Analysis: Wheat trade sees bumps in the road for CME-KCBT
CHICAGO (Reuters) - The merger of wheat futures markets in Chicago and Kansas City should boost trading volumes and exchange profits, but grain traders are worried about the effect on hedging and cash market pricing for hard red winter wheat.
"Hedgers and users of the Kansas City Board of Trade hard red winter wheat futures market recognize it and use it for what it is, the pricing mechanism for bread wheat. I don't see that changing in the near future. But longer term, like everything in our industry, it may get interesting," said Justin Gilpin, chief executive officer of the Kansas Wheat Commission, which represents growers of hard red winter wheat (HRW), the grain that's traded in Kansas City.
CME Group (CME.O), parent of the oldest and largest U.S. grain market, the Chicago Board of Trade, said on Wednesday it would purchase the 156-year-old Kansas City Board of Trade for $126 million in cash.
On paper, the merger makes sense. Chicago's strength -- a lot of speculative money -- should cut costs and boost KCBT volumes and options trading. CME also speaks with the loudest voice for the grain industry with regulators, farmers and farm bankers.
But there are distinct differences in the way the KCBT and CBOT have approached wheat trading, with large commercial firms still having more say in Kansas City, industry sources say. That's what has grain traders worried.
The flour millers and wheat exporters clustered in and around Kansas dominate the handling of HRW, the biggest U.S. variety and the main U.S. bread wheat.
"Kansas City was a model of how a market should be. I can't help but hope that Chicago is well aware of that and seeks to maintain the same standards of quality that have been there," said Morton Sosland, editor-in-chief of Milling and Baking News.
"It is a different contract, and the temptation is always how can we change this to attract increased trading? One of the ways of doing that is to lessen the quality requirements. I hope they don't do that," Sosland said.
The actual value of HRW wheat for flour milling can vary significantly based on the specific protein. Unlike Chicago, Kansas City grain traders still have a daily role in assessing the values - which differ by every two-tenths of a percent -- of protein. This "basis" scale of prices for cash wheat was and is produced by buyers, sellers and merchandisers. Flour millers use it as a daily benchmark, as does the U.S. baking industry.
"They post a daily cash basis, and I don't know how that is going to happen," Sosland said. "I'm sure there will be some sort of arrangement made, but I don't know what it is going to be. We were talking about it this morning."
Other veteran wheat traders from the KCBT floor, who asked for anonymity, confirmed the doubts about cash market pricing.
"There's some concern whether that will continue," said one longtime KCBT floor trader. "It was a public price. With the new ownership, that could change. The participants won't change."
KCBT Chairman Steve Campbell told Reuters he was confident that grain companies will continue using KCBT for wheat pricing.
"We all understand the historical nature of this exchange. We certainly appreciate it. It's our passion, it's what we grew up with," he said.
Glenn Hollander, a Chicago-based grain merchandiser, said the Kansas City cash market will evolve. Years ago there were regional grain exchanges in Des Moines, Iowa; Toledo, Ohio; St. Louis and elsewhere, he said.
"The industry has changed in the last 50 years. So much of the grain is traded over the phone," he said. "We haven't seen the people from Corn Products in years -- we pick up the phone and call them. The same thing with Cargill in Hammond (Indiana), with Nidera in Chicago. Bids aren't posted on the floor anymore."
The KCBT trader agreed that the Federal Grain Inspection Service (FGIS) and modern communications have changed things.
"Today, with the communications, with fax, Internet, emails, instant messages and the ability to say, 'Here's these cars, they are sitting at such a place, here's the FGIS inspection, you can put it out on the Internet and people will call," the trader said. "It could be done from an office, anywhere today."
As for a century-old rivalry between the exchanges, Campbell played down a culture clash.
"I wouldn't say that there is big culture difference at all. We both understand the history and tradition of the grain marketplace we serve," Campbell said.
One issue that may bring the different approaches of the two markets into sharp focus is "convergence."
CBOT, bringing more speculative money into KCBT wheat, will be a plus. But the flip side of that has been a byproduct of that money, grain traders say: lack of convergence of futures and cash prices during delivery periods.
The problem plagued CBOT wheat markets in recent years and prompted many hedgers to simply stop using futures as a hedging tool. Grain companies complained loudly to government regulators, saying a flood of Wall Street money allowed into CBOT markets artificially inflated futures prices far above actual cash prices based on supply and demand.
Lack of convergence also carried over into KCBT wheat. The CME put in place a complicated system of "variable storage rates" to try to fix the lack of convergence. But KCBT's solution -- a simpler set of seasonal storage fees -- has differed fundamentally from CME's. Traders wonder whether that will continue.
"Most people on the commercial side of the business who use these contracts for the purpose of hedging believe the Kansas City Board of Trade is a better contract. It comes closer to fulfilling its purpose than the CBOT wheat contract does today," the KCBT trader said. "Is there fear that down the road that the Kansas City could go the path of the CBOT? There is."
(Additional reporting by Carey Gillam. Editing by Peter Bohan and Douglas Royalty)
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