The game changer

Features - Strategies

Debuting this winter, CME snowfall contracts can help snow contractors offset the risk associated with unpredicatable snowfall totals.

March 10, 2010
Mike Zawacki

HodgsonIt’s been a while since a product had the potential to be a real game changer for the snow and ice removal industry.

In December, derivatives exchange CME Group introduced new snowfall contracts that will allow contractors to manage their financial risk related to unpredictable U.S. snowfall totals.

So what does this mean for the average snow contractor? Well, CME snowfall contracts will enable snow fighters to offset the financial loss of an under-whelming, or an excessive, winter.

“In a nutshell, CME snowfall contracts are a tool – just like a v-plow or a box spreader – that will allow contractors to do their jobs better and stabilize their profit margins,” says Jeff Hodgson, president of the Chicago Weather Brokerage, a firm that specializes in solutions for enabling companies to manage their exposure to unpredictable weather and who is actively brokering these new CME snowfall contracts to contractors in the snow and ice removal market.

Hodgson sat down with Mike Zawacki, editor of Snow Magazine, Lawn & Landscape’s sister publication, to answer some of the common questions he’s been encountering from the professional snow removal market.

So how would CME snowfall contracts work for the average snow removal contractor?
Conceptually, the idea is pretty simple. Pay-per-push and/or hourly business runs the risk of too little snow. If it doesn’t snow, you don’t service your accounts and thus your billing/revenue suffers. Therefore, you would want to purchase CME snowfall contracts that pay out in the event monthly and/or seasonal snowfall totals are below a pre-determined level.

Conversely, all-inclusive business has an unlimited risk to the upside in the event your area is hit with a tremendous amount of snow. CME snowfall contracts can then be purchased on the upside to achieve a payout if it snows above a predetermined level.

Very interesting. For snow contractors is there a minimum spend level?
Presently, there is not a minimum dollar value, but rather a minimum number of contracts one must buy/sell.
Transactions must be equal to or greater than 20 contracts. Therefore, if each contract costs $1,000, the total transaction size is $20,000. If the contract costs $6,000, the transaction size would be $120,000.

CWB is working diligently on designing a solution to trade this market on a smaller scale. We hope to have this rolled out for winter 2010-11.

This sounds an awful lot like insurance. And hasn’t this been tried before in the industry?
The concept is similar in nature to insurance in that it offers companies protection from adverse conditions, weather in this case. Frankly, I have always thought of insurance as protection from something you did not want to happen. In this sense, CME snowfall contracts are very similar to insurance.

Pay-per-push business has a risk of too little snow and seasonal accounts have the risk from too much snow. This product offers a cost-effective solution to protect your business from what you don’t want to happen. CME exchange traded snowfall contracts – binary options – are an entirely new concept. By having a product trade on the world’s leading and most diverse financial exchange you avoid counter-party risk and have a competitive bidding process for the best price. Additionally, unlike insurance this offers professional snow contractors much greater flexibility to trade in and out of positions.

This product has only recently debuted in the industry. How has it been received so far?
I have been amazed at how quickly snow contractors not only see the value in the risk management opportunities within the contracts, but also in how it becomes an advantage to their business.

I think we all can relate to how the business world has become commoditized whereby companies seem to compete merely on price. This product enables a company to grow its business in a risk-managed environment all the while offering its clients a competitive price. Because of this, I believe we will see exponential growth in this product for next winter as many companies incorporate CME snowfall contracts into their bidding efforts.

These contracts deal with snowfall accumulation. Ice is a big part of many contractors’ winter business. Do the contracts also take ice into consideration?
Yes, snow and ice are components of the measurement stations. Many contractors have asked if there is an ice factor built into the measurement process, such as a half-inch of ice equates to 12 inches of snow, but that is not the case.

Snow and ice measurements are factored in on a gross basis. Those pay-per-push and/or hourly businesses that purchase downside protection from low levels of snow can benefit due to an increase in ice over snow. They will be servicing their accounts for deicing needs yet profiting on their snowfall contracts. However, this would not be beneficial to all-inclusive accounts that have purchased upside protection from too much snow.

When you talk with snow contractors about CME snowfall contracts, what are their top questions?
The obvious question is how much the contracts will cost and how many they should purchase. Many companies have not quantified their weather-related exposure. What does 1 inch of snow mean to your company – is that $10,000 of profit or $100,000 of profit?

Educating the marketplace on the tradable snowfall market is a two-way effort. Contractors enlighten me on their business and I am showing them how the deployment of CME snowfall contracts can be incorporated into their business.

It’s all about transferring risk to normalize your revenue stream and predictability of earnings.

Any recommendations for contractors?
It’s important to know your numbers – risk, revenue, margins, fixed costs and variable costs. Only when you have a handle on your numbers will you know whether CME snowfall contracts make sense for your business. 

Is this product only feasible for large-scale contractors?
Not necessarily. This product has an extensive reach from snow removal contractors to salt suppliers, property management firms and even municipalities. With a 20-contract minimum transaction size, it does require an undeniable level of investment commitment that may not be feasible for every snow removal company. However, the barrier to entry has been noticeably reduced by the introduction of this product. Previously, these transactions could not be structured for such a small investment size with all the benefits of an exchange-traded product.

Those who are serious about growing their business and managing weather risk will see the value proposition this product offers regardless of the size of their balance sheet.

I understand how this protects a contractor’s bottom line, but could he purchase these contracts for his commercial clients? In a sense, using them as a value-added product that improves customer service?
This is most visible where the opportunity exists for snow removal contractors to employ CME snowfall contracts. The snowfall market facilitates contractors’ alignment of interests with that of their largest commercial accounts. All across the country, I hear the same response to risk management, which is that companies balance their business between pay-per-push and all-inclusive. This is a very prudent strategy.

Now, with the launch of CME snowfall contracts you can gain market share regardless of whether it’s pay-per-push or all-inclusive. CME snowfall contracts permit you to give your customers what they want. For instance, many companies are walking away from vast opportunities in all-inclusive business because they can’t secure enough pay-per-push business to offset the risk of too much snow. The CME snowfall product suite enables you to give your customers what they want, regardless of the structure.

For instance, most large-property managers in high-snowfall areas from Minneapolis to Cleveland to Boston all want an all-inclusive agreement. With CME snowfall contracts, you simply purchase low-end contracts that pay-out if it snows below a certain level, which then becomes the vehicle to pay your customer a rebate on their total investment. Then, you purchase upside protection to offset the additional costs incurred from extra visits from above-average snowfall levels. This protects your customer from overpaying for low snowfall and protects you from too much snow. It clearly aligns your interests. This is where I believe companies who implement this strategy early on will have a competitive market advantage over their competition. I have also met with some of the nations’ largest property management firms and can assure you this is what they desire from their snow removal contractors.