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**Testimony of the**

**National Grain and Feed Association**

**to the**

**Committee on Agriculture**

**U.S. House of Representatives**

**July 11, 2008**

Thank you, Mr. Chairman, and Mr. Goodlatte, for calling today's hearing
to examine activity in agricultural futures markets. The National Grain
and Feed Association (NGFA) appreciates the opportunity to testify.

I am Kendell Keith, President of the NGFA. Our members include over 900
companies, including grain elevators, feed manufacturers, oilseed
processors, flour mills, biofuels producers and marketers and many other
related commercial businesses. We estimate that these member firms
operate more than 6,000 facilities nationwide. The NGFA's member firms
have relied for years on U.S. agricultural futures markets to hedge
their price and inventory risk, and to aid them in assisting producers
to market their commodities and manage risk. As first-purchasers of
grains and oilseeds from producers, these firms rely on efficient and
well-functioning futures markets for price discovery and risk
management, and to help them provide marketing options for their
producer customers.

**[Financial Liquidity Crisis]{.underline}**

On May 15, the NGFA testified before the Subcommittee on General Farm
Commodities and Risk Management that grain elevators were feeling
financial stresses due to historically large borrowing to finance grain
inventory and margins necessary to maintain hedges. Today, spiraling
commodity futures prices have brought additional challenges to our
industry. If grain and oilseed prices continue to advance, we will
experience a further crunch on liquidity among grain hedgers that could
force companies to reduce cash grain-buying activities and could
ultimately cause additional company consolidation.

Typically, when producers want to market their crops, one of the primary
tools they utilize is forward cash contracts written with their local
elevator. When the elevator contracts with the producer to purchase cash
grain -- often for delivery many months later -- the elevator hedges its
cash position by selling futures on an exchange like the Chicago Board
of Trade, the Kansas City Board of Trade, or the Minneapolis Grain
Exchange. The elevator performs a valuable service for the producer by
assuming price risk on his behalf.

The problem this year is that futures prices for agricultural
commodities have reached record levels, spurred upward by historically
tight supplies, flooding in the Midwest, and an influx of speculative
investment capital. An elevator that forward contracted with a producer
last year and sold futures on-exchange -- a tried-and-true, prudent risk
management strategy -- now has seen futures prices advance to record
levels. As the gap between the elevator's short futures position and the
current futures price has grown, the elevator has been obligated to meet
ever-growing margin requirements established by a futures exchange --
margin requirements that we recognize as legitimately needed to protect
the financial well-being of the exchange and its clearing corporation.
Add to this the increasingly expensive financing of grain and oilseed
inventories and the elevator's borrowing needs have become immense.

To illustrate the heightened [harvest borrowing needs]{.underline} of a
typical country elevator today, the following simulation is derived from
an aggregate of the customer base of an NGFA-member firm that provides
futures and option brokerage services to the agricultural industry,
along with offering hedging education and merchandising risk-management
services. It arrives at an "average" case that is illustrative of
conditions faced by a "typical" commercial grain hedger today to
[purchase inventory]{.underline} -- increased borrowing needs in the
range of 250 -- 300%.

Figure 1

<table>
<colgroup>
<col style="width: 10%" />
<col style="width: 10%" />
<col style="width: 6%" />
<col style="width: 11%" />
<col style="width: 0%" />
<col style="width: 10%" />
<col style="width: 6%" />
<col style="width: 12%" />
<col style="width: 0%" />
<col style="width: 10%" />
<col style="width: 6%" />
<col style="width: 12%" />
<col style="width: 0%" />
</colgroup>
<tbody>
<tr class="odd">
<td></td>
<td></td>
<td><strong>A</strong></td>
<td></td>
<td></td>
<td></td>
<td><h1 id="b">B</h1></td>
<td></td>
<td></td>
<td></td>
<td><strong>C</strong></td>
<td></td>
<td></td>
</tr>
<tr class="even">
<td> </td>
<td> </td>
<td><strong>2006</strong></td>
<td> </td>
<td> </td>
<td colspan="3"><strong>2008 (Projected)</strong></td>
<td> </td>
<td colspan="3"><strong>2008 (Projected)</strong></td>
<td> </td>
</tr>
<tr class="odd">
<td> </td>
<td></td>
<td></td>
<td></td>
<td> </td>
<td colspan="3"><h3 id="big-crops">Big Crops</h3></td>
<td> </td>
<td colspan="3"><h2 id="small-crops">Small Crops</h2></td>
<td> </td>
</tr>
<tr class="even">
<td> </td>
<td>Bushels purchased</td>
<td>Price</td>
<td></td>
<td> </td>
<td> Bushels purchased</td>
<td>Price</td>
<td></td>
<td> </td>
<td>Bushels purchased</td>
<td>Price</td>
<td></td>
<td> </td>
</tr>
<tr class="odd">
<td><strong>Corn</strong></td>
<td>1,000,000</td>
<td>$2.30</td>
<td>$2,300,000</td>
<td> </td>
<td>1,230,000</td>
<td>$5.50</td>
<td>$6,765,000</td>
<td> </td>
<td>1,100,000</td>
<td>$7.50</td>
<td>$8,250,000</td>
<td> </td>
</tr>
<tr class="even">
<td><strong> </strong></td>
<td></td>
<td></td>
<td></td>
<td> </td>
<td> </td>
<td></td>
<td></td>
<td> </td>
<td> </td>
<td></td>
<td></td>
<td> </td>
</tr>
<tr class="odd">
<td><strong>Soybeans</strong></td>
<td>400,000</td>
<td>$5.50</td>
<td>$2,200,000</td>
<td> </td>
<td>428,000</td>
<td>$11.00</td>
<td>$4,708,000</td>
<td> </td>
<td>375,000</td>
<td>$16.00</td>
<td>$6,000,000</td>
<td> </td>
</tr>
<tr class="even">
<td><strong> </strong></td>
<td></td>
<td></td>
<td></td>
<td> </td>
<td> </td>
<td></td>
<td></td>
<td> </td>
<td> </td>
<td></td>
<td></td>
<td> </td>
</tr>
<tr class="odd">
<td><strong>Wheat</strong></td>
<td>150,000</td>
<td>$3.50</td>
<td>$525,000</td>
<td> </td>
<td>180,000</td>
<td>$7.00</td>
<td>$1,260,000</td>
<td> </td>
<td>170,000</td>
<td>$8.00</td>
<td>$1,360,000</td>
<td> </td>
</tr>
<tr class="even">
<td> </td>
<td> </td>
<td> </td>
<td> </td>
<td> </td>
<td> </td>
<td> </td>
<td> </td>
<td> </td>
<td> </td>
<td> </td>
<td> </td>
<td> </td>
</tr>
<tr class="odd">
<td colspan="2"><strong> Cost - Inventory </strong></td>
<td><strong> </strong></td>
<td><strong>$5,025,000</strong></td>
<td><strong> </strong></td>
<td><strong> </strong></td>
<td><strong> </strong></td>
<td><strong>$12,733,000</strong></td>
<td><strong> </strong></td>
<td><strong> </strong></td>
<td><strong> </strong></td>
<td><strong>$15,610,000</strong></td>
<td><strong> </strong></td>
</tr>
<tr class="even">
<td colspan="4"><strong>Harvest Inventory Cost Increase</strong></td>
<td></td>
<td></td>
<td></td>
<td><strong>253.4%</strong></td>
<td></td>
<td></td>
<td></td>
<td><strong>311.0%</strong></td>
<td></td>
</tr>
</tbody>
</table>

Source: Grain Service Corporation

To help further understand the financial stresses a "typical" elevator
might face when [hedging forward purchases]{.underline}, a separate but
related exercise looked at a selected group of elevators for whom the
actual weighted average per bushel "loss" on open 2008-crop, 2009-crop
and 2010-crop hedges were \$1.46 for corn, \$4.47 for soybeans and
\$3.51 for wheat, for a total weighted average hedging loss of \$2.49
per bushel (Figure 2). Applying those averages to several real-world
elevators who buy grain from producers and hedge on-exchange shows that
a "typical" country elevator's hedges could be "under water" in amounts
ranging from just less than \$1 million to almost \$8 million, as a
consequence of forward contracting with its producer-customers. (Note:
these figures are not specific to any one elevator; they are
illustrative in nature but believed to be indicative of actual hedging
results.)

Figure 2

# Hedge Losses -- \'08, \'09 and \'10 Crops

(Weighted average prices as of 2/29/08)

+-------------+---+----------+---+-----------+---+----------+---+---------+
|             |   | [Elev.   |   | [Elev.    |   | [Elev.   |   | [Elev.  |
|             |   | 1]{.un   |   | 2]{.u     |   | 3]{.un   |   | 4]{.und |
|             |   | derline} |   | nderline} |   | derline} |   | erline} |
+-------------+---+----------+---+-----------+---+----------+---+---------+
| > Corn      |   | 876,000  |   | 751,900   |   | 4        |   | 408,800 |
|             |   |          |   |           |   | ,015,000 |   |         |
+-------------+---+----------+---+-----------+---+----------+---+---------+
| > Soybeans  |   | 1        |   | 581,100   |   | 3        |   | 469,350 |
|             |   | ,005,750 |   |           |   | ,799,500 |   |         |
+-------------+---+----------+---+-----------+---+----------+---+---------+
| > Wheat     |   | 596,700  |   |           |   |          |   |         |
+-------------+---+----------+---+-----------+---+----------+---+---------+
| > Hedging   |   | \$2      |   | \$        |   | \$7      |   | \$      |
| > Loss      |   | ,478,450 |   | 1,333,000 |   | ,814,500 |   | 878,150 |
+-------------+---+----------+---+-----------+---+----------+---+---------+

1: Eastern corn belt, single-station elevator hedging 600,000 bushels
corn, 225,000 bushels soybeans and 170,000 bushels soft red wheat

2: Eastern corn belt, single-station elevator hedging 515,000 bushels
corn and 130,000 bushels soybeans

3: Northern corn belt, multi-station firm hedging 2.75 million bushels
corn and 850,000 bushels soybeans

4: Western corn belt, single-station elevator hedging 280,000 bushels
corn and 105,000 bushels soybeans

Source: Grain Service Corporation

Note that the above analysis was conducted using Feb. 29 prices. If we
factor in price changes since that time (through July 3), the "average"
hedger's situation has become even more dramatic, with average wheat
hedge losses easing somewhat, but corn and soybean hedge losses
escalating dramatically (Figure 3):

Figure 3

  --------------------- ------------------------- -------------------------
                        **2/29 per bushel loss**  **7/3 per bushel loss**

  Dec. '08 corn         \$5.64                    \$7.77

  Dec. '09 corn         \$5.38                    \$6.97

                                                  

  Nov. '08 beans        \$14.26                   \$16.31

  Nov. '09 beans        \$13.71                   \$15.54

                                                  

  July '08 wheat        \$10.00                   \$8.73

  July '09 wheat        \$9.70                    \$9.49
  --------------------- ------------------------- -------------------------

Source: Grain Service Corp.

Looking at these numbers, it is not difficult to understand that one
consequence of this financial liquidity squeeze is that many elevators
have been forced to restrict or even eliminate forward contracting with
producers. This is a very unfortunate situation given that many
producers rely exclusively on cash forward contracts to manage price
risks. Many elevators are unable to access enough funding to finance
hedges on new-crop forward purchases, and many view the risks of forward
purchases in an increasingly volatile marketplace as being unmanageable.
This is a significant shift in the way our industry does business, and
has frustrated producers who would like to lock in attractive prices for
this fall's harvest.

We believe the lenders who do business with our industry have done a
good job to date in responding to borrowing needs that are several
multiples of normal, expected levels. However, we are hearing from our
member companies that some lenders are at or near their lending limits,
while other lenders may have access to sufficient funds but are reaching
the upper bounds of the business risk they are willing to assume. In our
current tight stocks situation, additional price advances likely would
result in elevators being unable to access sufficient funds for
operations and for margining. In a worst case situation, another weather
event or other supply disruption this summer could drastically deepend
the financial difficulties for our industry, cause further
consolidation, and further reduce cash grain bids available to farmers.

The NGFA is not requesting any specific action by this committee or by
Congress at this time to respond to the financial liquidity crisis our
industry is facing. However, we do want the committee to be aware of the
situation, and we would like to keep you apprised as we move into the
critically important summer growing season.

I would add one final observation regarding our industry's financial
liquidity crisis and escalating commodity and food prices. At its core,
the problem goes back to supply and demand fundamentals. Today, U.S.
grain and oilseed production is having trouble keeping up with growing
demand driven by increasing consumption in developing countries like
China and India; the continuing growth of the U.S. biofuels sector; and
other factors. Grain stocks have declined in six of the last seven
years. We have seen market disruptions this year due to weather problems
in the Midwest. The current very tight supply/demand situation is bound
to result in higher commodity prices that will be attractive to
non-traditional market participants. One much-needed response, for which
the NGFA has called for many months, is for Secretary of Agriculture Ed
Schafer to announce a penalty-free early-out from Conservation Reserve
Program contracts on cropland that can be farmed in an environmentally
sustainable way.

**[Futures Market Transparency]{.underline}**

The NGFA's legislative priority with regard to futures markets is to
enhance transparency. Knowing who is participating in agricultural
futures markets and being able to gauge the impact of participants is
critically important to grain hedgers. The CFTC made an important
advance in this respect early last year when it implemented a new
"Index" category in the weekly Commitments of Traders report. However,
with the continuing influx of speculative investment capital into
agricultural futures markets, and the advent of new market participants
like exchange-traded funds (ETFs) and exchange-traded notes (ETNs) we
believe additional reporting and transparency is needed.

The challenge is identifying all market participants that should be
subject to enhanced reporting and, in turn, that should be reported on
by CFTC. Index funds, pension funds, swaps dealers, ETFs, and ETNs all
participate primarily on the long side of futures markets, and we
believe they should be required to report to CFTC on their
exchange-traded positions. However, there may be other new and
developing participants who should be subject to reporting too; the
challenge is how best to describe all the players correctly.

We would advise Congress against overly prescriptive approaches, as it
is difficult to anticipate outcomes and reactions of market
participants. It is not sufficient simply to require reporting from
"passive, long-only" participants. Some of the above players may
currently have short positions in futures markets; and some of them
might "go short" in a few small positions just to avoid reporting
requirements. In addition, as the market adjusts and likely goes into a
downward price trend at some point in the future, these participants may
adopt investing strategies that call for greater percentages of
commodity assets in short positions. We need to look to the future and
try to craft legislation that foresees these possibilities, and we look
forward to working with Congress in this effort.

We also would caution against Congress attempting to legislate things
like margin requirements or the share of futures positions that certain
types of participants can hold in agricultural futures markets. These
kinds of proposals have been made by various members of Congress with
regard to energy markets. For agricultural markets in particular, we
believe the establishment of appropriate margins for various market
circumstances is best left to the exchanges and their clearing
corporations, which are in the optimal position to make determinations
about what is needed to safeguard their financial integrity. We would
also fear the "law of unintended consequences" might apply in this case,
and that attempts to regulate "speculators" could overreach and affect
participants who are very important to providing liquidity in
agricultural futures markets.

**[Futures Market Performance Issues]{.underline}**

The NGFA's final major concern revolves around the performance of U.S.
agricultural futures markets. It is of paramount importance that futures
exchanges continue to serve their long-established roles of price
discovery and risk management for traditional users like grain hedgers.
We are deeply concerned that agricultural futures markets are not
satisfactorily performing those functions today.

In our May 15 testimony to the subcommittee, we submitted evidence that
cash and futures convergence in grain and oilseed contracts, a bedrock
principle for the hedging efficiency of futures markets, has been
compromised in recent months. That remains true today. Genuine
convergence occurs less often and only for short periods of time. The
band, or range, of convergence has widened due to several factors,
including: 1) higher and more volatile transportation costs, including
higher fuel costs; 2) demand for storage created by biofuels growth; and
3) the futures market running ahead of cash values due to the infusion
of speculative investment capital.

This lack of convergence -- or "divergence" as some are calling it -- is
evident in wider basis levels between cash and futures. Cash bids to
producers at any given location and time still reflect the true value of
physical commodities, but rapid advances in futures price levels have
widened basis to levels not historically expected.

As mentioned above, many factors are at work to influence price levels
and basis: transportation and fuel costs; changes in supply/demand
fundamentals; carry-over inventory levels; farmer selling; storage
rates; and more. Changes in any of these factors can result in
significant changes to basis levels, and today we are seeing many
changes occurring simultaneously. However, we believe that the
participation of large amounts of speculative investment capital like
index and pension funds into agricultural futures markets is causing
disruption in markets and resulting in futures prices that no longer
reflect true supply/demand fundamentals.

In today's marketplace, it is critically important that all market
participants -- including farmers and grain elevators -- be able to see
and understand the impacts of non-traditional participants like index
funds and others mentioned above. With supplies tight, demand high and
volatility increasing, proper identification and reporting of
speculative investment capital in agricultural futures markets should be
a priority.

Thank you again for the opportunity to participate in today's hearing. I
would be happy to respond to any questions, and to assist this committee
in development of any legislation that may move forward.