US grain industry turns heat on CBOT

Chicago: The US grain industry is stepping up a campaign to force changes in the Chicago Board of Trade's (CBOT) grain futures contracts, which merchants and processors say have broken down as a way to hedge price risks.

"It's a structural problem that has been allowed to continue. The reality here is the underlying structure is in serious trouble," said Jeffrey Hainline, president of brokerage Advance Trading of Bloomington, Illinois, and a leading critic of the CBOT's current agricultural contract rules.

Hainline and other critics will air their grievances to the CBOT's regulator, the Commodity Futures Trading Commission (CFTC), at a public hearing in Washington, DC, on July 29.

The CFTC held a hearing on April 22 to hear grain industry complaints, which centre on a breakdown in the way CBOT futures contracts and cash market prices have behaved when futures contracts expire.

The relationship, called 'convergence', refers to the delivery period for grain bought or sold on the CBOT, a unit of CME Group. Convergence is essential to hedging - the main economic reason that futures markets exist.

Until recently, the CBOT delivery process allowed efficient convergence of cash and futures prices. If futures were higher, cash grains moved to delivery points and brought down prices.

Hedge

This allowed a relatively perfect 'hedge' or risk offset: gains in one market were cancelled by losses in the other. But the grain owner's balancesheet remained stable and insured.

Such hedges for decades have been the basis for loans to farmers and commercial grain users by banks, who demand the futures positions as collateral for the loans.

But critics like Hainline and the National Grain and Feed Association, which includes more than 900 grain companies, say growing evidence shows CBOT market prices have disconnected from cash market supply-demand fundamentals, wreaking havoc with grain company and farmer finances, hedges and loans.

"We have had very poor convergence of cash and futures for tow and a half years," Hainline said.

One CBOT broker who handles large commercial hedge accounts said: "A lot of this resurfaced after the last delivery period, when cash and futures were $1 or more apart."

For example, on Friday, cash prices for barges of soft red winter wheat on the Illinois River south of Peoria ranged from $2.18 to $2.35 per bushel below CBOT September futures - about 25 per cent below the futures 'board' price.

The NGFA has been pushing the CFTC and the CBOT for months to address the convergence problem. Now, many elevators are only buying grain 30 to 60 days in advance, lacking confidence in the CBOT's hedge mechanism.

Banks, under pressure from credit market turmoil, are also pulling back. The NGFA said in a statement that "it plans to raise these issues with the CFTC on July 29. The CME Group issued a statement saying: "We are reviewing alternatives to improve contract performance."

Critics point to many factors behind soaring grain prices, from Wall Street's 'hot' money flooding into the CBOT and inflating grain prices beyond real cash demand to transport factors, booming exports, the weak dollar and the biofuels boom.