Market seeks way to establish convergence of cash price, futures price

By MATTHEW WEAVER

Capital Press

Efforts are under way to bring convergence to U.S. wheat contracts, but a Northwest grains analyst says the future remains uncertain.

Todd Kemp, the National Grain and Feed Association treasurer and director of marketing, said members have been concerned about a lack of convergence between cash and the futures market in Chicago Board of Trade wheat contracts for more than two years and are looking for ways to re-establish it.

"A grain hedger, when he purchases a cash feed from a producer, then turns around and hedges his cash purchase on a futures exchange," Kemp said. "As the contract moves toward expiration and enters the delivery period, he relies on a predictable relationship between cash and futures and the difference to narrow as it nears expiration."

The cash value is the price a buyer pays a seller for physical bushels of grain, Kemp said. The hedger is looking for the cash value and the futures value to grow closer as the contract moves into the delivery period at the time it expires.

In recent years, there has been a wider spread between cash and futures values, and the association hopes to re-establish the predictable relationship for hedgers, lenders and producers can rely on, Kemp said.

"If a grain elevator can't rely on consistent and predictable convergence, he's going to be much more limited in the type of cash-forward contracts he can offer producers," he said. "The risk -- the financial exposure to the elevator -- just escalates dramatically."

The Chicago Board of Trade has made several changes to wheat contracts by instituting seasonal storage rates, adding new delivery locations and tightening specifications. Kemp said these changes are a move in the right direction, but based on their performance, not sufficient in themselves to create convergence. Additional action is needed, he said.

In September, the association announced its support for variable storage rates, a concept proposed by the Chicago Mercantile Exchange Group.

The association believes variable storage rates are the next logical step, Kemp said

For typical producers, the contract change may not immediately look much different, Kemp said.

But Dan Steiner, grain merchant at Pendleton Grain Growers Inc., said a variable storage rate would be confusing.

"I don't even fully understand it," he said. "I don't know how anybody else in the trade is going to know or be able to calculate what the storage rate would be."

Steiner said regulatory efforts would reduce volume, but the Chicago Mercantile Exchange and Commodity Futures Trading Commission make money on volume.

"They're going to have to sacrifice some income in order to make this a viable instrument again," he said. "When money gets involved, it's not as easy or as clean as you might imagine."

Steiner urged growers and producers to be careful, especially in the coming year, and to be aware of historical prices.

In the past, Chicago futures have been used as a hedging advice for soft red wheat, which does not have a futures market and is a flat-priced commodity, Steiner said. It's indirectly related to soft white wheat.

Ideally, the markets would move together somewhat, he said, but farmers might not see the consistency of movement they seek.

"That can provide lots of opportunity, but it can also provide lots and lots of risk," he said. "Growers are going to have to be very careful about what may or may not happen if these guys are ever successful at trying to get convergence back," he said.

The CME Group is seeking input on variable storage rates from the industry and deciding whether they want to propose formally the change to wheat contracts. If proposed, it would be subject to the approval of the U.S. Commodity Futures Trading Commission, Kemp said.

The association is encouraging quick proposal and approval of the storage rates, he said.

"We don't think we ought to waste any time moving toward better performance," he said.

Steiner said he expects a long, slow process before convergence is found. "I just think there's a lot of incentive for them to drag their feet and move slowly on this," he said. "It's going to reduce volume and cost them money."

Steiner said the next step is to see what the Chicago Mercantile, the trading commission and U.S. Securities and Exchange Commission decide to do. The securities and exchange commission regulates bonds and stocks.

"They're going through the process of having these various hearings and trying to get input from the market place," Steiner said. "To me, it just feels like it's futile, like there's not a lot of hope these guys are ever going to get it fixed."

Despite initial conversations about the two commissions merging, Steiner said it no longer looks like that is happening.

"Thankfully, I think most of the grain elevators and co-ops that offer these kinds of tools understand the risks," he said. "As long as there's good communication between the growers and the people using these tools, I think they'll be OK, but they just need to really be careful."

 

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