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Non-convergence a problem for hard red winter wheat contractNon-convergence a problem for hard red winter wheat contract

Normally, the futures and cash prices move together and reach convergence by the contract delivery date; this year that did not happen.

Walt Davis 1

January 18, 2017

3 Min Read
GRAIN ON THE GROUND: Bunkers of wheat stored on the ground are a common sight all across Kansas as movement of wheat has been at a virtual standstill following the record 2016 harvest. Part of the reason for those storage piles at delivery elevators is a lack of convergence in the futures and cash prices.

Ag economists in Kansas are studying possible solutions to a problem that recurred in 2015 and 2016 after they thought it had been solved after the last time it arose in 2010 and 2011.

The problem is the failure of the hard red winter wheat contract to reach "convergence" during the delivery season.

"Normally, the futures contract price and the cash price will converge when the contract expires, and that is key for price discovery in the market," says Brian Briggeman, professor of ag economics at Kansas State University and executive director of the Arthur Capper Cooperative Center. "At times in 2016, that did not happen."

The futures price was from 50 cents to $1 above the cash price at delivery elevators in Wichita, Salina, Hutchinson and Kansas City during the July contract delivery period.

"There is strong incentive for delivery elevators to store wheat," Briggeman explains. "For these select few elevators, the warehouse receipts are worth more than the actual value of the grain on the cash market. So, instead of moving the grain through the cash market, these delivery elevators store the grain and bank the difference."

The gap widened rather than closed with the September and December contracts, and the result is massive piles of wheat on the ground all over the state — wheat that is losing quality and is likely to see the cash price further diminished the longer the problem drags on.

The last time this happened, back in 2011, the Kansas State Board of Trade changed the hard red winter wheat contract to raise the storage price from 6 cents a bushel to 9 cents a bushel from July to December — a move intended to reduce the incentive for storing grain.

That appeared to work in the intervening years. But this year, record yields that some growers consider a "once in a lifetime" harvest, coupled with reduced export demand, resulted in a drop in the cash price that was not matched by a drop in the futures price. In December, the gap between the futures price and the cash price was more than 70 cents.

K-State ag economists Art Barnaby and Dan O'Brien have been examining options to correct the problem and have produced a video series available at agmanager.info to help explain the issue.

Some critics argue that poor quality in the 2016 crop is also to blame for slow movement to markets.

But Art Barnaby, ag economist with K-State, argues that the contract is for No. 2 red wheat with protein above 11%, and most of the crop, while falling short of No.1 wheat with at least 12% protein, easily meets the contract standard.

Barnaby suggests that the problem for farmers is that they have no way to deliver the crop and capture the profit from their short position in the market.

Because only delivery elevators can issue warehouse receipts, farmers and country elevators are effectively prevented from delivering the grain that would arbitrage the contract and create convergence.

K-State's economists, in papers on the subject, say broadening delivery would encourage farmers and country elevators to deliver grain and capture the $1 difference between the futures and cash price.

Another alternative would be to increase the storage fees or provide variable-rate storage on the order of what is done with the soft wheat contract on the Chicago Board of Trade.

Those who oppose higher storage fees need to consider widening the delivery opportunity, Barnaby wrote. The importance of convergence to farmers and other players in the industry is discovery of the correct price for hard red winter wheat.

K-State economists will address the issue of non-convergence and what it means to farmers at Risk Assessment and Management workshops. Those are scheduled for Friday, Feb. 10, in Great Bend; Monday Feb. 13, in Herington; and Tuesday, Feb. 28, in LaCygne.

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