How to Hedge Your Bets for a Toast of Burgundy Pinot Noir

There is a particular category, in the cauldron of derivatives, the financial instruments that have been accused of being the trigger cause of the financial crisis, which could be fundamental to protect income in weather-sensitive industries (30% of world GDP, source: WRMA). It's weather derivatives.
An example is provided by the wine-making industry. In vineyards, open-sky wine factories, the climate has a significant impact on the quality and quantity of grapes and thus affects wine production.

In the context we are developing, there are two kinds of risks linked to climate events: catastrophic risk, i.e. a major-impact random event (e.g. hail), and systemic risk, which is highly recurrent (temperature variations with respect to the forecasting model. Catastrophic risk, when possible, is defrayed through an insurance contract (such as insurance against hail risk). Normally, systemic risk cannot be reduced through an insurance contract due to its being a recurrent hazard.

Currently, wine-making firms can develop strategies to hedge against risk by implementing non-financial strategies, for instance installing irrigation systems to offset the lack of rain, or planting vineyards in areas that have complementary pedoclimatic conditions (for example, the region of Trento DOC in Italy or Napa Valley in California). These can run against constraints, both in terms of territorial limits which prevent geographic hedging (such is the case of Franciacorta DOCG), and in terms of the amount of investment that needs to be sustained.
An alternative could be coverage against climate risk by using a hedging strategy based on the purchase of a weather derivative, as I proposed in an article of mine which was recently published on The International Journal of Wine Business, titled "Weather derivatives in the wine industry" and focusing on the production of world-famous Pinot Noir grapes in Burgundy. What type of risk per hectare linked to temperature and precipitation did a Burgundy vintner incur in the 1998-2008 period? Eight years out of eleven (i.e. in 73% of cases) the bioclimatic index which summarizes temperature and rain trends recorded occurrences which were significantly different from optimal values. This situation had effects in terms of actual with respect to theoretical yields, and of lower quality of the wine made. In economic terms, it translated into a loss of €3,354 per hectare and in the high volatility of yields. As a consequence, remaining uncovered meant not only losing money with respect to expected returns, but to be subjected to year-to-year variability of yields, creating uncertainty and undermining the planning of investment.
A hedging strategy that employs weather derivatives provides coverage against temperature, rain, and wind hazards. In the case studied, a potential economic gain of €91 per hectare and a -21.43% decrease in yield volatility could be envisaged by purchasing a weather derivative.
In particular, the financial coverage provided is optimal under the following combination of production factors: homogenous terrain and a single grape variety. The same strategy can be extended to other high-value-added harvests, such as fruit production, to stabilize agricultural income.

Finance can thus supply a high-value service to weather-sensitive industries, because it is able to contribute to higher business income stability, and, consequently, to more favorable scenarios in terms of a firm's management and development.