An article on “Non-Convergence of CME Hard Red Winter Wheat Futures and the Impact of Excessive Grain Inventories in Kansas” is available on the KSU AgManager website (www.AgManager.info) at the following web address:
Following is a summary of the article, with the full text on the AgManager website:
The current “wide wheat basis” situation that exists in the Kansas wheat market has resulted mainly from large, plentiful inventories of available wheat in combination with other grains in Kansas grain elevators. These large inventories of grain have led to increased demand for storage space in Kansas grain elevators – including those at approved delivery locations for wheat futures contracts. Because of this increased demand for grain storage space, the true value or price of physical grain storage at delivery locations has risen above the storage costs written into the CME Kansas hard red winter wheat contract. This difference is called a “wedge”, with a positive “wedge” occurring when the true value or price of physical grain storage is greater than the futures contract storage rate on delivered grains at delivery location grain elevators.
When short position holders of CME Kansas hard red winter wheat futures contracts make delivery on their futures contract positions in the form of warehouse receipts, they force long futures position holders to take delivery of those same warehouse receipts. Then because of the positive “wedge” that currently exists between the true price of physical storage space and the storage costs in the CME Kansas hard red winter wheat futures contract, these long position holders have an incentive to hold and “store” these warehouse receipts that they have taken delivery of indefinitely rather than to “load out” and convert them to grain in the cash market. Long position holders have a financial incentive to continue to accumulate and store warehouse receipts they have taken delivery of as long as a positive “wedge” exists at delivery location elevators – contributing to wider wheat basis levels and increasing non-convergence of Kansas wheat cash and futures prices over time beyond the specific delivery elevator locations.
Possible solutions to the formation of such positive “wedges” between the true value or price of physical storage and lower contractual storage rates and the occurrence of non-convergence of cash and futures prices in Kansas hard red winter wheat markets would be to either raise the contractual storage rates to a level as high as physical costs of storage have even been or are likely to be, or to establish a variable storage rate (VSR) mechanism for the CME Kansas hard red winter wheat futures contract as exists for the CME Chicago wheat futures contract. The solution of raising the fixed storage rate on delivered grain that currently exists in the CME on the Kansas HRW wheat futures contract would help to solve the problem of non-convergence between cash wheat prices and wheat futures at delivery point location elevators and the broader Kansas wheat market.
Low interest costs are another factor leading to non-convergence of Kansas wheat cash and futures prices. Low interest expenses reduce the economic total opportunity cost to long position holders how have been delivered on of holding warehouse receipts rather than “loading out”, stopping interest costs, and generating revenue in the cash grain market.
If these periodic times of non-convergence in the Kansas wheat market were eliminated or reduced in frequency of occurrence and degree of price impact, it would benefit Kansas farmers in terms of more effective and efficient crop revenue insurance programs and wheat marketing strategies. It would also help Kansas farmers and agribusinesses make more accurate and profitable decisions in regards to crop enterprise selection and profit maximizing decisions in regards to use of farm assets.
This topic will be discussed at the Kansas State University 2016 KSU Risk and Profit Conference, to be held August 18-19 in Manhattan, Kansas (http://www.agmanager.info/risk-and-profit-conference).