In 2016, like 2010, wheat basis levels in Kansas are extremely weak and CBOT KC HRW Wheat futures are NOT converging at delivery points such as Kansas City, Mo., or Salina, Kan.
The CME Group is currently soliciting feedback about whether to implement a Variable Storage Rate (VSR) in CBOT KC HRW Wheat futures and we strongly encourage KFB members to participate in this survey and have your voices heard. We also suggest that you indicate your support for the CME to implement a VSR.
What can a VSR do?
There is a fixed, seasonal rate for storage embedded in the KC HRW futures contract. Convergence issues can arise when crop size exceeds storage capacity, increasing the opportunity costs of storage. This is especially true when the opportunity cost of storage exceeds the fixed storage rate as defined within the futures contract delivery rules. Put simply: the demand for storage fluctuates by crop year and throughout the year, but the supply is fixed. This can cause problems such as interfering with arbitrage between futures prices and cash markets that is supposed to force convergence.
For example, the $0.32 difference between July HRW Wheat futures and truck bids in Kansas City (a par delivery point) in July, the $0.58 gap between September HRW Wheat futures and KC truck bids in September, and the $0.62 difference between December HRW Wheat futures and KC truck bids in December, all larger than average, suggest that CBOT KC HRW Wheat futures are:
a) Not accurately reflecting wheat market fundamentals (i.e. discovering commodity prices);
b) A much less effective hedging tool for wheat price risk management; and
c) Creating a larger gap in our "wheat income safety net," since it is the July Hard Red Winter Wheat futures contract that's used for the Revenue Protection crop insurance and when July wheat futures are not accurately reflecting market fundamentals, our wheat income safety net can be adversely affected.
What can’t a VSR do.
It is important to note though, that while the issues of weak basis and the lack of convergence are related, they are quite different. Weak or wider than average basis is a key market indicator, and today’s much weaker than average basis levels indicate that there is an overabundance of supply. The market can’t use all of our wheat and from a marketing standpoint, it is telling us to store. Implementation of a VSR or any changes to the CBOT KC HRW Wheat futures will NOT solve these issues.
While it is not a panacea, implementation of a VSR is a pragmatic step toward improving convergence.
FB policy is sound. AFBF #221 under we support, 2.1. "Maintaining the integrity of all U.S. commodity futures and options exchanges as a pricing mechanism by the members of the exchanges and their overseeing governing bodies. Such integrity includes consistent convergence between cash prices at delivery points and futures prices at contract expiration."
A pragmatic step toward better convergence would be to adopt a VSR provision in CBOT KC HRW Wheat futures, similar to what is already in place in their Soft Red Winter Wheat contract. This allows the futures contract storage costs to increase to whatever level is necessary to stop futures participants from arbitraging between futures contracts, and again bring the focus back to the cash - futures price relationship, and convergence.