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CME Tweaks wheat contract

08/31/2011 @ 7:14am

CHICAGO (Dow Jones)--CME Group Inc. (CME) unveiled changes to its wheat contract, the exchange's latest attempt to align its futures instrument with grain trading in the cash market.

The new specifications, which deal largely with the quality of wheat that can be delivered against the contract, are aimed at bringing futures prices closer together with the "cash" prices in the physical market.

CME operates the Chicago Board of Trade, the U.S.'s preeminent agricultural exchange, and has come under criticism for this lack of so-called convergence, which has created problems for farmers and food companies that seek to use CBOT wheat futures as an instrument to hedge commodity price risk.

Under the new standards, wheat containing more than four parts per million, or PPM, of vomitoxin can't be delivered against futures, starting with the September 2013 contract. Currently, wheat with this much vomitoxin can be delivered at a discount of 24 cents to the contract's price. In addition, CME will increase the price discount for wheat containing three PPM of vomitoxin to 20 cents per bushel from 12 cents.

Vomitoxin is a byproduct of a fungus that grows on wheat that has been exposed to excessive rain during a key development period of the crop's development. The Food & Drug Administration allows no more than one PPM of vomitoxin, or about one kernel in 80 pounds of wheat, in food meant for human consumption. Standards for livestock feed are looser.

"The market really doesn't want anything with any significant amount of vomitoxin," said Bryce Knorr, an analyst for Farm Futures, an agricultural publication.

This year, the U.S.'s harvest of soft, red winter wheat, which underpins the futures contract and is used to make flour for foods like crackers and donuts, was a big one. That combined with high corn prices means that more so than in previous years, wheat supplies are being directed to both food and animal-feed processors.

Prices for soft, red winter wheat futures have been rising recently on spillover support from gains in the corn market. On Tuesday, the most-active December wheat contract retreated 0.5% to $7.90 3/4 a bushel on the CBOT.

CME already had stiffened requirements on vomitoxin content in recent years. Still, grain users pushed for the latest adjustments to make "deliverable wheat meet standard merchandisable quality standards," according to the exchange.

"These are very realistic numbers now," said Dave Marshall, a commodities broker in Illinois who works with wheat farmers and millers, referring to the new standards.

The changes also are designed to make the wheat contract a more effective tool for protecting farmers against price volatility. The wheat contract has been criticized in recent years because cash prices have lagged below futures prices when the markets are supposed to come together, or converge, to make the futures contract an effective hedging tool for farmers. Hedges are less efficient for farmers if a wide gap exists between futures contracts sold for price protection and money taken in from cash grain sales.

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