WPI Spotlight

  • January 4, 2017
    Agribusiness can refer to virtually every commercial activity from crop and livestock production to... Trends and Agribusiness
  • November 3, 2016
    The All India Poultry Exporters Association wants the government to either ban the importation... India's Biotech Decision

Spotlight

If Food Were Treated as healthcare ...

The debate in Congress last year over Obamacare and in the GOP primary this year over Romneycare as well as the Supreme Court's consideration of the federal healthcare law can provide an interesting debate for food and agricultural policy. Right now Congress is trying to draft a farm bill, which includes food and nutrition programs such as the Supplemental Nutrition Assistance Program (SNAP). When it comes to SNAP, House Budget Committee Chairman Paul Ryan (R-Wisconsin) has said that the social safety net is at risk of becoming a "hammock." And that is one of the arguments against the new federal healthcare law. Indeed, one tenet in the Supreme Court oral arguments on the healthcare law is whether healthcare so important and unique that the federal government can require the purchase of certain services and standards.

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The Battle Between Indonesia, India and Malaysia

Tax policy is causing brouhaha in the palm oil trade. India has traditionally favored its palm oil refiners by imposing a 7.5 percent tariff on refined oil imports. However, now the largest exporter of palm oil, Indonesia, has raised its export tax on crude oil while lowering it on refined oil. As a result, India's imports of refined palm oil have risen, and so too has the blood pressure of India's refiners. Closely watching this battle is Malaysia, the second-largest exporter of palm oil, and several countries which also are major palm oil importers, including China. Just to keep it more interesting, Indonesia actually has a variable export tax, presumably to ensure adequate supplies for domestic consumers.

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Is This a Different Farm Land Boom?

The Jewish Passover seder rite begins with the youngest person, the one least familiar with history, to ask the question, "Why is this night different from all the others?" And so begins the ritual explanation of the history of the Jewish people. Recently, Jason Henderson, a vice president at the Omaha branch of the Kansas City Federal Reserve, posed the economic equivalent question for agriculture: "Why is this farm land boom different from all the others?" He went on to explain the cycle of U.S. agriculture over the past 100 years. The following are some highlights.

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Will Ethanol Production Slow?

Forty percent of the U.S. annual corn production now goes directly into ethanol production. As the world is fully aware, this is a massive number that has changed the face of the world corn and feed grains balance sheets to a degree never before witnessed.

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Excess Capacity and Additional Plants Indicate Crushed Margins

Anyone who has paid any attention to the soybean crushing sector in China knows that the last year or so have been brutal in terms of margins. Except for relatively brief periods since May 2010, soybean crush margins have been negative for both South American and U.S. soybeans imported and crushed in China. There was a short period in September when margins were positive, but they turned negative again in October and have mostly remained that way since then. The most recent data we've seen shows that Chinese crushers currently are losing around 150 yuan/MT (about $23.60/MT) processing South American soybeans and about 115 yuan/MT (about $18.15) processing U.S. soybeans based on replacement values. The average loss since early October has been about 58 yuan/MT for South American soybeans and about 34 yuan/MT for U.S. soybeans.

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Has the VSR Fixed the Wheat Convergence Problem?

Like the proverbial bad penny, the subject of wheat market convergence never seems to go away. In grain futures market jargon, "convergence" refers to the coming together of prices for physical grain and prices for the futures contracts representing that grain as each contract month becomes current for delivery of the physical grain. In theory, futures prices and cash prices should converge during the delivery month, or at least close thereto. The assumption that futures prices and cash prices of the underlying commodity will meet, or at least come closely together, is what makes futures markets a viable tool for hedging the price risks of being long or short the physical commodity. If that connection between cash and futures values does not exist, hedging cash positions with offsetting futures positions no longer shrinks price risks. It simply adds more risk.

We are not sure how long the problem of lack of convergence has plagued CBOT/CME wheat futures for which SRW is the underlying commodity, but it was more than nine years ago when we wrote a paper on the subject. Since then, the degree by which convergence was lacking varied. However, the problem became extreme in 2008 when wheat futures prices soared but cash prices did not. Cash SRW prices were nearly $2.00 below futures prices at one point, and CME wheat futures became useless, indeed dangerous for anyone owning or needing physical SRW.

This total breakdown of convergence attracted unusual public attention. We say unusual because esoteric structural issues with grain futures contracts hardly ever attract outside attention. But the extreme lack of convergence of CME wheat futures contracts in 2008/09 became so widely discussed that even a congressional sub-committee held a hearing on the topic. In the usual political fashion, the sub-committee blamed the lack of convergence on "excessive speculation," especially by index funds that held large long positions in CME wheat futures. We met with the sub-committee staff shortly before the hearing, and it was clear that this conclusion was already locked in well in advance.

To point the blame for lack of convergence on speculators required that quite a large body of contrary analysis be ignored. Most of the prominent academics known for their structural analysis of futures markets concluded that the level of speculation had little or nothing to do with the convergence problem. Even CFTC's analytical staff could find nothing to connect speculation or index funds to the lack of convergence. Nevertheless, speculators were tagged with the political blame, and this just added another reason for the subsequent Dodd-Frank financial market reform legislation to target them.

Aside from the politics, the trade and the CME (prompted by the CFTC) made a serious effort to identify factors causing the lack of convergence and find ways to "fix" the CME wheat contract that would improve convergence. The consensus was that if more SRW were delivered against spot contracts, futures and cash prices would be forced to meet. As it was, longs could take deliveries and hang onto them indefinitely by paying the delivery carrying charge of about 5 cents per bu per month. There was no way of impelling them to load out the wheat or redeliver it.

The solution seemed to be to increase the cost of carrying delivery wheat, but how? The CME's answer was to create a complex plan to produce variable storage rates (VSR) for delivery SRW. If during a set period of time the spread between the spot month and the next contract month averages a minimum of 80 percent of the delivery storage rate, then that storage rate is increased the equivalent of 3 cents per bu per month. If the average is between 50 percent and 80 percent, the rate is not changed. If it is below 50 percent, the rate is lowered 3 cents per month to a minimum rate of 5 cents per month.



(This article was originally published in the 8 December 2011 issue of Ag Perspectives as part of a WPI analysis by Bob Kohlmeyer. Click here to find out more about subscribing to Ag Perspectives.)

WPI Spotlight

  • January 4, 2017
    Agribusiness can refer to virtually every commercial activity from crop and livestock production to... Trends and Agribusiness
  • November 3, 2016
    The All India Poultry Exporters Association wants the government to either ban the importation... India's Biotech Decision