Understanding Heating Degree Day (HDD): Definition & Calculation Methods

A heating degree day (HDD) measures how many degrees a day's average temperature is below 65^o Fahrenheit (18^o °C), which is the temperature below which buildings need to be heated. HDDs are widely used to estimate energy demand and help utilities, farmers, and other industries plan for colder conditions. They also play a role in weather futures and risk-management markets, where monthly HDD totals determine the settlement value of certain contracts.

Understanding the Basics of Heating Degree Days (HDD)

While HDD can describe the overall need for heating as part of the planning for residential or commercial buildings, it is critical for the pricing of weather futures. In turn, that creates a risk management tool that utility, agriculture, construction and other firms can use to hedge their activities that depend on the weather—energy needs, growing season, outdoor work time, etc. The first weather futures contracts based on HDD were listed in September 1999 at the Chicago Mercantile Exchange (CME).

Calculating Heating Degree Days: Methods Explained

There are several ways to calculate HDD. The more detailed a record of temperature data, the more accurate the HDD calculation.

1. Subtract the average of a day's high and low temperatures from 65. For example, if the day's average temperature is 50^o F, its HDD is 15. If that day's average is above 65, the result is set to zero. If every day in a 30-day month had an average temperature of 50^o F, the month's HDD value would be 450 (15 x 30). The nominal settlement value for that month's weather derivative contract would therefore be $9,000 (450 x $20).
2. Subtract each half-hourly temperature reading from 65, with the provision that negative values be set to zero, then sum the result and divide by 48 (48 half-hours in a day). Then sum that value over 30 (for a 30-day month) and multiply by $20. If a given day's value is less than or equal to zero, that day has zero HDD. But if the value is positive, that number represents the HDD on that day.

For all methods, if the value for any given day is less than or equal to zero, that day has zero HDD. But if the value is positive, that number represents the HDD on that day.

A similar measurement, cooling degree day (CDD), reflects the amount of energy used to cool a home or business.

One caveat is that heating degree days are extremely localized. Heating (and cooling) needs vary greatly depending on the geographical region. The average HDD can vary between neighboring buildings due to differences in construction, orientation, insulation, sun exposure, and use.

The Bottom Line

A heating degree day (HDD) measures how far temperatures fall below 65°F (18°C) to estimate heating demand, and it's widely used by utilities, agriculture, and construction, as well as in pricing weather futures.

HDDs can be calculated from daily averages or more detailed temperature data, and results vary by location and building type. They are often paired with cooling degree days (CDD) to give a fuller picture of seasonal energy needs.