NGFA Urges Speedy Adoption of Variable Storage Rate to Enhance CBOT Wheat Futures Contract Performance

For Release
IMMEDIATE (Sept. 8, 2009)
   
 
WASHINGTON -- The National Grain and Feed Association (NGFA) has notified the CME Group that it supports the variable storage rate concept being considered by the exchange, calling it "the next logical step" in the ongoing effort to encourage convergence between cash and futures market values in the CBOT wheat futures contract. 

In a statement submitted to the CME Group, the NGFA urged the exchange to propose to the Commodity Futures Trading Commission (CFTC) that the variable storage rate concept be implemented by December if the September CBOT wheat futures contract at expiration does not exhibit better convergence than expected.  Convergence -- the narrowing between futures and cash prices as futures contracts near expiration -- has been lacking for the CBOT wheat contract for more than two years.

Established in 1896, the NGFA consists of more than 1,000 grain, feed and feed ingredient, grain processing, milling, export, biofuels and other grain-related companies that operate about 6,000 facilities that handle more than 70 percent of all U.S. grains and oilseeds.  It is the nation's largest trade association representing the interests of market participants who use grain and oilseed futures markets to hedge price and inventory risk.

Under the variable storage rate concept, storage (premium) charges assessed by grain elevators approved by the CME Group as locations for physical delivery of wheat to satisfy outstanding CBOT wheat futures contract obligations would expand or contract based upon the carry in the market that is implied by futures-market spreads. 

Under the proposal being considered by the CME Group and supported by the NGFA, an increase in the storage rate would be triggered if futures market spreads reached 80 percent or more of full carry.  Such an increase in storage rates would make it more costly to continue to hold or roll futures market positions forward, which has contributed to the significant gap between futures and cash market values.  Similarly, a decrease in storage rates would be triggered if futures-market spreads declined to 50 percent of full carry.  Under the proposal, the maximum that storage rates could increase or decrease would be about 3 cents per bushel per month, which the NGFA supported as a "significant adjustment" that should enhance convergence. 

The NGFA said variable storage rates would better reflect cash fundamentals and enhance the ability of market participants to manage basis risk, which has increased dramatically in recent years.  Better management of basis risk also should benefit banks and other lenders that provide financing to the agricultural sector, the NGFA noted.

The NGFA said that a major practical reason to implement variable storage rates as soon as possible -- preferably no later than December -- is that without such action, the seasonal storage rates implemented by the CME Group in July at delivery warehouses will decline in December by about 3 cents per bushel -- from the current approximately 8 cents per bushel to about 5 cents per bushel per month.  "Implementation in December would at least prevent the storage rate from moving in the wrong direction, and would prevent further delay in remedying the CBOT wheat futures contract's recent performance," said NGFA Risk Management Committee Chairman Rod Clark, vice president of CGB Diversified Services, Mount Vernon, Ind.

The seasonal storage rate was one of several steps taken by the CME Group over the last 18 months in an attempt to address the problematic lack of convergence in the CBOT wheat futures contract.  These other actions included changing the deliverable instrument to a shipping certificate, adding wheat delivery locations and, effective with the September contract, reducing limits for the presence of a mycotoxin known as deoxynivalenol (vomitoxin) in wheat delivered to satisfy outstanding CBOT wheat futures contracts.
 
The NGFA said the variable storage rate concept is "fairly straightforward," but encouraged the CME Group to fully inform market participants about its mechanics, and pledged to assist in that effort.  Further, the NGFA "fully supported" the CME Group's plan -- if the variable storage rate concept ultimately is proposed and adopted -- to post the full-carry calculation daily on the exchange's website, thereby enhancing market transparency.

Citing some confusion in the industry, the NGFA also recommended that the CME Group clarify its intent that the variable storage rate concept would replace -- not be in addition to -- the seasonal storage rate implemented earlier this year for the CBOT wheat futures contract.   In addition, the NGFA recommended that the variable storage rate be applied first to the CBOT wheat futures contract.  If it proves successful, as expected, it may merit consideration for application to the CBOT corn and soybean futures contracts in the future, the NGFA said.

The variable storage rate concept also is expected to garner support from the CFTC's Subcommittee on Convergence when it reports its findings to the CFTC Agricultural Advisory Committee shortly after expiration of the September CBOT wheat futures contract.  The CFTC convergence subcommittee is comprised of 18 experts representing a broad and diverse spectrum of agricultural futures market participants, including the NGFA.

The NGFA in August had met with senior staff leadership at the CME Group to discuss and provide further input on the variable storage rate concept as part of the association’s ongoing, substantive efforts to enhance the performance of U.S. futures markets for traditional users, such as grain merchants, feed manufacturers, grain processors, livestock and poultry operations, and others that rely upon futures contracts as hedging instruments to offset price and inventory risks in the cash market. 

The NGFA's efforts to address futures market performance also have encompassed discussions with Congress and the CFTC.  During testimony in late July before a Senate subcommittee, the NGFA urged both the CME Group and CFTC to be prepared to act quickly to adopt additional steps if CBOT wheat futures contract changes already being implemented by the exchange fall short in enhancing the contract's performance. 

The lack of convergence in the CBOT wheat futures contract has had significant adverse impacts on farmers and the grain, feed and processing industry, particularly during the volatile grain market environment that occurred in 2008.  Combined with a volatile soft wheat futures market that year, the lack of convergence contributed to extremely large margin requirements for grain buyers to maintain their hedge positions in the futures market.  That, in turn, caused many buyers to reduce or eliminate offering cash-forward contracts to producers, thereby limiting farmers' ability to capture favorable pricing opportunities during a period of rapidly escalating fuel and input costs. 

The NGFA's membership encompasses all sectors of the industry, including country, terminal and export grain elevators; feed and feed ingredient manufacturers; cash grain and feed merchants; end users of grain and grain products, including oilseed processors, corn refiners, flour millers, and livestock and poultry integrators; biofuel manufacturers; commodity futures brokers and commission merchants; and allied industries.  Canadian and Mexican firms also are NGFA members, and use its Trade Rules and Arbitration System by specific reference in their contracts.

The NGFA also consists of 35 affiliated state and regional grain and feed associations, as well as two international affiliated associations.   It has strategic alliances with the Pet Food Institute and the Grain Elevator and Processing Society, and is co-located and has a joint operating and services agreement with the North American Export Grain Association.