under which two parties exchange
their cash flows at the end of a specified period
based on the difference between the negotiated average
degree days (the strike
level) and the actual degree days (as evidenced by a temperature
index) in that period. For example, a gas company
expecting reduced revenue
due to a forecasted warmer-than-normal winter sells a heating degree day (HDD) swap
at a strike level of 1000 HDDs for the winter months (the swap period), to settle
at $10,000 per degree day
. At the end of the swap period, the company pays $10,000 for every degree day less than 1000 and receives $10,000 for every degree day higher than 2000.
It is a type of weather derivative
, pioneered by the US firm Enron energy corporation
and traded first time in September 1997 between it and another US firm, Koch Industries.