Observations from the 2018 Ag Commodity Futures Conf, Overland Park, KS, April 5-6 – No Consensus on Fixing Arbitrage to Cause Grain Price Convergence

The 2018 Agricultural Commodity Futures Conference was held in Overland Park, Kansas on April 5-6, 2018.  This meeting was sponsored by the Commodity Futures Trading Commission and the Center for Risk Management Education and Research in the Kansas State University Department of Agricultural Economics.

The agenda for this conference and an number presentations are available at the following web location:


Following is the first of two articles by KSU Agricultural Economics Art Barnaby and Daniel O’Brien discussing the findings of the conference – with a particular focus on the functions, efficiency, and performance of grain cash and futures markets.  This article is also available at the following web address on the KSU AgManager.info website:


Fixing Arbitrage to Cause Convergence; No Consensus

Prepared by

G. A. (Art) Barnaby, Jr. (barnaby@ksu.edu) , Professor, Dept. of Agricultural Economics

Daniel O’Brien (dobrien@ksu.edu), Extension Agricultural Economist

K-State Research and Extension, Kansas State University, Manhattan, KS 66506

April 16, 2018.


Kansas State University and the Commodity Futures Trading Commission (CFTC) recently held a joint conference on the lack of convergence in grain futures and many other futures trading issues.  Convergence is required for COOPs, grain elevator hedges, farmer hedges and crop insurance claims to work properly.  Without convergence, there is no connection between futures and cash markets, and grain future markets are not likely to survive in the long run without a reliable basis relationship with local cash prices.  Futures are not trading grain; they are trading the value of a shipping certificate that is received by the long when delivery occurs.  Non-convergence occurs when there is no credible threat of delivery.  Shipping certificate receivers have the right to store the grain and pay the storage indefinitely, currently 5 cents/month for corn and soybeans.  They also have the right to pick the date to load the grain out on a train/barge. 

Most grain industry traders don’t favor the Variable Storage Rate (VSR) mechanism now used on Chicago Mercantile Exchange (CME) Wheat futures contracts, and it appears there is little chance that VSR will be applied to corn and soybeans.  Other options for defining storage obligations in the CME wheat futures contracts included: 1) returning to a fixed storage rate; 2) fixed storage at a higher rate; 3) a seasonally adjusted storage rate; 4) a computer model estimated implied market “value of storage” with a committee adjusting the storage rate; 5) expanding the number of entities who can make delivery; and 6) a change to a no-storage futures contract.  Most participants at this conference were opposed to cash settlement and required load out of grain futures. 

Indexed funds, computerized trading, “Spoofing”, livestock contracts, etc. were also covered at this conference, but not included in this summary.  Papers and power point slides from the conference are located at:


Issue #1: CME Algorithm

CME has eliminated pit trading in favor of computerized matching of buy-sell orders.  Surprising, it is not the oldest futures contract bid that is filled first.  To the surprise of many participants, CME has an algorithm that determines which contracts are filled first.  There was one very upset participant that stated his order was not filled, even though his bid was higher than CME’s posted close.  His question was how was that possible?  Answer, that is how the algorithm works[ii].  Some participants questioned the “equity” and “fairness” of a CME algorithm determined queue order for filling contracts.  (See note at end of article on how the CME Algorithm functions)

Issue #2: Variable Storage Rate (VSR) Mechanism for CME Wheat & KS HRW Wheat Futures

As expected the Variable Storage Rate (VSR) generated a lot of discussion. There were a number of grain traders who made it very clear they don’t like VSR.  The argument is VSR leaves the long guessing what the storage cost will be, resulting in reduced liquidity in the deferred contracts. 

Dr. Scott Irwin, University of Illinois, made the case that non-convergence was caused by the futures stated storage rate being set below the market value for storage.  Multi-national grain elevators with delivery rights don’t deliver grain, they deliver a shipping certificate that only they can create.  In addition to delivery, these certificates are sold in a secondary market, but they will sell at a price that is higher or equal to the non-convergence.  If one could buy shipping certificates and gain by arbitraging the futures, then the arbitrage profit would be bid to zero almost immediately.

Dr. Irwin, as the acknowledged primary developer of the VSR, surprised many participants when he didn’t strongly defend it.  He spent most of his presentation talking about non-convergence in the corn market, rather than the wheat market.  He appeared to be more supportive of using the results from a mathematical model’s estimated “market” value of storage, and then a designating committee to determine whether to make any adjustments to the storage rate. If the CME wants to use a different model to adjust the storage rate and the math is made public, then one would expect that to work too.  However, if there is a committee that makes the final decision, then it adds another level of uncertainty; will they act or just go with the status quo?  This committee would likely add a whole new round of controversies about trading futures.

He also suggested that a seasonal storage rate might work for corn.  If one remembers after the first round of non-convergence in KC wheat in the early 2000’s, the exchange added a protein requirement for the first time and a seasonal storage rate.   However, those changes didn’t prevent the most recent round of non-convergence in HRW wheat.  Apparently indicating the higher seasonal rates applied at that time were not sufficient to bring about convergence in the HRW wheat futures contract.

Issue #3: No Storage Grain Futures Contracts

One participant argued for no-storage futures contracts.  Without a storage requirement, it would allow more entities to make delivery and arbitrage futures contract.  Alternatively, CME argues there is only one new crop supply provided each year (two, if you count Brazil) therefore, futures must include storage so that a market mechanism exists to reflect grain prices and grain storage costs.  Those supporting a “no-storage futures contract” counter that clearly someone will store grain, regardless of the futures contract.  They state that there are plenty of farmers who are willing to store grain and most of that grain is unpriced.  They indicate that markets will need to provide a return to storage, even with a no-storage futures contract, but that may require higher deferred prices.

Issue #4: Including Farmer Storage In Delivery of Grain Futures Contracts

Another participant suggested CME should allow farmers to store the grain at the futures storage rate, when delivery elevators don’t want to store grain.  The storage would need to be certified by USDA, utilizing local Farm Service Agency (FSA) offices would likely be certification of choice.  There would also be questions in the case of farm bankruptcies, whether the long still owns the grain the buyer has paid for plus the storage?  For this delivery alternative to be workable, there would need to be rules and procedures developed on how the grain would be moved from farm storage to load out on a train/barge. 

One of the grain merchandizers attending suggested that farmers should have their futures orders filled first.  As explained above, CME’s algorithm determines order that contracts are filled, and that the mechanism used by the CME within that algorithm is not transparent to the public in general or to farmers with futures positions in particular.


There was still no agreement on what the true cash price is for wheat, but at least everyone agreed there was non-convergence in wheat markets.  One participant wanted the protein requirement in the futures contract raised from 10.5% to 11%.  Currently, the Kansas HRW wheat futures contract does require 11% protein, but will accept 10.5% protein with a $0.10 per bushel discount.  It was surprising that many conference participants essentially considered the Kansas HRW wheat futures contract protein requirement to be the discounted 10.5% protein level rather than the 11% par value as stated in the contract.

One key takeaway from this conference was that nearly all of agriculture agrees that convergence is necessary for short hedges and crop insurance to work.  Proposed fixes include VSR, a model determined storage rate with a committee to make the final decision on storage rate changes, fixed storage at a higher rate, a seasonal adjusted fixed storage rate, and no-storage futures contracts.  However, there was no consensus on what if any changes to make to futures to cause convergence.  Among these participants, there was little support for strictly requiring “forced” load-out or cash settlement of grain contracts. They did agree that if there is no connection between futures and cash, then the grain futures are unlikely to survive. 

Lack of convergence also effects crop insurance as tool to cover a farmer’s short hedge.  Crop insurance coverage combined with CME hedging tools will be covered in the next AgManager update.

An Additional Note on How the CME Matching Algorithm Works

A grain trader provided us with the following response on how the CME order matching algorithm works.

“Almost all of the CME ag contracts are matched using tag 1142 (Match Algorithm Value) = “K” (“Algorithm K”). CME generically defines Algorithm K as a “split FIFO/pro-rata algorithm.” However, there are multiple rounds of allocation under Algorithm K:

  • Round 1: Top-Order Allocation: A top order allocation is given to the first incoming order that betters the market and is filled at a 100% between a minimum of 1 lot and a maximum of 100 lots (note the maximum for KC wheat contracts is 50 lots).
  • Round 2: Lead Market Maker Allocation: CME makes various vague statements about there being the possibility of a “lead market maker allocation” after the top order allocation. None of the CME’s published materials confirm whether there is a lead market maker allocation for the ag contracts and, if so, how big is that allocation?
  • Round 3: FIFO Allocation: 40% of the volume after the top-order and LMM allocations is allocated via FIFO.
  • Round 4: Pro-Rata Allocation: 60% of the volume after the top-order and LMM allocations is allocated via pro-rata, with order size and time being the variables for allocation.
  • Round 5: Top-Leveling Allocation: Any participant that did not receive an allocation via pro-rata allocation receives a 1-lot allocation, if volume remains.
  • Round 6: FIFO Allocation: Any volume remaining after top-leveling allocation is allocated via FIFO.”



2018 Soybean Market Situation & Outlook – Salina, KS on January 23, 2018

Following are the slides from a presentation on “Soybean Market Outlook in 2018” presented to 150 people at a “Kansas Soybean School” in Salina, Kansas held on January 23, 2018.   The workshop was sponsored by the Kansas Soybean Commission (http://kansassoybeans.org/) and K-State Research and Extension.

Following are the slides and key points presented by Extension Agricultural Economist Daniel O’Brien of the Department of Agricultural Economics at Kansas State University titled “Soybean Market Outlook in 2018“.  This presentation is available on the KSU AgManager.info website (http://www.agmanager.info/) at the following web address:




Corn and Grain Sorghum Market Situation & Outlook – Amarillo, Texas on January 24, 2018

Following are the slides from a presentation on “Feedgrain Market Outlook in 2018” presented by teleconference to a “Feedgrain Marketing Plan Workshop” in Amarillo, Texas held on January 23-24, 2018.   The workshop was sponsored by Texas Agri-Life Extension.

Following are the slides and key points presented by Extension Agricultural Economist Daniel O’Brien of the Department of Agricultural Economics at Kansas State University titled on “Feedgrain Market Outlook in 2018”.  This presentation will also be available on the KSU AgManager.info website (http://www.agmanager.info/) at the following web address:




“Start Up” Status of the Variable Storage Rate (VSR) for Kansas City HRW Wheat Futures

Variable Storage Rate or “VSR” calculations for the CME Kansas City Hard Red Winter Wheat futures contract have begun.  The Chicago Mercantile Exchange (CME) provides an ongoing daily record of how VSR calculations are progressing for the MARCH 2018 to MAY 2018 futures contract spread in comparison to what the CME calculates to be “Financial Full Carry” for wheat in storage.

Following is a statement from the CME regarding the Variable Storage Rate mechanism and its application:

“The Exchange will implement the VSR mechanism with an initial observation period beginning on December 19, 2017 and ending on February 23, 2018, evaluating the 2018 March – May KC HRW Wheat calendar spread relative to financial full carry with any changes to the storage rate effective on March 18, 2018. The storage rate will remain at 19.7/100s of one cent per bushel per day until the VSR mechanism triggers a change to the storage rate, at which point the storage rate will become either 16.5/100s of one cent per bushel per day if the storage rate is triggered down or 26.5/100s of one cent per bushel per day if the storage rate is triggered up. The seasonal storage rate currently in place for the Contracts will be suspended in lieu of the VSR mechanism, meaning the rate of 19.7/100s of one cent per bushel per day will remain in place until triggered up or down by the VSR mechanism.”

These VSR Calculations for both Kansas City HRW Wheat futures and Chicago Wheat futures are available a the following web address:


These preliminary VSR calculations with the MARCH-MAY 2018 KC HRW Wheat futures spread running at an average of 90.40% of Financial Full Carry for the December 19, 2017 through January 4, 2018 period would indicate that the CME will be increasing its storage rate used in the VSR calculation. Of course, the long term average through February 23, 2018 will provide the final determination of whether such changes are made.

This potential storage rate increase would be from the starting value of $0.00197 /bu/day ($0.0591 /bu/30 days) up to $0.00265 /bu/day ($0.0795 /bu/30 days) for the March-May 2018 period on wheat delivered against the MARCH 2018 CME KC HRW Wheat futures contract.

Note that the CME Chicago Wheat futures carrying charge is currently at $0.00365 /bu/day ($0.1095 /bu/30 days), and that the running average percent of full carry for Chicago wheat is only 51.42% for the same period.

Following are the KC HRW Wheat futures VSR calculations for through Thursday, January 4, 2018 with added formatting from Kansas State University Extension Agricultural Economics:


KSU Weekly Grain Market Analysis: Watching Crop Weather Trends in January & Seeds of a Wheat Market Turnaround

Grain market summary notes, charts and comments supporting the Grain Market Update presented in the KSU Agriculture Today radio program to be played on Friday, January 5, 2018 are available on the Kansas State University www.AgManager.info website at the following KSU web address:


The recorded radio program will be aired at 10:03 a.m. central time, Friday, January 5, 2018 on the K-State Radio Network (KSU Agriculture Today Radio) – web player available. A copy of the August 4th recording will be available at the KSU Agriculture Today website.

Following are sections of the Working notes for this week’s radio program up on the KSU AgManager.info website…

KSU Wheat Market Outlook in Late-December 2017 – U.S., World, and “World-Less-China” Market Scenarios for 2018

This report provides an analysis of U.S. and World wheat supply-demand factors and 2018 marketing year price prospects following the USDA’s December 12, 2017 Crop Production and World Agricultural Supply Demand Estimates (WASDE) reports.  It also incorporates U.S. wheat market supply-demand and price projections for the “next crop” 2018/19 marketing year from the USDA’s Long Term Agricultural Projections released on November 28, 2017. This article will be available in full on the KSU AgManager website in coming days (http://www.agmanager.info/).

Following is a summary – with the full analysis-article for Wheat Market Outlook in Late-December 2018 to be found at this web location:




A. Wheat Market Response to the December 12th USDA Reports

Since the USDA’s December 12th World Agricultural Supply and Demand Estimates (WASDE) report, CME MARCH 2018 Kansas HRW Wheat futures have traded higher.  MARCH 2018 Kansas HRW wheat futures opened at $4.13 on 12/12/2017 – the day of the report – but closed lower to $4.11 ¼ that day.  Since then, MARCH 2018 HRW wheat futures have trended higher to a close of $4.22 ¾ on Friday, December 22nd.   

That same day Kansas cash wheat price terminal quotes in central and eastern Kansas ranged from $3.42 ¼ to $3.83 ¼ per bushel – with basis ranging from $0.80 under to $0.39 under MARCH 2018 futures.  In western Kansas, representative wheat elevator bids ranged from $3.47 to $3.64 per bushel – with basis ranging from $0.85 under to $0.58 under MARCH 2018 futures.  Although cash prices are markedly above marketing loan rates, basis levels are still “wide and weak” compared to historic Kansas wheat basis patterns.

B. Key World Wheat Supply-Demand Findings in the December 12th USDA WASDE Report

For the “new crop” 2017/18 marketing year (MY) beginning on June 1, 2017, the USDA projected the following.

First, that World wheat total supplies would be 1,010.5 million metric tons (mmt) with total use of 742.1 mmt – both being record high levels for “new crop” MY 2017/18. 

Second, that World wheat exports will also trend marginally lower to 182.15 mmt in the “new crop” 2017/18 marketing year – down from a record high of 183.2 mmt last year, but still up from 172.8 mmt two years ago. 

Third, that World wheat ending stocks would be a record high 268.4 mmt in “new crop” MY 2017/18 – up from the previous record of 255.3 mmt in MY 2016/17, and from 241.4 mmt in MY 2015/16. 

Fourth, that World wheat percent ending stocks-to-use (S/U) would be 36.24% – up from 34.5% last year, and from 33.9% two years ago – rising to the highest level since 36.25% in MY 1998/99.

C. Perspectives on Current World Wheat Stock Levels

For a perspective on how historically large World total wheat stocks and World wheat percent stocks-to-use now are, consider that in MY 2007/08 the 34-year low in World wheat ending stocks of 128.2 mmt and at least a 57-year low in percent ending stocks-to-use of 20.9% stocks/use both occurred.  The 2007/08 marketing year was the last significant World wheat “short crop” marketing year to have occurred. 

The “tight supply-demand” situation in MY 2007/08 compares to the most recent USDA projections of 268.4 mmt ending stocks and 36.2% ending stocks-to-use projected for “new crop” MY 2017/18.  The present “large crop-over supply” situation in World and U.S. wheat markets continues to have a prevalent limiting influence on U.S. and World wheat prices – even with recent drought-fueled moves higher in the market. 

D. “World Less China” Wheat Market Situation

The broader “large crop-over supply-low price” situation in the World wheat market may be “obscuring” at some important underlying market issues.  

While the aggregate supply of wheat in World markets has grown, the supply of wheat from a “World Less China” perspective is projected to have actually “contracted” or “diminished” further in “new crop” MY 2017/18.   “World-Less-China” wheat percent (%) stocks-to-use have declined to the tightest level since at least MY 2012/13 when U.S. wheat cash prices averaged a record high $7.77 /bu.  If this “China supply isolation factor” eventually leads to noticeably tighter available global supplies of openly exportable wheat in the next 12 months, it could have a significant positive impact on U.S. and World wheat market prices.

However, unless there is this change in the broader, overriding focus of the World wheat market away from aggregate global supplies to available “World-Less-China supplies – it is likely that significant World wheat production problems and/or trade disruptions would need to occur in year 2018 in order to have wheat prices recover significantly in 2018.   Such disruptions elsewhere would likely cause the market to then focus on the limited availability of food quality wheat outside of China in the World market.   Also, ongoing strength in the U.S. dollar exchange rate continues to be a negative factor limiting the competitive affordability of U.S. wheat exports in World markets.    

E. U.S. Wheat Supply/Demand for “New Crop” MY 2017/18 & “Next Crop” MY 2018/19  

The USDA released their wheat production, supply-demand and price projections for the U.S. for “new crop” MY 2017/18 in the December 12th WASDE report, and for “next crop” MY 2018/19 in its November 28th Long Term Agricultural Projections.   

U.S. wheat plantings are forecast to be 45.000 million acres (ma) in 2018, down from 46.012 ma in 2017, and 50.119 ma in 2016, to the lowest level since the early 1900s.  Harvested acres are forecast at 38.3 ma in 2018 (85.11% harvested-to-planted), up from 37.586 ma (81.69% harvested-to-planted) in 2017, but down from 43.850 ma in 2016.  

The 2018 U.S. average wheat yield is estimated at 47.4 bu/ac, up from 46.3 bu/ac in 2017, but down from the 2016 record of 52.7 bu/acre. 

Wheat production in the U.S. in 2018 is forecast to be 1.815 billion bushels (bb), up from 1.741 bb in 2017, but down from 2.309 bb in 2016.  After adjustments by Kansas State University from the December 12th WASDE report, projected “next crop” MY 2018/19 total supplies are forecast at 2.910 bb, down from 3.071 bb in “new crop” MY 2017/18, and down from 3.402 bb in MY 2016/17.  U.S. Wheat total use of 2.072 bb is forecast for “next crop” MY 2018/19, down from 2.111 bb in “new crop” MY 2017/18, and from 2.222 bb in MY 2016/17. 

With previously mentioned KSU adjustments from the December 12th WASDE report, the USDA projected “next crop” MY 2018/19 ending stocks to be 838 million bushels (mb) (40.44% stocks/use), down from 960 mb in “new crop” MY 2017/18 (45.48% stocks/use), and 976 mb in MY 2016/17 (50.03% stocks/use).   

United States’ wheat prices are projected to average $4.60 /bu in “next crop” MY 2018/19, unchanged from “new crop” MY 2017/18, but up from $3.89 in MY 2016/17, and comparable to $4.89 /bu in MY 2015/16, and $5.99 /bu in MY 2014/15.   It is estimated by Kansas State University that these USDA projections for “new crop” MY 2017/18 have a 75% probability of occurring.

F. Two Alternative KSU U.S. Wheat S/D Forecast for “New Crop” MY 2017/18 

To represent possible alternative outcomes from the USDA’s December 12th projection, two potential KSU-Scenarios for U.S. wheat supply-demand and prices are presented for “new crop” MY 2017/18.    

KSU Scenario 1) “Lower Export” Scenario (15% probability) assumes for “new crop” MY 2017/18 that the following outcome occurs.  This scenario assumes that there will be 46.012 ma planted, 81.69% harvested-to-planted, 37.586 ma harvested, 46.3 bu/ac average yield, 1.741 bb production, 3.071 bb total supplies, 775 mb exports, 120 mb feed & residual use, 1.911 bb total use, 1.160 bb ending stocks, 60.70% Stocks/Use, & $4.10 /bu U.S. wheat average price.

KSU Scenario 2) “Higher U.S. Wheat Exports” Scenario (10% probability) assumes for “new crop” MY 2017/18 that the following outcome happens.  This scenario assumes that there will be 46.012 ma planted, 81.69% harvested-to-planted, 37.586 ma harvested, 46.3 bu/ac average yield, 1.741 bb production, 3.071 bb total supplies, 1.150 bb exports, 120 mb feed & residual use, 2.286 bb total use, 785 mb ending stocks, 34.34% Stocks/Use, & $5.10 /bu U.S. wheat average price.



KSU Ag Econ “Wheat Market Outlook for 2018” Presentation

Following is a presentation on “Wheat Market Outlook for 2018”.  This information was given as part of a larger “Grain Market Outlook for 2018” presentation given by Kansas State University Extension Agricultural Economist Daniel O’Brien at a Farming for the Future meeting in Pratt, Kansas on December 14, 2017.

Additional Farming for the Future conferences in Kansas are planned for December 19th in Salina, January 10th in Scott City, and January 11th in Emporia.  Registration information can be found at the following web address:



The full “Grain Market Outlook for 2018” presentation is available online at the KSU AgManager website at the following web address:


Information on Corn, Grain Sorghum, Soybean & Cotton supply-demand and market outlook is be provided in companion posts.

Following is information on “Wheat Market Outlook for 2018”: