UPDATE 1-Wheat spreads stay wide as CME begins VSR process

* CME Group starts VSR process by tracking wheat spreads

* Trade expects higher storage rates due to wide spreads

* Critics warn VSR plan may cause new market distortions
(Recasts with CME Group data; adds bullets, byline, links)

By Julie Ingwersen

CHICAGO, May 19 (BestGrowthStock) – Traders and analysts expect CME
Group (CME.O: ) to raise the storage rates on deliverable wheat
futures this summer as part of its new “variable storage rates”
(VSR) plan, given wide carries in the market.

The VSR system is intended to improve convergence between
cash wheat prices and Chicago Board of Trade wheat futures at
expiration. Market participants have said that large gaps
between futures and cash wheat prices have reduced the CBOT
wheat contract’s value as a tool for managing price risk.

But as the exchange began tracking wheat spreads on
Wednesday, the first step in the complex process of adjusting
storage rates, some questioned whether the VSR scheme would
cause new distortions in the market.

“This could be a case of unintended consequences,” said
Rich Feltes, senior vice president of MF Global Research in
Chicago.

By making wheat storage more profitable, Feltes said, VSR
could add to hefty stockpiles of soft red winter wheat, the
commodity underlying CBOT wheat futures, and even boost U.S.
production despite sluggish demand.

VSR works by raising storage rates on deliverable CBOT
wheat at times when the spreads between contracts get too wide,
and lowering rates when the spreads contract.

CME Group on Wednesday began tracking the spread between
July and September wheat futures, along with the cost of
financial full carry — the cost of storing wheat from one
delivery period to the next.

The exchange will report the cost of the spread as a
percentage of full carry each day from May 19 through June 25,
which is the expiration date of CBOT July wheat options.

If the spread trades at 80 percent of full carry or more,
on average, during that period, the maximum daily storage rate
for wheat would rise from $0.00165 per bushel (roughly 5 cents
per bushel per month), to $0.00265 per bushel (about 8 cents
per bushel per month).

The new rate would go into effect starting July 18.

CME Group said Wednesday that the July/September wheat
spread settled at 17.5 cents per bushel, or 143.1 percent of
full carry, estimated at 12.23 cents.

PENALIZING INDEX FUNDS

CBOT wheat spreads are not expected to tighten any time
soon, Feltes and others said, because plentiful global supplies
of wheat are pressuring nearby contracts relative to the
deferreds.

As a result, traders expect the spreads to stay above full
carry through June, triggering higher storage rates in July.
And the exchange can continue to raise the rates, using the
same system ahead of each successive contract’s expiration.

Traders said the VSR plan, approved last November, has
already widened CBOT wheat spreads, with deferred contracts
trading at unusually large premiums to front months.

Higher storage fees will make it more costly for passive,
long-only investors, such as commodity index funds, to
perpetually roll their long wheat positions forward.

Some regulators have accused index funds — long-term
investors that have no intention of taking delivery of physical
grain — of artificially inflating wheat futures prices above
cash values. Index funds hold some 40 percent of the open
interest in CBOT wheat futures.

But along with penalizing index funds, critics of VSR say
the plan could create an artificial shortage of soft red winter
wheat in the cash market, creating new distortions.

“What is happening here is the perverse effect of adding
false demand for wheat, because it’s so profitable to store
it,” said Doug Carper, an independent commodity trader based in
Lincoln, Nebraska.

LINKS:

FACTBOX-Variable rate plan for wheat [ID:nN18182576]

Daily CME variable storage rate data [ID:nN19250073]

COLUMN-Will Variable Rates Fix Wheat? [ID:nN18119563]

Investment Basics

(Reporting by Julie Ingwersen; Editing by Marguerita Choy)

UPDATE 1-Wheat spreads stay wide as CME begins VSR process