Gensec structures first South African weather derivatives contract

ZZ2 Ceres, one of South Africa’s largest fruit and vegetables businesses, has become the first company in the country to use weather derivatives. Its frost protection contract was structured by Gensec Bank, and runs from October 14 to November 30 2002. The bank was unable to reveal the size of the deal.

The structure will pay ZZ2 Ceres for each day in the calculation period that the minimum temperature recorded on an hourly basis is less than or equal to 0 degrees Celsius. “The diminishing insurance capacity in the Western Cape, coupled with the difficulty of proving a frost loss in terms of the assessment process, proves weather derivatives to be a viable alternative to traditional insurance coverage,” said Wayne Sacharowitz, structured products manager at Gensec in Johannesburg. “We see this as a significant milestone with vast potential, especially since the predominant focus of weather derivatives [elsewhere] has been on the energy and utility sectors.”

South Africa has a deregulated and unsubsidised agricultural sector, which means producers are increasingly looking to hedge against adverse weather conditions, thereby minimising losses, Sacharowitz added.

The contract was developed in partnership with Element Re, the weather risk division of Bermuda-domiciled financial services company XL Capital.

When Gensec announced its plans to set up a weather derivatives desk in March, it had originally planned to work in partnership with Missouri-based energy company, and weather risk pioneer, Aquila. Since that time, Aquila has abandoned its entire trading operations, including weather risk.

As well as agricultural companies, Gensec is also set to target energy firms since the South African energy market is in the process of deregulation, said Sacharowitz. Around 10% of South Africa's electricity market should be opened up for competition this year, with a further 20% next year. As private companies compete for revenues, they will increasingly seek innovative financial risk management solutions, Sacharowitz claimed.