Chicago Wheat Futures Struggle to Match Cash Prices

“MGEX recognizes the serious issue the lack of convergence creates for futures market participants in the agricultural industry. It is unfortunate several commodities,

for any number of reasons, have not been experiencing successful convergence, creating a concern across our common marketplace. In this light, our Federal regulators continue to provide support to the exchanges in an effort

to remedy this concern of the marketplace. MGEX is pleased to note the continued successful convergence of our Hard Red Spring Wheat contract.” MGEeX President and CEOeo, Mark G. BagGen

The futures markets were developed in the 1800’s to try and minimize price movement risk for cash buyers and sellers. If we could buy and sell a standardized product for a future time period, there would be more stability in the business. The futures markets have operated successfully for over 100 years, but the Commodity Futures Trading Commission is currently investigating some bumps in the road that are occurring in the Chicago soft red winter wheat futures market.

 A futures contract is a substitute for the cash product. If you sell a futures contract of wheat, it should be similar in price to the cash wheat market for that time period. Convergence is the term used by traders: The tendency for the price of cash products and their related futures contracts to come together, usually at delivery time. There are adjustments from the futures to cash price for factors such as delivery location and quality, but farmers who sell to elevators are familiar with those adjustments. Spring wheat growers who sell on the Minneapolis wheat futures market have a general idea of what price their local elevator will offer, in relation to the futures price. The difference between the cash price and futures price is called the basis. Spring wheat growers are also aware what will happen if you do not deliver the specified quality, which is typically a protein discount or premium.

Now imagine you are a wheat grower who has decided to sell next year’s crop on the futures market. You sell the wheat futures for $6.50, but you know your local basis is around fifty cents under, so you expect a cash price of $6.00. Now it is time to deliver, but instead of a fifty under basis, you have a $2 under basis, and a cash price of $4.50. Your attempt to forward contract wheat using the futures contract has not worked because of the large difference between the cash price and future price. There was not convergence between the cash wheat price and the futures price.

This farmer nightmare scenariohas been occurring in the Chicago wheat futures market. Beginning last summer, the Chicago futures market and the cash market started moving in opposite directions. A basis that has averaged from -15 to -50 cents under the futures market, was now running more than $2 under the futures market. If a farmer had sold futures for $7, and expected $6.50, he was now receiving $5 instead. There has not been adequate convergence in the Chicago wheat market.

To remedy the problem, the CFTC has convened a Subcommittee on Convergence in Agricultural Commodity Markets. The CME (CBOT) has already implemented some changes to the futures contract, such as delivery locations and storage rates, but the committee’s work continues. One hurdle to solving the problem is that not everyone agrees on the cause of the problem. When surveyed, committee participants listed a range of causes such as delivery locations, vomitoxin specifications, the size of speculative and index fund positions, and commercial industry consolidation.

Farmers are not the only ones who have suffered from this lack of price convergence. Commercial buyers of soft red winter are also frustrated because of their inability to effectively hedge their purchases. Vince Peterson, Vice President of Overseas Operations for U.S. Wheat Associates serves on the subcommittee and shares the frustrations of buyers and sellers alike. “One large, domestic soft red winter wheat buyer is using Kansas City wheat futures to hedge their wheat purchases because the Chicago market just isn’t as effective for hedging,” says Peterson. To insure wheat growers have a voice in helping to find a solution to the problem, Peterson serves on the subcommittee while Daren Coppock, Chief Executive Officer for the National Association of Wheat Growers, serves on the subcommittee’s parent, the CFTC’s Agricultural Advisory Committee.As farmers listen to or read headlines about ineffective futures markets or investigations into wheat futures, they should remember that this is currently a problem limited to Chicago wheat futures. There is still convergence in the Hard Red Spring Wheat futures on MGEX. The committee’s work to correct the convergence problems in Chicago wheat will continue, but solutions will not be found overnight.