CME Group is celebrating the one-year anniversary of a controversial storage scheme for its benchmark wheat futures contract by saying it has fixed a long-standing problem on futures deliveries.
Traders, however, remain far from convinced.
Arguing that the cure has been worse than the disease, the traders say that by tweaking the century-old contract to artificially engineer “convergence” in the spot or first-delivery month — the critical coming-together of cash and futures prices during futures delivery — CME has drained liquidity and raised risk.
“If you only look at the front end of the problem, then yes, it works. But that’s not the whole problem,” said Glenn Hollander, general partner of Chicago-based cash grain merchant Hollander + Feuerhaken.
A year ago, after years of complaints from hedgers that wheat futures remained far above cash at deliveries, CME put in place variable storage rates (VSR), a complicated scheme to raise storage fees for wheat and thus try to spur more movement of wheat into commercial channels.
The CME points to statistics showing improved convergence, touting VSR as a success. But grain traders say that view is short-sighted, literally.
They note that CME soft red winter wheat storage fees have risen four-fold in the past year and are now at 20 cents a bushel a month, compared with five cents for corn and soybeans. That increase is borne by wheat users, such as millers and exporters. (All figures US$.)
Hollander says the system has distorted the market, inflating soft red wheat prices so much it has become difficult for domestic wheat millers and exporters to source wheat despite ample U.S. supplies.
“It’s cheaper to bring feed wheat in from Canada than buy feed wheat in the United States,” Hollander added.
Another trader said: “It’s creating artificially high prices for soft wheat for end-users in this country because it rewards the terminal elevator to keep wheat away from the marketplace as long as they capture the storage income.”
The net result has been terminal elevators “hoarding” wheat, traders say.
The VSR scheme ratchets storage fees up or down as contracts near delivery. That price variability has caused spreaders to flee the market, they say — reflected in a 16 per cent decline in CME wheat futures open interest in the past year, according to CME data.
Traders say the price distortion has also spread to farmers, who have been seeding and storing more soft red wheat based on the inflated futures prices for next year, when actual supply/demand fundamentals should be discouraging seedings.
Closest in years
“There are differences of opinion about how it affects the contract from a trading and hedging perspective, but I don’t think anyone could argue it hasn’t at least contributed to the objective of improving convergence,” David Lehman, a CME managing director, told Reuters. “We didn’t reach true convergence until the variable storage rate was introduced.”
Soft wheat cash and futures prices in recent deliveries have been the closest in years at CME’s biggest delivery point in Toledo, Ohio, in the midst of the largest SRW growing area. Giants such as ADM and The Andersons dominate storage there.
CME’s September 2010 wheat was the first contract affected by VSR, when storage rates went to eight cents a bushel from five. A year later, cash prices moved above futures, an 80-odd-cent improvement in convergence, during the September 2011 delivery period.
Traditionally, if futures are higher than cash prices in a delivery period, then grain is delivered and futures fall into convergence. But if cash prices are higher, grain is not delivered and futures rise to meet cash market levels.
Traders say that calculus changed in recent years with the tidal wave of Wall Street money flowing into the grain markets. In wheat, this created a distortion where futures traded as much as $2 above cash wheat at delivery.
The National Grain and Feed Association, a big trade group that includes grain storage elevators, supports VSR.
“It’s not a perfect system but it achieved its initial goal,” said Tom Coyle, vice-president of Nidera North America and NGFA chairman when VSR was designed.
Many futures traders and analysts still disagree.
“The contract is broke,” said Roy Huckabay, a grain analyst with The Linn Group. “I can’t get people to trade it. They won’t bull spread it, they won’t bear spread.”
A veteran U.S. wheat trader said: “It has killed liquidity in the front month spread and killed any trade in the deferreds. People have lost their faith in the contract and the exchange.”
But CME says there are no immediate plans to revise its VSR formula, and supporters such as Coyle say traders will adjust.
“Over time all market participants will adjust their trading strategies accordingly — it’s a flexible system,” Coyle said.