September 9, 2009

A top US grain group on Tuesday (Sept 8) urged the CME Group Inc. (CME) to implement a variable storage rate for CBOT wheat futures by December if a gap persists between cash prices and futures.

 

The National Grain and Feed Association told CME officials in a statement that the variable storage rate is the "next logical step" in the exchange's attempt to improve convergence between cash prices and futures. The markets are supposed to come together when futures contracts go into delivery to facilitate hedging, but cash prices have sagged well below futures for more than two years.

 

CME is assessing the concept of a variable storage rate and is expected to propose it because cash wheat prices have remained weak during the delivery period for the CBOT September contract. The CBOT trades soft red winter wheat, which is grown in the eastern third of the country and used to make pastries and snack foods.

 

Under the variable storage rate concept, storage charges assessed by grain elevators would change from month to month based on the carry in the market that is implied by futures-market spreads. Carry is the cost to long-position holders of taking delivery of the grain, and includes storage, insurance and interest.

 

An increase in storage rates would make it more costly to continue to hold or roll futures market positions forward, which have contributed to a significant gap between futures and cash market values, according to the grain association.

 

CME, which owns the CBOT, previously overhauled the wheat contract to improve convergence. However, traders say the changes have failed. CME earlier this year added new delivery territories, implemented a seasonal storage rate with two pre-set levels and lowered the allowable limit of vomitoxin, a fungal byproduct.

 

The variable rate, if approved, would replace the seasonal rate, the CME has said. If the seasonal storage rate stays in place in December, it is slated to decrease to five cents per bushel per month from eight cents per bushel per month.

 

"Implementation of a variable storage rate in December would at least prevent the storage rate from moving in the wrong direction, and would prevent further delay in remedying the CBOT wheat futures contract's recent performance," said Rod Clark, chairman of the grain association's risk management committee and vice president of CGB Diversified Services in Mount Vernon, Ind.

 

A variable storage rate would "better reflect cash fundamentals and enhance the ability of market participants to manage basis risk, which has increased dramatically in recent years," according to the association. Basis is the difference between cash prices and futures.

 

"Better management of basis risk also should benefit banks and other lenders that provide financing to the agricultural sector," the association said in a statement.

 

The lack of convergence in the CBOT wheat has hurt farmers and the grain industry, particularly during a run-up to record prices in 2008, by contributing to large margin requirements for grain buyers to maintain their hedge positions in the futures market, according to the association. High margins caused buyers to "reduce or eliminate offering cash-forward contracts to producers, thereby limiting farmers' ability to capture favorable pricing opportunities during a period of rapidly escalating fuel and input costs," it said.