derivatives Equity Derivatives Illegal Betting

Extent of linkage with economy*

$ 7.5 tr of foreign trade $ 20-25 trillion of bond $ 10-15 trillion of equity portfolio -----------

Trading Turnover (in $ Trillion)*

Approx. $1500-1600 trillion

Linkage of the underlying with economy is important

Ensures buyers & Sellers Base liquidity further deepens the market

Weather impacts approx.

$ 2.15 trillion (vis-vis, a total annual global savings of $7.5 tr) ?

Weather Derivatives

$ 150 bn (for Indian economy)

GDP of $150 bn in India GDP of $ 200-250 bn in India & China GDP of $ 400-450 bn in top 8 developing economies

*The economist 2005, 2006

Weather Risk

The Eventual Market

Primary Markets Risk amount (in Rs. bn) transferred by-15 Risk amount (in Rs. bn) transferred by2020 AgriEquity/Comm odity Funds Agri-Funds Commodity Risk amount (in Rs. bn) transferred by15 --25-30 Risk amount (in Rs. bn) transferred by2020 400-450 100-150

Agri-input
Banks/Comm Other(s)

50-75
25-50 25-50

100-125
500-600 150-200

Coming together to create a market of approx. S 0.6 tr by 2020

Speculators /Hedge Funds Commodity Capital

Capital employed by-15 (in Rs bn) 5.0 25.0

Capital employed by2020 (in Rs. Bn) 150.0 55.0

Weather Risk

Structure of the market

End Users Energy Construction Agriculture Retail Transport Food Inter-Dealer Brokers Consultants Energy Companies Reinsurers Insurance Brokers Banks
OTC
Exchange

Intermediaries

Primary

Secondary

Tertiary

Insurers & Banks

Investors

Weather Risk

Agenda
Background Examples of Weather Insurance in India Issues Initiatives

Weather Risk

Issues
No historical precedence No active cash/spot markets
No way to quantify impact of weather No way to price weather for different locations (any given geographic longitude-latitude) Large distances

Concept of weather based risk management is new and abstract No secondary market to supplement it Regulatory Issues Financial product penetration in agri-market is shallow

Weather Risk

Issues
Existing Weather Insurance
High Basis Risk Inadequate Weather Station Coverage Inaccurate cover design
Difficult for the insured to envisage cover benefits

High Cost of Risk Transfer

Weather Risk

Basis Risk Impact

Basis Risk Loanee Farmer

Yes

Rain at Obsy?

No

No Rain at Farm? Yes No Insured? Normal Yield Yes Yes Normal Yield No Claim - No Loan Default - Yes Loan Default - No Rain at Farm?

No

Yes Insured? Normal Yield Yes Loan Default No Claim - Yes Normal Yield No Claim - Yes Loan Default - No No

Yes

Normal Yield No Claim - No Loan Default - Yes

Failed Insurance because of basis risk. Higher the basis risk, higher is the insurance failure

Weather Risk

Current Weather Risk Management Practice

Unable to reduce cost of risk transfer by diversification in a covariate environment Transfer Forecast

Monitoring Quantification

Lesser or no attention to: -Accurate risk identification -Inherent risk management possibilities -Proper monitoring for risk minimization -Inherent basis risk --Inadequate shorters

Identification

Outcome is high cost of risk transfer and failed risk management program

Weather Risk

Agenda
Background Examples of Weather Insurance in India Issues Initiatives

Weather Risk

Our Initiatives
Create the much needed Cash/spot market

Real Time Data availability for any given long-lat

Decision Support system(s) for major customer segments

Platform enabling Trading and cost reduction

Marketing Network/Relatio nships

Build active futures/option trading market

Weather Risk

Our Initiatives
Deepening the Primary market Developing the secondary market in tandem
Launching the Indices for key regions Approaching the key market segments
Commodity funds, Agri-funds, Rainfall speculators, International trading funds Push for regulations on participation by Banks and MFIs

Technology development Resolving the key constraints

Presence in both the OTC and exchange traded market Developing the Hybrid market

Quantos, Satellite Image weather indices, Weather-Area yield Cat indices

Weather Risk

Organizing Real Time Data

On Site wireless Sensors Processing of data received from sensors and converting it according to specific product

Covering important agricultural zones real time, at a cost of approx. Rs.500 per sq.km or Rs.5 per ha Generation of Historical records for any given long.- lat. Position
Statistical & Neural Network model

Farmers Console (GIS)

Weather Risk

computer vision/aerial imaging

Mosaic generated from images taken from UAV of IITK campus (Courtsey Aurora Integrated Systems)

aerial image mosaicing

aerial image registration

Weather Risk

Agro based applications of UAV

Hyperspectral Remote Sensing Indices for Crop Status

Aerial imaging has been identified as the foremost technique to generate agronomy indices EO sensors along with a FLIR sensor provide accurate estimation of crop/vegetation growth and health Addition of hyper-spectral sensors provide information that as of now exists only through low resolution satellite data UAVs flying at various altitudes can provide very high resolution images as compared to satellite data Within-field variability of yield monitor spatial data can be collected during harvest and correlated with hyperspectral indices related to crop growth and canopy structure, chlorophyll concentration, and water content.

Weather Risk

Spatial Interpolation

RMS error ( under square root transformation) ~ 2mm

Neural network, AI (HMM) models to improve precision

Weather Risk

Decision Support Architecture

Plugging out of risk

Transfer Forecast

Monitoring Quantification
Establishing Existence of Risk

Identification

Weather Risk

Calculating Stage-wise Water Imbalance

Water Surplus / (Deficit)

Water Availability

Water Requirement

Depends on:

Depends on:

Total Rainfall Soil Conditions

Crop Physiology Max & Min Temperature Sunshine Hours Relative Humidity

Soil Condition is specific to a given area Water imbalance at each stage has different impact on yield Water imbalance can be scientifically modeled
Different model required for each crop & location

Weather Risk

Water Imbalance Yield Impact

Weather Risk

Phase-wise Impact of Weather Risk E.g. of Paddy Crop

Normal phase wise water requirement(mm)

103.5
41 32.2 25.2 8.4 0.80 62 32.0 25.3 8.0 0.85 109 31.1 24.6 7.5 0.85 188 30.6 24.2 8.8 0.85 237 30.0 24.1 7.5 0.85

218.3
263 29.5 23.8 8.2 0.90 255 29.3 23.9 7.2 0.90 269 28.5 23.1 8.0 0.90 227 28.8 22.9 7.3 0.90 238 28.9 23.3 6.7 0.90

143.7
224 28.3 23.2 7.2 0.90 186 28.2 23.0 9.0 0.90 160 28.8 23.4 8.5 0.90 150 28.3 23.0 8.0 0.85

94.7
145 28.6 23.0 8.8 0.85 91 28.6 23.0 9.0 0.85 82 29.1 23.0 7.5 0.80

96.6
60 29.3 22.9 8.0 0.80 60 28.9 22.9 8.2 0.80 56 29.3 22.9 7.7 0.80 56 29.9 22.9 7.0 0.80 56 30.2 23.4 6.8 0.80 42 30.8 23.6 7.7 0.75 34 30.8 23.4 6.4 0.75 27 31.1 23.4 7.8 0.75 26 31.1 23.0 7.9 0.75

Weekly Rainfall(mm) total normal Max. temp. 0 C weather Min. temp. 0 C

Sunshine hours Humidity

HARVESTING

1.2
GRAIN FORMATION

Life history and mean dates of important epochs of crop growth

FLOWERING

VEGETATIVE GROWTH

0.4
TRANSPLANTING SOWING Standard weeks Months

0.2
JULY AUGUST SEPTEMBER OCTOBER NOVEMBER

20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45
MAY JUNE

Yield Response Factor to water imbalance. Higher response factor means higher impact on yield due to water imbalance

Weather Risk

Modeling Pest & Extreme Weather Risks

Identifying yield losses on account pest and disease accelerating weather conditions
For e.g. rainy conditions with conducive temperature & humidity cause extreme elongation of downy mildew in Grapes

Preparing catastrophe risk models to identify and evaluate losses on account of extreme weather conditions
E.g.Thunderstorm and Flood modeling

Economic models for other participants in the agricultural chain Take into account other factors such as logistics, existing risk management mechanisms

Weather Risk

Decision Support System

Forecast Inputs

Front-end Output Identification & Quantification of the Risk

Scientific modeling of risk Simplified output in vernacular language for farmers

-Crop Planning -Irrigation planning -Pest Management -Yield forecast -Risk Transfer

Current Weather Data

Needs to be customized for Banks portfolio

Weather Risk

At Village Service Point

Analysis of impact
Special package for Rainwater harvesting project

Optimal crop planning based on weather and phenological models for all long-lat points in the region To be transferred to farmers and agricultural traders through extension services, banks

Weather Forecasts for a location based on models

Optimal loan and insurance design for all long-lat points in a particular region

Weather Risk

Weather Risk

Weather Risk

Trading Platform
Trading possible on any given long-lat Guided by DSS Embedded Allocation algorithm Supported by market making funds Available for both OTC, traded futures & options

Futures Exchange

Favorable/ adverse weather conditions Purchase of agriculture Inputs Substitution, competitive comparison, availability of banking loan

Futures Exchange

Loss of Profit, opportunity Companys ability to supply the inputs at the right time, right price, right place

Weather Risk

Facilitating Linkages
Trading Market

Agri-trader / Speculator

Premium reduction possibilities due to hedging in trading market

Distribution Outreach

Banks

Weather Futures Trading

Exchange traded options/Insurance

Village level service points

Trading Fund

Input providers to be roped in to share premiums

The network to be established across dry-land regions of the country Prominent FII trading funds (re-insurers being roped in) Exploring geographical diversification Targeting/identifying the sellers in the weather market Link with the trading market Explore the OTC market

Weather Risk

Developing the Hybrid Market

Hybrid Area yield -weather

weather rainfall, temp, humidity,

Quantos, hybrid Weather-satellite images

Weather Risk

Our Role
End Users Energy Construction Agriculture Retail Transport Food Inter-Dealer Brokers Consultants Energy Companies Reinsurers Insurance Brokers Banks
OTC
Exchange

Intermediaries

Primary

Secondary

Tertiary

Insurers & Banks

Investors

Technology Service Provider

Weather Risk

Thank you

Weather Risk