A Little More Background on Wheat Spreads

The fundamental reason for the appeal of Minneapolis and Kansas City wheat futures at small premiums (or discounts) to Chicago wheat is that both call for delivery of wheat with higher protein content. A more legalistic approach is that they both represent wheat deliverable against the Chicago CBOT contract without penalty. The MGE and KC contracts could be worth less if they represented "stranded" wheat that had no outlet, but the Mississippi River is still flowing today and will likely be flowing tomorrow, so that does not look like a real problem. Another reason for a Chicago premium would be that there is specific demand for "soft," low protein wheat.

The supply/demand balance for Chicago soft red winter wheat does appear tighter than the outlook for the much larger hard red winter wheat markets represented by the MGE and KC futures. But the prospect of a soft wheat shortage is remote as demand would shift to higher protein wheat if it were offered at a discount and the hard wheat is deliverable against the CBOT futures. So the CBOT could go to a premium that reflects the cost of transporting wheat to their delivery points (Chicago, Toledo) in excess of the cost of delivering to MGE or KC elevators.

In fact, I don't believe that the supply/demand balance for soft wheat is an important factor driving the intermarket wheat futures spreads today. The major issue is that CBOT wheat futures have been diverging from the underlying cash wheat market for several years. To the extent that the futures become unhinged from the physical market, it becomes impossible to make any fundamental forecast about their price relative to other instruments. The CBOT has recognized this problem and has implemented VSR (variable storage rates). While VSR may not have a big impact at first, within 6-12 months the onerous terms for storage without "loading out" physical wheat will force the futures to converge with the physical and the normal intermarket wheat spread relationships based on protein content will reassert themselves.