Why doesn't someone do something?
For months, a usual comment from farmers has been about the terrible basis between their local price and the Chicago Board of Trade futures price. The spread between the cash price and futures price has reached levels most of us thought were impossible just a few years ago. Theoretically the difference between the two should reflect the cost of delivery to Chicago plus the elevators margin.
In the past few years, it has become practically impossible for individuals or small elevators to deliver against a futures contract. Regulations governing delivery have become so restrictive that only specific elevators in certain locations can deliver. The result is that as more futures trading is being done by large funds, there is less tendency for the futures price to reflect the true value of grain.
The most common solution offered to this dilemma is for the farmer to either use the futures market himself and wait for the basis to narrow or to sell on a HTA contract with the basis open. There is a down side to each of these. Some elevators will not write a HTA contract. Even if the elevator offers the contract, the basis may not have narrowed by delivery time and the farmer is stuck the bad basis.
Using the futures contract exposes the farmer to margin calls. If the basis moves sharply higher and the basis widens out, the farmer may not only have cash flow problems but also get stuck with the basis going wider instead of narrower. Neither of these alternatives looks as good as having a futures price that reflects the true value of the grain.
There is a third alternative. Unfortunately it has not been used nearly as much as some observers thought it would. A couple of years ago the Minneapolis Grain Exchange started offering contracts on cash grain indices. Prices for these contracts are based on an average cash price for delivery at numerous elevators around the country.
There is no delivery. On expiration the futures contracts are settled with cash using the national average price on the expiration day. This sounds like even more of a paper game than the CBOT system. The feeder cattle contracts at the Mercantile Exchange have been settled this way for many years and it has worked out well. The settlement price does a much better job of reflecting the true cash value than the price in Chicago.
For instance, on September 27, the December CBOT corn futures price was 3.86 3/4. The December cash index was $3.63 1/4. My local price was $3.34. There is still a spread, but it is 30 cents better. For November soybeans the numbers, $10.09, $9.21 and $8.81, are 90 cents better. This lower basis risk makes the possibility of hedging easier.
There is one big catch to this innovation in marketing. Almost no one is using it. Trading in these index futures has been almost non existent since inception. As of Friday, the open interest in corn futures was 16 contracts. Initially there did not seem to be a big push by the exchange to stimulate business. With little trading, there was no liquidity. I was very disappointed that this did not develop into a useful tool for farmers. I know that the Minneapolis Exchange now has a market maker so that the use of these contracts will be practical.