Crop Production and Grain Stocks Trends in the U.S. and Kansas – Following from Abundant U.S. Grain Harvests

One of the factors causing U.S. grain prices to stay at their current moderate-to-low levels is the total quantity of U.S. corn, grain sorghum, wheat and soybeans available relative to commercial off-farm storage capacity.  This “strain” on storage capacity can be described as a “high demand for grain storage space.”  The net result of strong demand for limited U.S. grain storage capacity is a high real cost of storage – a factor that is influencing the U.S. hard red winter wheat market located in the central and southern plains states (Kansas, Oklahoma, Texas, Colorado, etc.).

The following slides are meant to illustrate this “oversupply relative to grain storage” situation as it exists in the U.S. and in the state of Kansas in the 2016/17 marketing year.  In summary, large crop supplies relative to available storage capacity characterize the U.S. grain storage and handling industry at this point in time.  Looking into the future the remedy for this current situation will come from either reduced grain supplies or increased grain usage.  The quickest remedy would seem be some sort of short crop/short supply situation in the U.S. in the coming months of year 2017.  Although it would be a surprise to the market, some combination of foreign crop production problems and increased U.S. grain export demand would also help to alleviate the current oversupply situation.

So, the grain market waits to see whether some combination of these supply – demand factors may reduce supplies relative available to grain storage capacity.  It is not too much of a “stretch” to say that we should know the answer to that question by August-September 2017!

 

 

Non-Convergence of CME HRW Wheat Futures and the DEC 2015, JULY 2016, and SEPT 2017 Contracts

An article on “Non-Convergence of CME HRW Wheat Futures for the DEC 2015, JULY 2016, and SEPT 2017 Contracts” is available on the KSU AgManager website (www.AgManager.info) at the following web address:

http://www.agmanager.info/non-convergence-cme-kansas-hrw-wheat-futures-dec-2015-july-2016-and-sept-2016-contracts

Following is a summary of the article, with the full text, figures, and data table on the AgManager website:

*****

Summary

Since the delivery period for the SEPT 2015 Chicago Mercantile Exchange (CME) Kansas Hard Red Winter (HRW) wheat futures contract, basis bids at designated delivery elevator locations during futures contract delivery periods have been markedly wider than the futures-cash price differentials at delivery designated in the CME Kansas HRW wheat futures contract specifications.  This market condition seems to be due to a combination of excessive supplies of wheat and to non-convergence of futures with cash wheat prices during delivery periods at designated delivery elevators.

During the late-August delivery period for the SEPT 2016 CME Kansas HRW wheat futures contract, truck bids for ordinary wheat in Kansas City, MO – where a number of the designated delivery elevators for the CME Kansas HRW wheat futures contracts are located – were $0.55-$0.58 per bushel under futures.  At other CME Kansas HRW wheat futures contract delivery elevator locations in Wichita, Hutchinson, and Salina, Kansas, wheat basis levels (i.e., the difference between futures and local cash prices) of $0.80-$0.85 per bushel under futures were recorded.  These basis levels are markedly wider than the location-based price differentials formally designated to occur during delivery according to CME Kansas HRW wheat futures contract specifications, i.e., $0.12 per bushel under at Salina/Abilene delivery elevators, $0.09 per bushel under at Hutchinson, $0.06 under at Wichita, and no discount or “par” at Kansas City, MO truck bid locations.

While this lack of convergence at designated delivery elevator locations between cash and futures prices for HRW wheat has been due partly to a combination of wheat market supply-demand factors, it seems that issues related to the design of the futures contract itself are also contributing significantly.  This is particularly true in regards to grain delivered by short futures position holders on CME Kansas HRW wheat futures contracts.

Potential remedies to non-convergence in the CME Kansas HRW wheat futures contract include instituting a VSR on this contract as well as the Chicago wheat futures contract, or to raise the fixed storage rate paid on warehouse receipts in the CME Kansas HRW wheat futures contract high enough to motivate “load out” cash sales instead of storage on the part of long position holders.

Causes of Current Wide Wheat Basis Levels in Kansas

Wide wheat basis levels that have existed in Kansas wheat markets since July 2016 are primarily the result of a) a large 2016 Kansas wheat crop, b) only a moderate pace of usage of U.S. hard red winter wheat in terms of exports, milling, and wheat feeding, and c) large inventories of wheat relative to available storage space at grain elevators in the state. And with large Kansas 2016 fall crop harvests occurring following the large 2016 wheat crop – the Kansas grain elevator system is expected to be filled beyond its constructed storage capacity, with the excess being placed temporarily in outdoor piles of grain (much of it to be covered with plastic, etc.).

While the supply-demand situation for wheat and other crops in Kansas is the primary factor leading to lower cash grain prices and wide basis levels, the lack of convergence between the Chicago Mercantile Exchange (CME) Kansas Hard Red Winter (HRW) wheat futures contract and cash prices at designated delivery elevator locations in Kansas during the delivery periods for the JULY 2016 and SEPTEMBER 2016 contracts has also been a contributing factor.

Non-convergence of HRW wheat futures and cash prices in Kansas has been an ongoing, periodic problem since at least early 2009.  Table 1 and Figure 1 show wheat cash prices for truck bids and basis levels for Ordinary HRW wheat at Kansas City, Missouri for the MARCH 2009 through SEPTEMBER 2016 CME Kansas HRW wheat futures contracts.  Kansas City, Missouri one of the – if not the primary – designated delivery elevator location for the CME Kansas HRW wheat futures contract.  Table 1 and Figure 2 show basis levels during these same CME HRW wheat futures contract delivery periods in Kansas City, Missouri as well at other designated delivery locations in Wichita, Hutchinson, and Salina-Abilene in Kansas. The cash prices and basis levels for Wichita, Hutchinson, and Salina-Abilene represent the reported upper ends of the cash price trading ranges for these locations from USDA Agricultural Marketing Service (AMS) daily reports for central Kansas grain markets.

Wheat Basis During Delivery Periods for the DEC 2015, JULY 2016 and SEPT 2016 CME Kansas HRW Wheat Futures Contracts

During calendar years 2009 through 2014, there were periods of extremely wide basis levels for the Kansas HRW wheat futures contract during delivery periods at Kansas City, Missouri delivery locations.  This was especially true during delivery for the DEC 2009 through MAY 2011 Kansas HRW wheat contracts. During this time frame, delivery period basis levels at Kansas City, Missouri delivery locations widened to $0.50 to $0.90 per bushel under associated expiring futures contracts.

This widening of wheat basis levels was primarily responsible for motivating changes that were made to the Kansas HRW wheat futures contract by the Kansas City Board of Trade in year 2011 – consisting of higher fixed storage rates on delivered warehouse receipts and tighter wheat protein and quality standards are delivered wheat.

Following is a record of the wheat basis levels that occurred at designated delivery elevators for the CME Kansas HRW wheat futures contract from the DEC 2015 futures contract forward through the SEPT 2016 futures contract.

  1. DECEMBER 2015 CME Kansas HRW Wheat Futures

Non-convergence of HRW wheat futures and cash prices during delivery periods has occurred consistently during the 2015/16 and 2016/17 marketing years.  Following what is more likely to be “convergence-like” performance for the JULY 2015 and SEPTEMBER 2015 CME Kansas wheat futures contracts, the DEC 2015 contract appeared to not converge with cash prices during the contract delivery period.

During the November 19-24, 2015 time-frame, truck bids for cash wheat in Kansas City, Missouri ranged from $4.17 to $4.25 per bushel.  Wheat basis levels ranged from $0.38-$0.40 under nearby DEC 2015 futures for November 19-20, and under MARCH 2016 futures for November 23-24 (Table 1, Figures 1 & 2).  During this same period, wheat basis bids at designated delivery locations in Salina ranged from $0.25-$0.30 under, compared to $0.20-$0.25 under in Hutchinson, and $0.25-$0.30 in Wichita.

These cash basis levels for the DEC 2015 Kansas HRW wheat contract were wider than the location-based price differentials formally designated to occur in the CME Kansas HRW wheat futures contract specifications, i.e., $0.12 per bushel under at Salina/Abilene delivery elevators, $0.09 per bushel under at Hutchinson, $0.06 under at Wichita, and no discount or “par” at Kansas City, Missouri truck bid locations.

  1. MARCH 2016 CME Kansas HRW Wheat Futures

After seeming non-convergence during delivery for the DEC 2015 CME Kansas HRW wheat futures contract, the basis levels during delivery for MARCH 2016 futures for the 2/23-2/26/2016 period were consistently $0.18 under in Kansas City, Missouri, and $0.35 under in Salina, $0.30 under in Hutchinson, and primarily $0.32 under in Wichita (with a late one day “jump” to $0.55 under on 2/26/2016) (Table 1, Figures 1 & 2).

As for the DEC 2015 CME Kansas HRW wheat futures contract, these cash basis levels for the MARCH Kansas HRW wheat contract are wider than the location-based price differentials formally designated to occur according to CME Kansas HRW wheat futures contract specifications, i.e., $0.12 per bushel under at Salina/Abilene delivery elevators, $0.09 per bushel under at Hutchinson, $0.06 under at Wichita, and no discount or “par” at Kansas City, Missouri truck bid locations.

  1. MAY 2016 CME Kansas HRW Wheat Futures

Basis levels during delivery for MARCH 2016 futures for the 4/26-4/29/2016 period were consistently $0.17 under in Kansas City, Missouri, and $0.45 under in Salina, $0.40 under in Hutchinson, and $0.35-$0.50 under in Wichita (i.e., $0.50 under on 4/26-27, and $0.35 under on 4/28-29) (Table 1, Figures 1 & 2).

As for the DEC 2015 and MARCH 2016 CME Kansas HRW wheat futures contracts, these cash basis levels for the MAY Kansas HRW wheat contract are wider than the location-based price differentials formally designated to occur according to CME Kansas HRW wheat futures contract specifications, i.e., $0.12 per bushel under at Salina/Abilene delivery elevators, $0.09 per bushel under at Hutchinson, $0.06 under at Wichita, and no discount or “par” at Kansas City, Missouri truck bid locations.

  1. JULY 2016 CME Kansas HRW Wheat Futures

During the June 27-30, 2016 period truck bids for cash wheat in Kansas City, Missouri ranged from $3.74 to $3.88 per bushel.  Basis levels were $0.25 under nearby JULY 2016 futures for the June 27-30 period (Table 1, Figures 1 & 2).  During this same period, wheat basis bids at designated delivery locations in Salina were $0.65 under, compared to $0.55 under in Hutchinson, and $0.65 in Wichita.

As has consistently occurred since the DEC 2015 CME Kansas HRW wheat futures contract delivery period, these cash basis levels for the JULY 2016 Kansas HRW wheat contract are markedly wider than the location-based price differentials formally designated to occur in the CME Kansas HRW wheat futures contract specifications, i.e., $0.12 per bushel under at Salina/Abilene delivery elevators, $0.09 per bushel under at Hutchinson, $0.06 under at Wichita, and no discount or “par” at Kansas City, Missouri truck bid locations.

  1. SEPTEMBER 2016 CME Kansas HRW Wheat Futures

Truck bids for cash wheat in Kansas City, Missouri ranged from $3.10 to $3.51 per bushel for the August 25-30, 2016 period.  Basis levels were $0.55 under nearby SEPT 2016 futures for August 25-26, and $0.58 under DEC 2016 futures for August 29-30 (Table 1, Figures 1 & 2).  During this same period, wheat basis bids at designated delivery locations in Salina, Kansas were $0.85 under, compared to $0.80 under in Hutchinson, and $0.85 in Wichita.

In what has developed to be a consistent pattern since late 2015, these cash basis levels for the SEPT 2016 Kansas HRW wheat contract are markedly wider than the location-based price differentials formally designated to occur according to CME Kansas HRW wheat futures contract specifications, i.e., $0.12 per bushel under at Salina/Abilene delivery elevators, $0.09 per bushel under at Hutchinson, $0.06 under at Wichita, and no discount or “par” at Kansas City, Missouri truck bid locations.

Possible Solutions to Non-Convergence in CME Kansas HRW Wheat Futures

It appears that this lack of convergence at designated delivery elevator locations between cash and futures prices for HRW wheat has been due to a combination of wheat market supply-demand factors as well as issues concerning the design of the futures contract itself.  This is particularly true in regards to grain delivered by short futures position holders on CME Kansas HRW wheat futures contracts.

In the Chicago wheat futures contract, the CME has instituted a Variable Storage Rate (VSR) mechanism that systematically increases or adjusts the rate of storage paid on the warehouse receipts by long position holders during times periods when the true price of storage moves higher.   During times of tight storage when the implicit market value of storage space increases, this increased storage rate on warehouse receipts (as driven by the automatic VSR adjustment mechanism in the Chicago wheat contract) provides a disincentive for continued holding of warehouse receipts by long position holders, and tends to motivate “load out” cash sales in the wheat market.  Increased “load out” or cash sales are a primary means of helping to bring about cash-futures convergence.

According CME Kansas HRW wheat futures contract specifications, long position holders who have been delivered on can choose to “load out” (sell the grain in the cash market) or pay fixed, contract specified storage rates charged on the warehouse receipts that they are have been forced to accept delivery of.  These warehouse receipt storage rates are calculated on a daily basis, and are approximately $0.09 per bushel per month during the July-November period, and approximately $0.06 per bushel per month during December-June.  During times when excessive inventories of wheat exist, available storage space is at a premium, and the cash price penalty for “loading out” and selling cash wheat as opposed holding warehouse receipts and paying designated contract storage costs is high. As a result, long position holders who have been delivered on have an incentive to hold the warehouse receipts – continuing to pay designated futures contract storage costs on them – rather than selling in the cash market (i.e., loading out).

In summary, supply-demand conditions for wheat in Kansas and the U.S. are certainly a major factor encouraging wide wheat basis levels at this time.  However, during key futures contract delivery periods wide differences between CME Kansas HRW wheat futures and cash prices at the designated delivery elevators can be attributed to a lack of convergence between cash and futures prices – contrary to the intended original design of such futures contracts.

Among potential remedies to non-convergence in the CME Kansas HRW wheat futures contract include instituting a VSR on this contract as well, or to raise the storage rate paid on warehouse receipts high enough to motivate “load out” cash sales instead of storage.  An August 11, 2016 newsletter by Kansas State University titled “Non-Convergence of CME Hard Red Winter Wheat Futures and the Impact of Excessive Grain Inventories in Kanas” goes into more detail on the causes and potential remedies of non-convergence issues in HRW wheat futures.

slide1 slide2

 

Non-Convergence of CME Hard Red Winter Wheat Futures and the Impact of Excessive Grain Inventories in Kansas

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:

http://www.agmanager.info/non-convergence-cme-hard-red-winter-wheat-futures-and-impact-excessive-grain-inventories-kansas

Following is a summary of the article, with the full text on the AgManager website:

*****

Summary

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).

Slide1 Slide2 Slide3 Slide4 Slide5 Slide6 Slide7 Slide8 Slide9 Slide10 Slide11

 

How would the grain industry react in the long run should USDA reports be sharply reduced?

Comments by Daniel O’Brien – Kansas State University

(All opinions are those of the author and not necessarily those of Kansas State University Agricultural Economics)

Re: The Long Run Impact and Industry Response to Sharply Reduced USDA Grain Market Information

https://i1.wp.com/oklahomafarmreport.com/wire/news/2010/02/media/03203_AussieWheat.jpg

Australian Wheat Harvest – 2010 (Source: http://oklahomafarmreport.com/wire/news/2010/)

Following are some thoughts on what the state of grain market industry information would look like in the future if there were either “no” or a “sharply limited” number of USDA reports to rely on from the USDA National Agricultural Statistical Service (NASS), Agricultural Marketing Service (AMS), Economic Research Service (ERS) and the like.

First and foremost, grain producers and users would be paying much more attention to basis and cash price trends at various upstream and down stream locations in the U.S. and world grain marketing systems – along with any arbitrage opportunities that may exist from transportation of grain between points.  The market would also be more closely attuned to grain futures carrying charges and the general structure of futures prices as signals of whether to hold and store grain or to “sell now”.  And in the absence of public grain supply-demand information, technical market analysis would probably be relied upon more heavily – as ag producers with crops to sell as well as users of grain with needs to fulfill would be looking wherever they can for guidance on what to do to fulfill their respective grain marketing information needs.

Also, it is likely that additional private analysts of U.S. and world crop prospects would spring up to take advantage of the need for market supply-demand information that is now provided by the USDA.  At this time it can be said that private firms are now likely “crowded out of the market” to some degree by the USDA – but would find opportunities for profitably supplying this type of information in the vacuum left by reduced USDA information availability.

A whole host of private “cottage industries” may likely spring up in various major U.S. crop producing states – generating local-regional crop rating and development information to fill the information need that the USDA now provides with its crop progress and condition reports. And this would be done for a profit motivation, with individuals & firms competing for the title of providing the best info to market decision makers. We would probably see these local “in the field” crop appraisal efforts supplemented by even more intensive use of private satellite technology to assess domestic and foreign crop development prospects.

It also would be of no surprise to see many of the people that are now employed by the USDA NASS, AMS, ERS and other agencies in high demand in private industry to “show the way” in how to collect, analyze, and provide the flow and type of crop information needed by U.S. agriculture to make pricing and risk management decisions.

The likely downsides of a sharp reduction in USDA grain market information over time would be that what is now a “public good” available to all regardless of economic means, i.e., access to grain market information from the USDA, would very likely become to a significant degree a “for fee” enterprise that not all U.S. grain producers would likely be able to pay for and therefore have access to.  To remedy this problem, it is possible that we would see the commodity futures exchanges (CME, MGEX, etc.) eventually bring together resources to cover the need for public information.  This happens in other countries (South America for instance).  However, it still seems that the availability of domestic and international market information to all market participants regardless of economic means would be reduced – even more than may be the case in some instances in markets at this time.

Also, the long term historic high quality data set that is heavily relied upon by the U.S. and world agricultural sectors for market perspective and analysis of the relative impact of ag market factors on price  prospects would be discontinued or curtailed.  If this were to happen, there would be an intense effort to “bootstrap” and/or “jackknife” together the old USDA data sets with the new private industry consensus forecasts that would likely become available.   However, in the transition from public to private information, the reliability of market information and therefore of market decision making would suffer – with the possibility of greater grain market price volatility and uncertainty.

In the bottom line, U.S. agricultural decision makers from farm to agribusiness would likely become all that much more dependent on the consensus forecasts available via the grain futures and cash markets for market information – increasingly looking to futures prices as a “consensus indices” of price prospects resulting from supply-demand forces in U.S. grain markets.

As a caution, to the degree that grain markets would be more vulnerable to the withholding of cash price or local production information by major local/regional market participants – then market performance and efficiency could suffer.  The means of overcoming this vulnerability and helping market arbitrage to be all that much more effective would likely be the development of an even more voracious and aggressive set of private “in-the-field” grain market information entrepreneurs – seeking and finding the info “gaps” that may exist from time to time in local ag markets, and trumpeting them to the larger market (for a fee).

https://i2.wp.com/southeastfarmpress.com/site-files/southeastfarmpress.com/files/imagecache/medium_img/uploads/2013/09/china-sorghum-purchase.jpg

Grain Sorghum in the U.S. (source: http://southeastfarmpress.com/markets/us-sorghum-industry-trying-break-chinese-market)

In summary, the vacuum in local market information would likely eventually be filled by private means should the USDA’s grain market information function be done away with or sharply curtailed.  However, the key question is the degree to which the “public good” which is now USDA grain market information would be adequately replaced and provided for medium to small agricultural producers here in the U.S. and abroad.

Daniel O’Brien
Extension Agricultural Economist
Kansas State University

KC Fed Study on Impact of Extended Trading Hours on Ag Commodity Market Volatility-Riskiness

Following is a report released by the Kansas City Federal Reserve Bank (KC FED) (http://www.kc.frb.org/) titled “Have Extended Trading Hours Made Agricultural Commodity Markets Riskier?”  The research was conducted and the article was written by Nathan Kauffman – an economist at the Omaha Branch of the Federal Reserve Bank of Kansas.

This article focuses on the impact of extended trading hours specifically on corn futures since May 2012.  The web address and summary of the report are provided below.

****************

Have Extended Trading Hours Made Agricultural Commodity Markets Riskier?

by Nathan Kauffman – Economist for the KC Fed (Omaha Branch)

Published in the Forthcoming issue of the Economic Review (here), a quarterly publication of the Kansas City Federal Reserve Bank.

Web references: http://www.kansascityfed.org/publicat/econrev/pdf/13q3Kauffman.pdf

https://i2.wp.com/www.indianagrain.com/media/images/blog_entries/3248.jpg

The Chicago Board of Trade (Source: http://www.indianagrain.com/blog/grain-traders-ponder-cme-hours-expansion)

Summary

Traders in agricultural commodity markets view volatility differently depending on their objectives. Producers generally dislike volatility and uncertainty and they trade on futures markets to lessen the risk associated with price changes. Nonproducers—traders with no direct involvement in producing or using the commodities themselves—seek to profit from uncertainty by predicting the path of futures prices.

Producers are concerned that a recent extension of trading hours at commodity exchanges could lead to heightened volatility since trading is now taking place during the release of key government reports on commodity supply and demand.

Kauffman examines the effect of extended trading hours on intraday corn futures markets and finds evidence of brief periods of elevated price volatility around the release of government reports. He concludes that producers whose long-term risk management strategies are not sensitive to brief spikes in intraday volatility are unlikely to be adversely affected.

Nathan Kauffman

Nathan Kauffman, Economist at the Omaha Branch of the Kansas City Federal Reserve Bank (biography)

New USDA ERS Study on “Non-Convergence in Domestic Commodity Futures Markets…”

Following is a report released by the USDA Economic Research Service (ERS) (http://www.ers.usda.gov/) concerning noncovergence in U.S. domestic commodity futures markets. The authors are the leading USDA and University experts in this field of study – and provide arguably the best information available as to why the problem of non-convergence of agricultural commodity futures and cash prices occurred, and what can be done in the future to encourage convergence to occur in the future.

****************

Non-Convergence in Domestic Commodity Futures Markets: Causes, Consequences, and Remedies

by Michael K. Adjemian, Philip Garcia, Scott Irwin and Aaron Smith

ERS Economic Information Bulletin number 115, August 2013

Web references: http://www.ers.usda.gov/media/1157033/eib115.pdf

and http://www.ers.usda.gov/publications/

https://i1.wp.com/www.ers.usda.gov/media/1157023/eib115_cover.jpg

Abstract

During most of 2005-10, the price of expiring U.S. corn, soybeans, and wheat futures contracts settled much higher than corresponding delivery market cash prices.  Because futures contracts at expiration are commonly thought to be equivalent to cash grain, this commodity price non-convergence appeared inconsistent with the law of one price.  In addition, sustained non-convergence concerns market participants, exchanges, and policy-makers because it can make hedging less effective, send confusing signals to the market, threaten the viability of a contract, and ultimately lead to a misallocation of agricultural resources.  This report summarizes prominent theories that have been offered to explain non-convergence, including a new model that explains how the structure of a competitive delivery market can generate a positive expiring basis. The data support this delivery market theory over alternative explanations. Finally, we discuss various policy levers thathave been offered to address non-convergence, as well as their likely impacts.

https://i0.wp.com/static.fairfaxrural.com.au/multimedia/images/large/574988.jpg

Grain piles in Australia (Source: http://www.theland.com.au/news/agriculture/cropping/general-news/asx-to-list-wa-wheat-futures-and-options/)

https://i1.wp.com/www.grainprofessional.com/blog/wp-content/uploads/2010/07/board-of-trade.jpg

The Chicago Board of Trade (Source: http://www.grainprofessional.com/)