Towards a Blockchain Weather Derivative Financial Instrument for Hedging Volumetric Risks of Solar Power Producers

Abstract

The weather-dependent nature of solar power makes Solar Power Producers susceptible to the unpredictability of sunshine. Temperature-based weather derivatives have recently emerged as an effective volumetric risk cross-hedge for Solar Power Producers, given that temperature positively correlates with solar radiation. Temperature-based put and call options, mostly traded on organized exchanges, require users to pay premiums that are costly and difficult to price. Swap contracts can serve as an economical alternative since they do not require premiums. However, they are only traded over-the-counter and are thus illiquid and liable to counterparty credit risks. For these reasons, a novel blockchain temperature-based weather derivative swap marketplace is proposed that mitigates the risks inherent in traditional swap contracts. The payoff structure and governing mechanisms of the smart contract that underpins this instrument are also developed. A preliminary investigation of this new financial instrument shows its efficacy in hedging volumetric risks of Solar Power Producers.