“Right about now, Jerry Choate should be hiring workers and getting ready to install displays in the visitor's center at Cheyenne Bottoms near Hoisington. Instead, he's waiting. Persistent rains have turned what generally is shallow-water wetland into a sea of deep water.”—9/21/2007 The Hayes Daily News, Kansas
“Construction cannot begin until the area receives adequate rain… soil conditions at the new school site are about eight percent drier than what is considered normal for this time of year… the general contractor cannot begin construction on the school's foundation...”—9/20/2007 The Madison Courier, Kentucky
“The work still is not over at South Junior High School. Because of 45 days of weather delays, the new completion date has been moved back from Oct. 1 to Nov. 16.”—10/9/2007 Lawrence Journal-World, Kansas
Bad weather can turn a missed construction deadline into a news headline.
But bad weather isn’t news to construction business owners who go to work with the elements every day. Severe, unpredictable weather can send construction costs skyrocketing and revenue spiraling. Bad weather impacts materials, equipment, laborers and the quality and quantity of work. Delays are especially expensive when a construction loan is involved. Loans come with interest, and with interest, time is literally money. Bad weather certainly isn’t cheap. Economists say weather impacts $3.8 trillion a year in the United States. That’s one-third of the economy.
According to the Institutional Investors Group on Climate Change (IIGCC), the construction industry will be impacted by global warming in three ways:
- The physical impact of weather, such as too much rain, heat and cold.
- The need for new materials and building techniques that protect structures and roads from severe weather
- The cost of insuring climate change
The insurance sector is beginning to factor climate change into premiums, making it more expensive to build in severe weather-prone areas like the Atlantic Seaboard and Gulf Coast. High premiums could prevent new homeowners from being able to afford to build and prevent previous homeowners from rebuilding. Higher premiums could mean fewer projects.
The IIGCC also outlines the key risks climate change poses on the construction industry, which includes the risk of reduced raw materials, increased regulatory standards, increased energy prices and higher costs caused by weather delays.
When it comes to climate change, it’s not all gloom and doom for the construction industry. The good news is that warm winters are lengthening the construction season. Projects are starting earlier in the spring, and deadlines are reaching well into winter months that were once off limits. According to WeatherBill, Inc.’s recent study on temperature trends in the United States, 57 percent of major United States cities are experiencing winter warming trends.
Then there is the bad news: Scientists say global warming is contributing to more intense, more unpredictable storms that can dampen the goals of a construction deadline. As climate change becomes more pronounced, more and more businesses are seeing the impact of weather on their revenue and costs. Business owners in weather sensitive industries like construction are looking for protection from climate change and the impact of unpredictable weather.
Getting Paid for Bad Weather
“If a project isn’t done on time, costs can add up and profits can be lost,” says John Hickey, a civil engineer and attorney in Jordan Schrader’s Dirt Law practice. “Construction delay is one of the most litigated issues in construction law. Knowing that risk, I am surprised that many contractors enter contracts without a plan of action for documenting impacts to their performance. With respect to impacts caused by severe weather, contractors can usually recover extra time but not extra money. That said, even if the contract allows for the recovery of extra time because of a weather delay, contractors still must be sure to document the impact to their performance properly or risk losing any right to recover.”
Project contracts and insurance have been historically used in the construction industry to safeguard projects from weather delays, but they only safeguard against catastrophic damage. Severe weather that isn’t catastrophic can be just as damaging to a business, physically and financially. In the 1990s, an old financial tool called a future was turned into a new type of weather protection against the threat of day-to-day weather events.
In 1997, energy companies started using weather futures to protect their bottom lines against unseasonably hot and cold temperatures. The unusual temperatures kept consumers from turning down their air conditioning or turning up their heat, preventing energy companies from reaching revenue goals and leaving them with excess energy. Weather futures reduced the energy companies’ seasonal weather risk, and the concept soon caught on with Fortune 100 companies.
Over the past decade, other weather-sensitive industries like construction, agriculture, travel, leisure, retail and transportation have started using futures to protect their revenue. Today, futures are simple and affordable.
Unlike insurance, derivatives do not require proof of loss for payment. There’s no claims process. Businesses get paid for bad weather as soon as it is measured at a weather station. The stations are typically managed by the National Weather Service and are located at airports. The U.S. Commodity Futures Trading Commission requires that businesses purchasing futures have a net worth of $1 million (an individual must have $5 million).
Futures and Construction
One of the biggest benefits of futures is that they are fully customizable. Business owners pick the type of weather that hurts their revenue, where the weather is measured, when they want to be paid and how much they want to be paid. Custom protection is especially important in the construction industry because every project comes with a unique set of weather risks. At one site, bad weather could be too much rain or too much heat. For another site, bad weather could be drought or too much cold. One project could require a week’s worth of protection, while another needs a season or an entire year’s worth protection. Futures take almost every bad weather scenario into account to achieve the exact level of protection a business needs.
“Contractors are living with weather risk so their business plans are designed to handle some bad days now and then,” explains Professor Arthur Small from the Department of Meteorology at Pennsylvania State University. “They can take lots of little hits from bad weather. What they can’t take is a big hit. A ‘big hit’ doesn’t necessarily mean a hurricane. There’s insurance for that. What they can’t take is a big hit like an entire rainy season.”
Futures are not a form of insurance. Instead, futures can help fill the gap between the time bad weather happens and the time an insurance company pays for damages. Again, futures don’t require proof of loss; they only require proof of bad weather. Futures’ payouts can help maintain payroll, pay for additional equipment and supplies and help pay for damaged materials before insurance compensation is complete. Construction business owners can also use futures to strengthen project pitches. Instead of passing weather risk off to clients, the risk gets taken on by the company providing the future.
“One clean application of futures is for contracts that specifically reference weather delays,” says Small, who also teaches weather risk management at the university. “If there is a clause that says ‘here’s the weather risk, and here’s the penalty if the bad weather happens,’ then contractors can take that risk and hand it off to someone else in exchange for payment. It can save the costs of litigation.”
Small says there are three main challenges when it comes to integrating weather risk management and weather futures into the construction industry.
“First, there needs to be a qualitative understanding of the risk,” says Small. “For example, lots of firms know cold temperatures are bad for pouring concrete, but few companies will have asked, ‘Is this a measurable risk?’”
There are several weather risk managers that can help decode weather risk, some for free and others that charge a fee.
Historical weather data helps address what Small says is a second challenge: Determining the probability of bad weather. Historical data helps contractors know the probability of extreme weather and then helps put a price on a future.
Small says the third challenge is finding the right weather station for measuring weather.
“The contract has to be based on historical data at weather stations. If you are building airports, where National Weather Service stations are usually located, you are in great shape,” says Small. “At an airport, you’ve got high-quality data right where you are operating. But if you are building anywhere else, there could be a gap between the weather that is measured and the weather at your project’s location.” In spite of those three challenges, weather risk managers say the biggest risk for business owners to take is to not do anything to protect their revenue.
“Good contractors think ahead of the game. They are always trying to anticipate what will happen during the progress of the work and plan accordingly,” says Hickey, engineer with Jordan Schrader’s Dirt Law Practice.
Weather risk management is a strategy for planning ahead. Using futures helps make sure business owners are rewarded for their forward-thinking by offering peace of mind and payments to offset losses incurred during periods of unusually bad weather.
The most important question any business owner should ask is, “What risk is at the top of my list?” If bad weather is at the top of the list, then futures are a way to pass the risk to someone else, control costs and protect revenue.
Weather will always make the news, but construction business owners should leave the headlines to movie stars and politicians.
Construction Business Owner, December 2007