|A little bit about
wheat production and futures markets
Farmland covers at least three-quarters of Illinois' land area, with
nearly 90 percent of farmland categorized as 'prime'. Illinois, the 25th
largest state, ranks third nationally in total prime farmland acreage - the
state's fertile soil and flat terrain are ideal for farming. Wheat
is the third most common grain grown in the state, after corn and soybeans.
Acreage devoted to wheat has been declining since the early 1900s,
and it now makes up only a small percentage of the state's total land area.
Much of the acreage previously devoted to wheat has been replaced by corn
and soybeans, which each make up about 30 percent of the state's land. Higher
per-acre yields also mean that more wheat can be grown on less land.
2007-2008 was a bumper year for the US wheat crop. Low stocks of grain from
the previous season, a strong demand for exports, and the participation of
hedge funds in the commodities markets drove up prices to historic
levels, reaching $9.70/bushel in March 2009. Sadly, farmers don't always
benefit from high prices, having locked in their selling price with a local
grain elevator months or even years ahead of time. Elevator operators
then sell futures contracts for that same quantity of grain to hedge that
price against losses. Grain elevators profit by speculating on the
difference between the local cash price and the futures price that occurs
at certain times of the year.
Futures contracts are contracts to buy or sell a commodity on a given delivery
date for a given price. When a contract comes due, rather than taking physical
delivery of a commodity the price difference can be settled in cash, resulting
in a profit for the buyer or the seller. Most of the transactions on
an exchange are for hedging risk or for speculation, and physical delivery
on a futures contract is rare. Other than the type of wheat futures
traded (soft red winter), the Chicago Mercantile Exchange (CME) has almost
no geographic or physical relationship to the wheat grown in Illinois. Still,
because farmers, brokers, and grain elevators look to futures prices to determine
the cash price per bushel of (real) wheat, the CME is of unmost importance
to the Illinois farming community.
Recently, the difference between cash and futures prices for wheat have grown
larger and more unstable. This creates great difficulties for farmers
and elevators trying to manage their risk, and has caused many local grain
elevators to go belly-up. Whether or not the wheat market was the victim
of excessive speculation was the topic of a recent Senate committee inquiry.
The committee found that large purchases of Chicago wheat futures by
large index fund traders had driven up prices excessively and "disrupted
the normal relationship" between futures and cash markets. Recently, some
have made the eminently reasonable argument that rather than being determined
by the futures market, cash prices for farm commodities should be determined
by the actual cost of production, plus a profit margin - the same way one
might price most other products.