Rice traders debate changes to CBOT futures contract

* US rice farmers frustrated as cash prices lag futures

* CME considers adding variable storage rates for CBOT rice

* Traders warn of threat to liquidity

* CME offers no timeframe for decision on contract changes

By Julie Ingwersen

CHICAGO, Feb 1 (Reuters) - U.S. rice farmers are frustrated with a persistent lag between cash rice prices and Chicago Board of Trade rough rice futures, and some think implementing variable storage rates, like that used for CBOT wheat, might help improve convergence.

The ability of futures to match cash prices during the delivery period is a key indicator of how a futures contract is performing as a hedging tool.

But at an industry meeting in Chicago Wednesday held by the CME Group, parent of the CBOT, some traders warned that a variable storage rate, or VSR, would hurt the rice market.

"I believe a variable storage rate will drive out speculators, drive out funds and could distort the contract to a point where end-users don't feel they can use it anymore," said David Durra, a trader with AgSpread Analytics Inc who gave a presentation at the meeting.

VSR is one of several ideas that CME Group has proposed in an effort to improve convergence between cash rice prices and futures during delivery.

CME officials did not give a timeframe for deciding whether to change the rice contract.

Wednesday's three-hour meeting drew roughly 70 people including traders, farmers, merchandisers and millers, some of whom traveled from Arkansas and Louisiana, in the heart of the U.S. rice production belt.

John David Frith, a Louisiana rice grower, said farmers in his area were planting far less rice than they did five years ago, partly due to poor price convergence.

The threat of a widening cash basis -- the price difference between cash and futures -- makes it impossible for growers making planting decisions to predict what kind of price they will get for rice at the following harvest. As a result, securing credit can be difficult.

Frith said growers are turning instead to corn, soybeans and cotton, which have offered higher returns as well as better price convergence and predictability.

"We need to get our rice farmers back to farming rice," Frith said.

"Do I know that (VSR) is the right thing for rice? No, but that is something that looks good to me. As a farmer, my main thing is that it converges," Frith said.

The exchange is also considering expanding the delivery territory for rice futures, which is currently limited to 12 counties in Arkansas, and switching the delivery instrument from a warehouse receipt to a shipping certificate -- the same instrument used for corn, wheat and soybean futures.

VSR SUPPORTED AND OPPOSED

Under the VSR system in CBOT wheat, maximum storage rates rise when the price spread between the front two futures contracts widens above 80 percent of "full carry" during a five-week observation period. If the spread narrows below 50 percent, the storage rates fall.

During the first five wheat contract cycles after VSR was launched in 2010, storage rates rose to 20 cents per bushel per month, from 5 cents a year earlier -- a factor that produced wide carries, or premiums, for deferred wheat futures contracts.

Critics said the changes distorted the spreads, destroyed convergence in deferred contracts and drove away some commercial hedgers as well as speculators.

Yet the changes encouraged more storage of soft red wheat, the type traded in Chicago, which eventually lifted cash prices closer to futures as end-users found they had to pay up to buy cash wheat out of storage.

"After implementing VSR, we saw a dramatic improvement in the basis," said Tom Coyle, vice president of Nidera North America, who gave a presentation at the meeting supporting VSR's performance in wheat.

"The (wheat) market is now getting itself back in balance. It (VSR) has had the desired impact, which was to increase convergence. Convergence is critical; it is the core principal," Coyle said.

Several Chicago traders said privately they opposed any changes to the rice contract, preferring to let the market resolve the convergence issue on its own.

One of the reasons that cash prices have fallen below futures, they noted, stems from a temporary anomaly -- the unusually poor quality of the 2010 U.S. rice harvest, which hurt export demand and depressed cash prices.

Much of that 2010 crop has been blended off, and stronger cash demand may emerge if U.S. rice plantings decline in 2012, as some have predicted.