The CME explained the VSR mechanism examines nearby calendar spreads to determine adjustments to the maximum storage charges that regular warehouses can charge holders of its outstanding warehouse receipts. The VSR provides a formula for triggering higher maximum allowable storage charges when futures spreads are at or near financial full carry, and lower maximum allowable storage charges when futures spreads are narrow or inverted. After an initial adjustment to harmonize base storage rate increments with the exchange’s soft red winter wheat futures contracts, where the VSR was introduced in 2010, the mechanics of the VSR mechanism for the K.C. contracts and the soft red winter wheat futures contracts shall be identical.
The aim of the VSR is to improve cash-futures convergence at futures contract expiration.
The CME said it would release the results of the observation period via a special executive report in advance of the March 18 effective date. The results of the observation period shall be determined by the following standards:
- 1.A VSR result of 50% of financial full carry or less will result in the contracts’ maximum storage charge being lowered from 19.7/100s to 16.5/100s of one cent per bushel per day on March 18, 2018.
- 2.A VSR result between 50% and 80% of financial full carry will result in the contracts’ maximum storage charge remaining unchanged at 19.7/100s of one cent per bushel per day on March 18, 2018.
- 3.A VSR result of 80% of financial full carry or more will result in the contracts’ maximum storage charge being raised from 19.7/100s to 26.5/100s of one cent per bushel per day on March 18, 2018.
If the maximum storage charge of 19.7/100s of one cent per bushel per day remains unchanged on March 18, 2018, it will remain in place until a subsequent observation period where the VSR mechanism triggers that rate down to 16.5/100s or up to 26.5/100s of one cent per bushel per day. The CME said this will harmonize the storage rate increment of the contracts with the exchange’s soft red winter wheat futures contracts.
The CME said once triggered to either 16.5/100s or 26.5/100s, the VSR mechanism for all subsequent observation periods will be consistent with exchange’s soft red winter wheat futures as follows:
- 1.A VSR result of 50% of financial full carry or less will result in the contracts’ maximum storage charge decreasing by 10/100s of one cent per bushel per day on the 18th calendar day of the nearby contract month.
- 2.A VSR result between 50% and 80% of financial full carry will result in the contracts’ maximum storage charge remaining unchanged on the 18th calendar day of the nearby contract month.
- 3.A VSR result of 80% of financial full carry or more will result in the contracts’ maximum storage charge increasing by 10/100s of one cent per bushel per day on the 18th calendar day of the nearby contract month. The maximum storage rate will not be reduced below 16.5/100s of one cent per bushel per day.
The VSR will continually expand financial full carry until calendar spreads fall below 80% of financial full carry. MBN
||| Read More: VSR adds uncertainty to already treacherous cash hard red winter wheat market |||
VSR adds uncertainty to already treacherous cash hard red winter wheat market
KANSAS CITY, MISSOURI, U.S. — The impending start to the variable storage rate (VSR) mechanism for the Kansas City wheat futures contract may add another layer of uncertainty for those navigating the complexities posed by an historically strong cash hard red winter wheat market.
The cash hard red winter wheat basis has held stubbornly at the highest levels since 2008. In that year, both cash wheat premiums and wheat futures surged because of sharp reductions in U.S. and world wheat production and supply. This year, the cash hard winter wheat basis reflected the shortfall not of wheat in general, supplies are more than adequate in the United States and record large worldwide, but of wheat with the protein and quality the domestic market and quality-conscious foreign buyers require.The adequacy of U.S. and world wheat supplies overall was reflected in winter wheat futures declining steadily in the past several weeks to set a series of new contract lows. Toward last week’s end, Kansas City nearby wheat futures traded below year-ago levels despite the 2017-18 hard red winter wheat supply being 12% smaller than the 2016-17 supply. Minneapolis spring wheat futures have dropped as well and were trading at the lowest levels since early June.
The primary feature propelling the cash hard red winter wheat basis to historically high levels was the harvest of two consecutive low-protein crops. Across broad expanses of the hard winter wheat belt, there simply was little wheat with protein high enough to meet minimal milling and baking requirements. In areas where there was wheat with middle or even high protein, much of the supply from the 2018 crop had subpar quality.
The cash hard red winter wheat basis as posted in Kansas City reflected the value end users placed on protein with 13%-protein hard red winter wheat premiums quoted 45c a bushel higher than 12% protein, $1.10 higher than 11% protein and a whopping $2 higher than ordinary wheat. The spread between premiums on 11%-protein hard red winter wheat and ordinary wheat was a daunting 90c a bushel and was a measure of just how much wheat with protein below 11% was thought to be held in store in the country.
The value of protein also was reflected in the spread between Minneapolis spring wheat futures and Kansas City futures, which was nearly $2 a bushel.
Hard red winter wheat shipments were limited during the fall crop harvest and only now were beginning to accelerate. Delayed shipments of wheat for application against December and even late-November contracts finally were received.
At the same time, relatively wide carrying charges in K.C. wheat futures encouraged elevators and other country owners of wheat to store supply and not aggressively load it into the spot market. The cash wheat basis was elevated in an attempt to pry supply loose from the firm country hands.
That’s where the VSR comes in. When wheat supplies are adequate or even ample, carrying charges in wheat futures typically are wide. Currently, seasonal storage rates equating to 6c a bushel per month apply to hard red winter wheat. Should the current March-May futures spread at around 13c a bushel be sustained through the Dec. 19-Feb. 23 observation period preparatory to setting the storage rate under the VSR on March 18, the storage rate may be raised to 8c a bushel. This may help sustain a strong cash hard red winter wheat basis going forward as mills and exporters attempt to pull wheat into marketing channels from elevators seeking to reap maximum benefit from the carry.
A final ingredient for this “perfect storm,” as one wheat buyer termed the current cash hard red winter market, was the inability to use the delivery mechanism of the K.C. futures contract to procure usable wheat should that prove necessary. This was because wheat with protein below 11% and as low as 10.5% was deliverable, albeit with a discount. After two consecutive low-protein hard red winter wheat crops, most of the deliverable supply was likely to comprise wheat with protein too low to be of much use to the domestic market except as feed.Hopes were invested in the 2018 crop. Hard red winter wheat plantings won’t be known with certainty until the release of the U.S. Department of Agriculture’s Winter Wheat and Canola Seeding report in January. Millers and bakers hoped no matter what the size of the harvest, 2018 hard red winter wheat will provide protein more in line with historical averages. Even then, it will take some time for the huge supply of low-protein wheat overhanging the market to fed, exported or blended.