The thing you cannot deliver
Return to what an exchange needs. Something fungible, so one unit settles like any other. A deliverable grade it can write down, so both sides know what arrives. A cost of carry, so the forward curve has an anchor. And enough continuous trading for a clearing house to mark positions and let people out of them. A whisky cask fails all four because it is gloriously specific. Temperature looks like it should fail them harder still. You cannot deliver a July in Chicago; you cannot store one; there is no grade to inspect and nothing to carry.
And yet Chicago has traded the weather since 1999. The move that made it possible was not an attempt to standardise the weather. It was the decision to standardise a number instead.
Degree days, and the number that clears
The number is the degree day. Take a reference temperature of 65 degrees Fahrenheit, or 18 Celsius, the point utilities noticed long ago is roughly where furnaces and air conditioners switch on. Measure how far a day's average temperature sits below that line and you have a heating degree day; how far above, a cooling degree day. Add them across a month or a season and a whole winter or summer collapses into a single figure.
That figure does every job the physical cask could not. It is perfectly fungible, because one heating degree day is identical to the next. Its grade is written down, because settlement is read off a named weather station that both sides agree on in advance. It clears in cash, at a fixed twenty dollars per index point on the US contracts, so nobody ever takes delivery of a cold snap. The Chicago Mercantile Exchange lists these on thirteen US cities, from New York to Portland, as monthly contracts and as bundled seasonal strips. You are not trading the weather. You are trading an agreed measurement of it, and a measurement is something a clearing house can hold.
Where it came from, and why you have not heard of it
The market was born in the late 1990s, when energy firms worked out that a mild winter cost them as surely as a price move did. In September 1997 Enron and Koch struck the first standalone degree-day swap, and within two years the Chicago Mercantile Exchange had turned the idea into listed futures. It then shrank after the 2007 to 2008 financial crisis took several of its early market makers with it, and it sat quietly for years, a working market that almost nobody outside a utility desk had any reason to watch.
Part of why you have not heard of it is that most of it happens where you cannot see. Roughly 90% of weather derivative activity is still struck over the counter, off the exchange entirely, bank to counterparty. The listed contracts are the visible tenth of a much larger private market that industry estimates have put as high as twenty-five billion dollars.
The quiet boom
Lately the quiet part has grown loud. As heatwaves and hard freezes have arrived more often, the demand to hedge them has climbed in step. Average open interest in the exchange's weather contracts ran four times higher across the first nine months of 2023 than a year earlier, and twelve times higher than in 2019; trading volume quadrupled in a year. By that September the exchange was carrying around 170,000 weather contracts in open interest. Measured against 2022, average volumes were up more than 260%, and the number of contracts outstanding was up 48% in a single year.
The hedgers are the ones you would expect first: energy companies and utilities, then agriculture, construction, retail, the ski resort praying for snow and the festival praying against rain. What is newer is the money arriving from the other side of the trade. Hedge funds have begun to treat weather as an asset in its own right, a risk to be warehoused and priced rather than simply avoided, and Kenneth Griffin's Citadel is among them. Such firms, in the words of Martin Malinow of Parameter Climate, "see themselves as a risk warehouse like an insurance or reinsurance company."
What the market cannot fix
None of this makes it a machine for easy money, and the honest part of the column belongs here. A contract settles on one named city's weather station, and your barn, your pipeline or your shop is somewhere else, so you are left carrying the gap between the two. That is basis risk, and on weather it can be wide. Away from the core cities and the near months the order book thins, and getting out of a position is not always cheap. Underneath both sits a deeper problem that the recent growth quietly leans on. Every one of these contracts is priced against a record of what the weather normally does, and a changing climate is precisely the case where the past is a poor guide to the future. The instrument people are reaching for to manage a less predictable climate is built on the assumption that the climate stays predictable enough to model. That tension does not make the market useless. It makes it something to use with your eyes open.
The point
Last week the absence of a market carried the information. This week the presence of one does. Weather could be listed where whisky could not, and the reason is the entire lesson of the series: you cannot standardise a barrel without destroying the thing that gives it value, but you can standardise a temperature by turning it into a number and settling in cash. An exchange never needs the thing itself. It needs a grade it can write down, a price it can clear, and a way out for both sides, and a degree day supplies all three where a cask supplies none.
So the next time something is sold to you as a market, ask the plain question the weather desk answered decades ago: what exactly settles, against what published number, and how do you get out. If the answers are good, an exchange is usually somewhere behind them. If there are no answers, that absence is worth reading too.
Levanter Markets publishes for education. Nothing here is financial advice.