Commentary: A new study by economists Wolfram Schlenker and Charles Taylor has revealed that markets believe in global warming. This is an important result as markets serve as information aggregators. By aggregating across many participants, markets can provide insights into the expectations of those who have studied the issues and are willing to put their money where their month is. Because of the vast sums of money involved, one would expect markets to quickly reflect the consensus.
This is a remarkable result as surveys show considerable climate skepticism among Americans. A recent survey by Pew Research Center, for example, found that less than half of Americans believe in anthropogenic global warming. U.S. politicians reflect the publics skepticism, expressing mixed views about climate change. The result is failure to pass legislation aimed at mitigating global warming. Donald famously withdrew from the Paris Accord.
Financial market participants are not as skeptical of climate change as the general public. As it turns out, beginning in 2002, weather futures contracts have been traded on the Chicago Board of Trade for eight cities. They allow traders to bet on the whether the weather will be warmer or colder than average in a given month.
Weather futures are calibrated to 650F because that is the temperature below which people cool and above which they heat. So a day with a high temperature of 850F counts as 20 heating days while a 450F day is 20 cooling days. These days are then summed over the month to determine the contracts payout.
These futures allow companies to hedge against weather related out comes. For example, an electric company can hedge against hot weather resulting in high electricity demand due to hotter than average weather. The contracts also allow an opportunity for speculators to profit from global warming, or the lack there of. If traders expect believe temperatures will be higher, then an investor can bid up heat days; and if the expectation is for lower prices, then the investor can bid up cool days. The balance between those who expect hotter vs. cooler days determines the price of the weather futures.
Because the contracts are traded prior to the month on which they are priced, their price represents the markets expectation of future weather. Thus, at the beginning of May, market participants begin to trade based on their expectation of weather in June. Those who think that May will be unusually hot will bid up the price of heat-day units futures and down the price of cold-day futures.
What Schlenker and Taylor did was take more 16-years of data for eight cities to calculate the implied temperature expectation of the traders of these weather contracts. What they found was that the traders, individuals who are putting their own money on the line, act as if they believe in global warming.
In fact, the prices of weather futures closely followed the predictions of climate scientists, which appeared to have actually materialized. There was close agreement between market traders, scientific consensus, and actual climate outcomes. And this has been true since the early 2000’s.
There is an interesting corollary of the above result. If any of you, dear reader, doubt the scientific consensus about climate change, there is a simple way to profit on this, which is to sell warming futures and buy cooling futures. Profits are to be had, ye climate deniers.