Last Wednesday, the corn market pulled back to a technical point and Thursday it bounced off it. Fundamentally, crops aren’t made or lost in May, so debates over planted acres and Chinese demand for old and new crop will continue to manipulate prices. In a month weather becomes a factor and it’s impossible to know today what exactly will happen. I expect a bumpy road yet for prices this summer.
The Export Delivery Process
Recently I received a request for an explanation of the corn futures delivery process. So, I reached out to my good friend Joe Rich of O’Bryan Commodities to help me summarize this complex process.
History
The current delivery process was set up many decades ago when corn exports were nearly 30% of total demand. The total US exported bushels stayed relatively consistent for 40 years but have increased about 50% in volume in the last 5 years. Despite these recent increases, exports today only account for 15% of total corn usage in the US. The feed and ethanol sectors each usually consume more than twice as much as what is exported.
Export Delivery Facility Locations
There are about 40 export delivery facilities registered with the CME group (i.e., the owners of the board of trade). These facilities are located from just east of Chicago and follow the Illinois river through Peoria and down to St. Louis. All these locations can load grain on barges that can eventually be sent to New Orleans.
Originally the Illinois river system was the most logical area for the delivery facilities to be because of their proximity to the Chicago Board of Trade and the high concentration of corn and bean acres nearby.
About 10 different large grain companies own all these facilities. Some companies have just 1 delivery facility and 2 companies have more than 10 registered delivery points. Facility sizes range from minimal storage to 12+ million bushels of space.
How Is Delivery Taken?
Loading barges that hold 55,000 bushels are the “defacto” trading mechanism of the export delivery process. So, if someone wants to take physical delivery on the board of trade, it generally requires taking a large quantity all at once. Some facilities can accommodate buyers by loading rail cars.
What Is the Delivery System Used For?
The current delivery system allows the price of grain on the CME to represent the actual price of the physical grain at a defined location at a certain point in time. For example, deliverable stocks of corn near Chicago are valued with a near zero-basis level. However, the further away from Chicago the grain is located the more basis values vary. For instance, corn may be +40 cents to the CME in Ohio, but -40 cents to the CME in North Dakota.
However, since grain is exported out of New Orleans, barge freight costs vary all along the river. The locations that are closer to New Orleans will have rates that are less than those that are further away. This required that the CME had to develop a rate structure that was fair for all of the delivery facilities along the Illinois river from the points between Chicago and St. Louis to New Orleans. Therefore, the CME set rates on how much premium elevators in Peoria or St. Louis can charge to loadout grain for the delivery process. Premiums are higher for locations further downstream from Chicago on the river with the St Louis area being having the highest rates.
How Does the Delivery Process Start?
It starts by a futures contract turning into a “delivery receipt.” This occurs during the approximant 10-trading days period that usually starts a day before the 1st day of the contract month. So, for December corn the delivery period would run approximately 11/30 through 12/14.
The delivery elevator can elect to “put grain out for delivery” in the form of a registered receipt with the CME. The decision process first starts with the delivery elevator comparing the value of their grain as either loaded out at the set premium value over the CME price for their location verses their local basis market prices. If the best sale is to deliver, the delivery elevator will tell the CME of their intentions and it will be registered as a deliverable stock ticket, which will show which facility location the grain will be located at.
The receipt will be assigned to the oldest long position futures contract on the CME. This is why the average trader is told to be out of their long positions before the delivery process begins. Once a delivery receipt is applied to a futures contract holder that entity can do one of three things with the receipt:
If the new receipt owner has enough receipts at one specific delivery elevator to fill a barge (i.e. 11 contracts), they can choose to load the grain out and take physical delivery of the grain.
The new receipt owner could redeliver the receipt back into the market if it is still within the delivery process time window.
The new receipt owner could pay the CME storage fees until a later date to redeliver receipt or load out physical grain.
Why Would Someone Take Physical Delivery? You would only want to load out grain and take physical delivery if you couldn’t source grain any other way. Generally, taking actual delivery is a last resort for sourcing grain because the delivery system is slow and inefficient. It takes time to get barges into place to the load at the delivery elevator and the holder of the receipts must pay storage until the grain is loaded out. On top of that once the grain is loaded in barges the choices for where to take that grain becomes extremely limited as there are not a lot less choices for who can take a barge and be able to unload it around the country. Ultimately though it comes down to freight costs and spreads. There are daily bids for cash corn on barges in New Orleans, LA often abbreviated to NOLA. These bids for a barge of corn are delivered to NOLA with the Costs of Insurance and Freight (CIF) from all points on the river systems in the US. “CIF NOLA” barge bids are the most-commonly traded single cash market in the US. CIF NOLA bids are based on supply and demand from barge freight rates on the entire river system, so changes in barge demand can impact freight rates and basis bids in NOLA. All barge loading facilities and every delivery facility are very familiar with daily freight rates and bid accordingly off the CIF NOLA bids. These barge bids compete against ethanol plants and rail loaders looking for grain throughout the Midwest and influences basis values around the country. On the flip side, basis value adjustments at ethanol plants and feed mills can impact basis demand on the CIF NOLA bids. For instance, if there was limited corn supply somewhere, basis values will adjust to incentivize corn be moved to the areas of higher demand and would likely eventually work their way back to impact delivery elevators in Illinois. If demand for grain is severe enough, basis values may encourage someone to just buy the grain on the CME, load it on a barge, and send it to NOLA. That’s why market participants are always monitoring barge freight costs, location load-out spreads, interest rates, basis bids delivered to Illinois facilities and basis bids for CIF NOLA barges. What Usually Happens Once receipts are delivered upon, the spreads between the futures contracts or basis bids for barges will quickly adjust. This will encourage the receipt holder to likely do option #2 above and redeliver. Often the original elevator hopes to end up reowning their own receipts and cancel the contract delivery all together as this is the most profitable scenario for them. However, if the original delivery facility owner doesn’t get their own receipts back and the holder of the receipt doesn’t want to take delivery then option #3 cold become an option. This scenario can often provide opportunities for people with large sums of cash to generate some guaranteed income. Why Would They Do This? It usually boils down to the cost of money (i.e., interest) and is mostly done by hedge fund managers or large grain companies attempting a quick low risk return on investment. For example, most traders use margin to buy and sell contracts on the board of trade (current minimum margin on a contract is around $2500). If someone with a long futures contract allows that contract position to be delivered upon, they must come up with the full value of the contract. If that price was $6/bushel that would mean the long futures holder have to come up with $30,000 that day. Hedge funds trying to turn a profit will compare storage costs that are predetermined by the CME for delivery facilities and the cost of their money (i.e., internal company interest rates) against the futures market carry (i.e., price difference between 2 months). Usually during a big crop year the carry will be larger than the storage rates and the interest that companies feel the money in their bank account is worth. This kind of scenario could provide a hedge fund with a market position that has better returns than US Treasury Bills. Plus, since the Board of Trade has never had a default on receipts to date, it can be considered a safe investment on par with the US Treasury for some large financial institutions. Can the Delivery System Be Rigged? The CME vigorously monitors the delivery process to prevent manipulation for personal or company gain. Therefore, market participants taking or loading out delivery must be able to justify their reasons to the CME to ensure the market is working appropriately. Why Does This All Matter? The delivery process is a big driver of the spreads between futures month contracts. It also determines how much carry is needed in the market or if supply is limited and warrants an inverse to pull the grain out of storage. The delivery process can also help trigger cancellations of sales contracts potentially in tight market years. Large carries or inverses can also provide indications of futures price direction as well. Bottom Line The delivery process is extremely complex with many moving parts. Very few participants can take or load out physical delivery. Occasionally, if the market conditions are right, hedge fund managers will participate in the delivery process if there is sufficient return on investment opportunities. And ultimately, the delivery market helps adjust futures values and the price market participants can receive to ensure that supply and demand meet as efficiently as possible. It’s not a perfect system and there many who wished it worked differently, but it’s what we have today.
Jon Scheve Superior Feed Ingredients, LLC
9358 Oak Ave Waconia, MN 55387 jon@superiorfeed.com
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