Rain or shine, they aid business climate

Are you willing to bet the farm on weather reports you get on the Internet?

Weatherbill.com lets you hedge your business risk when you are affected by the weather. Is it a good deal? You bet-literally

Rain or shine, they aid business climate

Startup offers financial hedge against weather

by Ilana DeBare, San Francisco Chronicle Staff Writer
This article appeared on page C - 1 of the San Francisco Chronicle
Wednesday, June 6, 2007

A San Francisco startup is touting a new kind of financial hedge aimed at helping small businesses weather the weather.

WeatherBill, a venture capital-backed firm started by two former Google employees, sells what are called weather derivatives -- contracts that pay out in cash if the weather hits a selected level of heat, cold, rain or drought.

Weather derivatives have mostly been available to very large companies such as electric utilities for a decade. But WeatherBill is making them available over the Internet to smaller companies that are affected by the weather, such as golf courses, restaurants and even hair salons.

So, for instance, a San Francisco golf course trying to compensate for slow business on rainy autumn days could buy a contract that would pay $500 for each day with more than half an inch of rain between Oct. 1 and Nov. 30. WeatherBill quotes a price of $1,451.74 for such a contract.

"We can sell a weather contract for $1 or $100 million," said Chief Executive Officer David Friedberg, who founded the company with Chief Technology Officer Siraj Khaliq. "We've used technology to let us address the needs of businesses of any size."

In reality, WeatherBill's services will initially be limited to businesses with a net worth of $1 million or more. That rules out very small mom-and-pop firms.

And some observers caution that weather derivatives are too complicated and risky for most small businesses. They note that weather derivatives were pioneered by Enron as a tiny part of its business during the go-go days before its collapse.

"It's basically placing a bet, and you might as well go to the Preakness," said Rick Vassar, a Virginia risk management consultant and author of the book, "Hide! Here Comes the Insurance Guy."

WeatherBill isn't the first company selling tools for businesses to protect themselves from bad weather. Insurance companies have traditionally offered policies covering catastrophic weather or major crop failures. They've also offered policies covering cancellation of special events due to weather.

But WeatherBill's contracts go beyond catastrophes like hurricanes, to address more-modest weather challenges such as a somewhat rainy spring or cool summer.

And unlike insurance, WeatherBill doesn't require businesses to show proof of actual losses to get a payout.

Spencer Malay Hair, an Atlanta salon and day spa that opened less than a year ago, is a WeatherBill client and an example of how weather derivatives can work for a small business.

The salon's owners rely on walk-in customers from a nearby movie theater as a way to build a client base. But they found their walk-ins dropped dramatically on sunny days when people stayed away from the movies.

Searching on the Web for weather forecast information, co-owner Ray Luciano stumbled upon WeatherBill. He and partner Spencer Malay decided to spend $2,000 for a contract that would pay them $10,000 if the weather were completely dry over a particular two-day weekend.

The skies did indeed stay dry, and the salon reaped $10,000. Luciano and Malay bought a similar contract for another weekend and reaped another $10,000.

They plan to continue buying a weather contract every few months until their salon is busy enough that they no longer need walk-in clients.

"If it had rained, we would have lost $2,000 but we would have more than made up for it with the new clients we would have gotten," Luciano said. "This helps us protect ourselves if the weather doesn't go the way we want it to."

Not all of WeatherBill's clients, of course, receive the dramatic payoff that Spencer Malay Hair did.

The challenge for weather contract buyers is weighing the likelihood of bad weather against the cost of protection.

"You need to be really, really informed," Vassar said. "A lot of small-businesspeople don't have the time or expertise to do this kind of financial modeling."

WeatherBill faces its own set of challenges. To turn a profit, the company must rely on databases of historical weather information and complex mathematical formulas aimed at calculating the likelihood that a given time period will be wet, dry, cold or hot. And it's got to do this at a time when global warming is calling much historical weather data into question.

The company also must find enough customers to balance its own risk -- offsetting payments to some clients with revenues from others who didn't win a payout.

"Their challenge is to build a diversified book, so their risk is spread across different kinds of weather conditions, different geographical areas and different time periods," said Scott Mathews, president of WeatherEX LLC, a commodity trading advisory firm. "If they have that, they won't be inundated by rain people or drought people."

WeatherBill has some deep-pocketed help. It has venture capital investment from New Enterprise Associates and Index Ventures. Nephila Capital, a $3 billion reinsurance company, also owns a minority stake in WeatherBill and provides reinsurance for the firm.

Friedberg said he got the idea for WeatherBill about two years ago when he was still working in Google's corporate acquisitions division and Khaliq was an engineer there. Friedberg lived across the street from a bicycle shop and noticed that its business plummeted on rainy days. "I thought it would be cool to do something to help protect these businesses whose revenues were so dependent on the weather," he said.

At that point, Friedberg had never heard of weather derivatives. But derivatives had been around since the late 1990s.

Electric deregulation, which spread across the country in the 1990s, meant that utilities were no longer able to pass all their costs on to consumers. They began looking for ways to control expenses such as unexpected spikes in the cost of energy due to weather. Enron started selling weather derivatives and soon a mini-industry developed.

More than 730,000 weather contracts worth about $20 billion in potential payouts were traded during the past year through the Chicago Mercantile Exchange and over the counter, according to the Weather Risk Management Association. But nearly all of these contracts were written for large entities such as utilities.

WeatherBill aims to reach smaller businesses by using the Internet to streamline the process, making it as simple to price a weather contract as it is to buy something on eBay.

"It's a very interesting concept and might have broad appeal because it's not insurance -- no applications or assumed claims hassles, (and) easy online contracts," said Charles Wilson, a risk management consultant with RiskSmart Solutions in El Cerrito.