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Convergence issues still a threat to CBOT grains-study
November 12, 2011 / 1:16 AM / 6 years ago

Convergence issues still a threat to CBOT grains-study

* Farm-market economists release wheat convergence study

* Reliability as a hedging market called into question

* Value of storing physical wheat seen distorting prices

By Christine Stebbins

CHICAGO, Nov 11 (Reuters) - A new study of pricing and storage problems with Chicago Board of Trade wheat futures concludes that “fixes” aren’t working and the problems may be a threat to the long-term health of CBOT grain markets.

“If non-convergence were to persist, there would be potential for a competing set of futures contracts that enforces convergence to replace the current CBOT and KCBOT (Kansas City Board of Trade) contracts,” the study says.

The study, titled “Futures Market Failure?”, was written by University of Illinois economists Scott Irwin and Philip Garcia and University of California Davis economist Aaron Smith.

The CBOT wheat contract, the world benchmark for decades, has been under intense attack in recent years by farmers and by commercial grain hedgers, which buy grain and process, export or feed it to livestock.

The focus of the criticism -- which has drawn in the regulator of the CME Group , CBOT’s parent, the Commodity Futures Trading Commission -- has been an inflated value for CME wheat futures compared to actual cash prices during futures delivery periods.

Normally, if futures are higher than cash, grain is delivered against the contract and prices converge. If futures are lower, grain is withheld and futures rise -- and converge.

The authors say the root cause of non-convergence occurred because the price of physical storage in the cash market rose above the fixed storage rate specified in grain futures at futures delivery locations. The result is that wheat consistently remains more profitable to store than deliver.

Nearly all wheat delivered against CBOT futures ends up in the Toledo, Ohio, wheat growing region at facilities owned by The Andersons, an exchange-approved warehousing firm.

The fixed futures storage rate was too low compared to market conditions starting in 2006, the study says.

As a result CBOT wheat had failed to converge at expiration for about five years, with futures as much as $2 per bushel over cash, a signal the contract was broken, grain firms say.

“CBOT wheat has been the poster child for non-convergence,” the study says.

But the economists also found similar problems in the even larger CBOT corn and soybean contracts in a five-year period.

“Between 2005 and 2010 many Chicago Board of Trade corn, wheat and soybean contract expirations exhibited convergence failure with futures contracts expiring at prices up to 35 percent greater than the prevailing cash grain price,” it said.


Trying to “fix” the contract, the CME has put in place “variable storage rates,” or VSR -- a complicated scheme that can raise or lower storage fees for wheat every delivery period to, in theory, spur or restrict movement of wheat into commercial channels.

Under the current system, VSR has inflated storage fees to the point that it has made soft red winter prices uncompetitive in export markets.

“The institution of a variable rate storage rule appears to have resolved the immediate convergence problems in that market, but significant obstacles remain. The VSR is complicated and potentially prone to manipulation,” it said.

Irwin said in an interview that he and his colleagues were confident they had sorted the reasons for the anomalies in the CBOT wheat contract, which have baffled many experts who have tried to sort the mechanics of cash grain merchandising, the role of big companies, and even the role of Wall Street brokers in engineering new and profitable ways to “hold” grain.

“We finally think we have cracked the riddle of these recent and massive and unprecedented convergence problems,” Irwin, who has been a consultant to the CME and CFTC on grain market economics in recent years, told Reuters.

“It’s all about what is the true market value of what I would have to pay to get a commercial elevator in the delivery territory to use the space instead of them,” Irwin said.

Irwin said CME corn and soybean contracts are at risk of running into convergence problems similar to wheat. He has recommended to CME to consider raising storage rates at a fixed rate say 8-10 cents -- not a variable rate.

“As a result of studies like this and ongoing feedback from industry, over the last few years we’ve made modifications to our wheat contract that have resulted in significantly enhanced convergence,” CME said in a statement commenting on the study.

The study is available at

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