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CFTC Panel Recommends Incremental Modifications to Wheat Contracts

There are a couple potential "quick fixes" to the problem of lack of convergence between Chicago futures and the cash market for soft red winter wheat. But a panel studying the issue for the Commodity Futures Trading Commission Thursday backed off from recommending any drastic changes.

Instead, the group appears ready to put together recommendations for more incremental modifications to the beleaguered contract.

The Subcommittee on Convergence in Agricultural Commodity Markets, created by the CFTC's Agricultural Advisory Committee, appeared in agreement only to support a proposal for what amount to variable storage charges on wheat held for delivery. The panel, which held a two-hour teleconference Thursday afternoon after the market closed, also asked the CFTC staff to prepare more information on a cash-settled wheat contract and a plan to discount wheat delivery certificates as they age.

The subcommittee dodged any action on the 800-pound gorilla in the debate — limiting index fund holdings. That issue will be addressed in three other CFTC hearings over the next two weeks. While much of those hearings will focus on energy, action to limit a hedge exemption index funds use as a loophole could also apply to the grain market, having serious consequences for prices.

Wheat prices broke sharply on Wednesday after Thursday's meeting was announced, with traders fearing drastic action could lead to liquidation.

The CFTC group also took no action on an earlier proposal to compel load-out on deliveries, an idea put forth by the National Grain and Feed Association. One problem with the delivery system currently appears to be the fact that some of those owning receipts never intend to actually take physical delivery of the wheat. Instead, they hedge it and earn a better interest rate on the investment than can be had in money markets or other similar investments.

The industry has been attempting to solve the problem of weak basis in the Chicago market for several years, a issue that reached its peak a year ago when cash soft red winter wheat traded for $2 or more less than futures. The CME Group, owner of the Chicago Board of Trade, has already reworked its futures contract several times, adding delivery points, increasing storage fees, or premiums, and limiting the number of delivery certificates than can be held by investors who don't intend to take physical delivery.

Those changes appeared to help a little into July delivery this year; basis along the Ohio River strengthened to 45 to 50 cents under futures. That's still historically very weak, but a vast improvement over a year ago. Since the roll to September, however, basis weakened again and cash is $1 or more under futures at most locations.

Dave Lehman, of the CME Group, said the changes are helping, albeit slowly. Only a few hundred contracts were delivered at the new locations, muting their impact, and futures spreads have remained at full carry, returning an interest rate of 3% to 5%. That's one reason for the interest in putting together a variable rate system for storage charges, though any major charges would take time to accumulate.

Tighter vomitoxin standards that take effect Sept. 1 may also help; some of those holding certificates may have wanted to wait until the next standards take effect, Lehman said.

While the CME continues to maintain that index funds were not responsible for volatility in the wheat market last year, there appeared to be some agreement that the desire of index funds to own wheat was part of the basis problem. Index funds currently are long almost two times the size of the 2009 soft red winter wheat crop, because they see wheat as a good hedge against inflation. The Chicago contract is the default global wheat contract, enough though it is delivered with soft red winter wheat, which accounts for only 20% of the U.S. crop.