U.S. Wheat Farmers Fret Over Failing Market Hedges As Incomes Slump12/26/2016
Kansas wheat farmer Michael Jordan is breaking with a century-old tradition grain producers have trusted to protect their businesses: He has stopped using futures to hedge risks to his crops.
The CME Group’s Kansas City wheat contract sets grain prices for millers, exporters and other grain buyers both today and in the future. Traditionally, prices converge with the price of wheat sold in local cash markets.
But Jordan and other U.S. farmers say they no longer trust this hedging tool, amid growing complaints among producers and grain elevators that the hard red winter (HRW) wheat contract is broken.
The last three expiring contracts have gone off the board with wider-than-normal basis at their registered delivery locations, with cash prices 25 percent or more lower, according to exchange and cash market data.
The Commodity Futures Trading Commission (CFTC) is “very aware of the problem” but has not made any promises about if or how the problem may be addressed, said Kansas Wheat Commission Chief Executive Justin Gilpin, who met with CFTC Chairman Timothy Massad in Kansas City in August.
The exchange, too, knows there is an issue, but has been reticent to make any promises, said David Schemm, president of the National Association of Wheat Growers.
The CFTC declined to comment on the matter to Reuters.
CME spokesman Michael Shore told Reuters, “We continue to have discussions with a broad cross-section of customers in this market regarding their concerns,” but he declined to comment directly on the matter.
Futures contract problems have happened before. CME’s soft red winter wheat contract failed to converge for nine straight contract expirations beginning in 2008, before CME implemented a scheme known as variable storage rates (VSR) to force convergence.
Among possible solutions being discussed for the HRW contract are a doubling of current storage rates or enacting a VSR scheme, Schemm said.
The issue is sowing financial uncertainty throughout the agricultural economy, from grain elevators and wheat millers to crop insurers and farm banks.
“This is turning a lot of storage hedges and new-crop forward contracts on their heads,” said Dan O’Brien, an agricultural economist with Kansas State University.
Growers hedge risk via forward cash contracts with elevators, which take market positions to cover their own risk. They, in turn, are able to offer farmers competitive prices for future deliveries of grain.
Crop insurance calculations are also askew as prices that set premiums and determine payouts, set by futures prices, are far different than actual cash prices.
Schemm said that hurt his own farm. He missed out on a crop insurance payout of about $10,000 because the futures prices used to calculate his policy benefits did not reflect how far the cash market value of his grain had fallen.
One key factor behind the contract problem, said Kansas State University agricultural economist Art Barnaby, is storage.
The HRW contract sets monthly wheat storage costs at 6 and 9 cents per bushel. But elevators storing HRW wheat for these contracts – including ADM, Cargill, Marubeni Group’s Gavilon Grain – say the price tag for this storage should actually be valued much higher, Barnaby said.
That’s because they do not want their storage capacity filled with grain they cannot sell.
Meanwhile, massive global supplies of wheat are keeping cash prices low, especially in Kansas, where farmers harvested record-large yields this year.
The lack of coming-together of futures and cash prices has left many farmers fearful this season. The loss of market protections, they say, threatens to heap further pain on farmers struggling with decade-low grain prices and net farm incomes at a seven-year low.
Farmers have used futures for decades to hedge the financial risk of planting a crop by locking in prices for future grain sales.
“The whole point of hedging is to protect yourself against price moves,” said Jordan, who planted 1,000 acres of hard red winter wheat this fall in north-central Kansas. “But instead, all this has done is increased the risk.”
Source: Karl Plume, Yahoo Finance