Key Supply-Demand Factors “Driving” Grain Markets (KSU Extension Ag Economics)

The following presentation on “Key Supply-Demand Factors ‘Driving” Grain Markets” was given on Tuesday, March 14, 2017 to the AgEcon 605 class on “Price Analysis and Forecasting” as a guest lecture.  The class is regularly taught by Dr. Richard Llewelyn of the Kansas State University Department of Agricultural Economics.

This presentation focuses on the key factors that have been “driving” or influencing grain markets over the last 15-25 years.   The full presentation will be available on the KSU Agricultural Economics website at the following web location:

http://www.agmanager.info/sites/default/files/pdf/OBrien_GrainMarketDrivers_03-15-17.pdf

 

 

 

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:

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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.

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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:

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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).

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KSU Weekly Grain Market Summary – with 2013 Feedgrain and Wheat Market Projections (via KSU AgManager)

Grain market summary notes, charts and audio for the KSU Agriculture Today Grain Outlook to be played on Friday, December 21, 2012 are up on  the Kansas State University www.AgManager.info website at the following web address: http://www.agmanager.info/news/Articles/KSRN_GrainOutlook_12-21-12.pdf

The recorded radio program was aired at 10:03 a.m., Friday, December 21st on KFRM Radio (here) – web player available.  The recording can also be listened to via a link from the following website in the “Radio Interviews” section: http://www.agmanager.info/news/default.asp

United States Seasonal Drought Outlook Graphic - click on image to enlarge

The U.S. Seasonal Drought Outlook report available from the National Weather Service Climate Prediction Center (http://www.cpc.ncep.noaa.gov/) at the following web address: http://www.cpc.ncep.noaa.gov/products/expert_assessment/seasonal_drought.html

Source: http://faculty.weber.edu/kmackay/walter_prescott_webb__great_plai.htm

“Estimated Rules for Monetary Policy” (via George Kahn, Kansas City Federal Reserve Bank)

George Kahn, Vice President and Economist at the Kansas City Federal Reserve Bank (http://www.kansascityfed.org/) released an applied research article in October 2012 titled “Estimated Rules for Monetary Policy” which can be found here.

The author indicates the following about this critical topic:

“This article estimates policy rules over periods of favorable economic performance to derive benchmark rules that might be useful guides for future monetary policy.”

“Section I describes two simple, nonestimated rules that have been proposed as guides for policy and examines how closely they describe the actual setting of policy over various periods.”

“Section II identifies time periods over which macroeconomic performance has generally been favorable and estimates policy rules that describe how monetary policy responded to key indicators over these periods.”

“Section III evaluates past and current policy relative to the estimated rule and gives a number of reasons why policymakers should remain cautious about blindly following any estimated rule.”

“The article concludes that a rule that puts somewhat greater weight on inflation than output in determining a setting for the federal funds rate has worked well in the past and could be a useful guide in the future. However, some of the unique features of the current economic situation—including a binding zero lower bound on interest rates and a desire to manage downside risk to the outlook for economic activity—may suggest a need for flexibility in following the prescription of any rule based on past performance.”