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Cooling degree days is a term that is used in various places around the world to identify any day where the temperature rises above a standard level, and local residents begin to make use of air conditioning to cool building interiors. In most situations, the calculations for cooling degree days are presented in terms of Fahrenheit rather than Celsius. This is significant for investors, since the use of air conditioning in private and public buildings has an impact on the value of weather futures.
The process of arriving at the cooling degree days figure for a given day follows a basic pattern. Identification of the benchmark temperature is key to the process, with 65 degrees Fahrenheit (18.34 degrees Celsius) often used as this standard. From there, the actual high and low temperatures that occurred throughout the twenty-four hour period are averaged. The benchmark temperature is subtracted from the average temperature for the day, leaving what is known as a cooling degree day or CDD. For example, if the average temperature for a given day is 75 degrees Fahrenheit (23.89 Celsius), this would leave a cooling degree day of 10 (or 5.5 if the Celsius scale is used).
This figure becomes important for investors, as the cumulative cooling degree days for a given month help to drive the value of a weather derivative contract for that month. Assuming that the entire thirty day month had an average temperature of 75 degrees Fahrenheit (23.89 Celsius), this would translate into thirty days with a cooling degree days rating of ten, with Fahrenheit readings used as the standard. A dollar figure is assigned to the cumulative figure representing the thirty day period, making it possible to determine the total value of the CDDs for that month. That figure is then multiplied by a fixed dollar amount. For example, thirty days of an individual CDD of ten would mean a cumulative total of $3,000 US Dollars (USD). Assuming the dollar value assigned to each day is $25.00 USD, this means the cooling degree days for that month comes to $7,500.00 USD as the nominal settlement value for that month’s weather derivative contract.
A similar approach is used during cold months to determine the value of weather derivatives during months when air conditioning is not in common use. During these colder months, the calculation is referred to as heating degree days rather than cooling degree days. The idea behind both of these basic calculations is that consumers will utilize energy sources to maintain a comfortable temperature. As the usage increases, so does the degree days figure, which in turn increases the value of the weather derivative contract for that particular month.
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