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**Testimony**

**of**

**Garry Niemeyer**

**National Corn Growers Association**

**Before the**

**U.S. House Agriculture Subcommittee**

> **on**

**General Farm Commodities and Risk Management**

**Longworth House Office Building**

**Room 1300**

**Washington, DC**

**May 15, 2008**

Good morning, I am Garry Niemeyer and I am a corn and soybean farmer in
central Illinois. I am here today representing the National Corn Growers
Association (NCGA). NCGA represents the interests of over 32,000 corn
farmers throughout the U.S.

For over 100 years, the commodity exchanges have played the two valuable
roles critically important to farmers; price discovery and risk
management. Over the last several months, though, we have witnessed a
lack of convergence between cash and futures markets as the futures
contract expires. While the corn market has experienced significant lack
of convergence, it is nothing compared to what has occurred in the wheat
pits.

Without market convergence the futures markets are not fulfilling the
role of price discovery. It leads many to question whether market
fundamentals still underpin current grain prices. Economic theory
suggests convergence is not really a point at zero, but a band of plus
or minus a few cents either side of zero, varying based on current
supply and demand factors. Further, it is natural to assume that the
increased risk inherit in the grain markets would cause the "band of
convergence" to expand from historical norms, but is 35 to 50 cents a
real true measure of this risk? If the constant media barrage about
scarcity is to be believed, you would certainly think the cash grain
markets would converge closer to zero rather than spreading
dramatically.

Moreover, a weakening of price discovery is rippling into the farm
credit system, resulting in banks having difficulty in collateralizing
loans to elevators and farmers, alike. It is this tightening in the
agriculture credit markets that is setting the stage for a more serious
problem.

It is our position that the lack of convergence is a symptom, not the
disease. For a number of reasons, some of which I will detail later,
grain markets are not performing with the efficiency in past years and
this places farmers directly in the path of an economic storm.

Please do not misconstrue this point. Corn Growers are not upset about
higher corn and grain prices. Our concern is that the current prices
quoted may not be fundamentally supported. This is leading people to
speculate that we may be witnessing the development of a "commodity
bubble." As this bubble has inflated, it has resulted in hardships for
the elevator industry and has been devastating to our livestock
customers. The sharp rise in prices has also impaired many growers'
ability to do price risk management.

To those who want to blame biofuels for today's grain prices, I will
simply state a close examination of the facts and market trends would
indicate that such claims are difficult to substantiate. In the 2005-06
marketing year when the first Renewable Fuels Standard was approved by
Congress, average farm-gate price for corn was \$2.00 per bushel On May
9, 2008, USDA released its revised estimate for this marketing year's
corn price at \$4.10 - \$4.40. So what has changed? The simple sound
bite is to point to ethanol and say "we've increased the demand for corn
driving up the price". During the last 3 years, corn for ethanol has
increased from 1.6 billion bushels to a projected 3 billion, a 1.4
billion bushel increase in demand. What frequently gets overlooked is
that over this same time period production has risen from 11.1 billion
to 13.1 billion bushels over this time. This raises the question how a 2
billion increase in usage offset by a 2 billion bushel increase in
production provides the necessary fundamental underpinning for a more
than doubling of the corn price. Now contrast this estimated \$4.25 corn
price received to the May 12, 2008 closing price on the Chicago Board of
Trade (CBOT) for July futures, \$6.14 ¾. Although an imperfect
comparison, it illustrates there is a significant difference between the
prices farmers are receiving and the futures market.

The real damage to the elevator industry hit home in early March when
many elevators took major hits on margin calls. Several leading grain
companies' initial response was to suspend forward contracting. While
the suspension was short lived, severe restrictions were placed on new
contracts once forward contracting was re-established. These
restrictions on new grain contracts are the most troubling. Each of the
large grain companies have instituted limits on writing new grain
contracts. One company will not forward contract grain more than 60 days
out. Two others will not contract grain more than 12 months in the
future. Naturally, this has permeated down to the country elevator
level. One of my local elevators will not contract for grain this fall
and I assure you this is not a central Illinois phenomenon, but it is
occurring across the country. As a farmer, how am I supposed to manage
price risk, if my elevator will not contract grain? I am not talking
about locking in prices 2 and 3 years into the future. But, how do I
manage risks for the corn crop I would be planting today if it had not
rained Tuesday?

Over the last several years, farmers have grown accustomed to the
elevator industry's willingness to carry the futures market risk for us.
It has been quite common for us to do Hedge to Arrive contracts with the
local elevator. The elevator would take the offsetting positions on the
CBOT and absorb any margin risks. Of course, some of this risk would
eventually be bid into the basis. During periods of little volatility,
though, this risk premium was not that great. In return for carrying
that risk, elevators were also able to lock in volume. Elevators make
their profits in handling bushels. But, it is the more recent wild
volatility and subsequent margin calls that have led to the restrictions
on contracts. For example, one of the larger grain companies that
re-established contracting for 12 months forward has implemented a 15¢
per bushel fee to write a HTA. It is worth noting that new fee is 15¢ in
addition to what ever the basis might be when I am ready to deliver the
grain.

Although farmers have always had the ability to do their own risk
management on the exchanges, it is estimated that less than 10 percent
of farmers actually do this themselves. Perhaps we have been spoiled
because the elevators were willing to provide this service. Now, we will
have to absorb the cost and risks of the futures market. In today's
market conditions, these costs and risks are not insignificant. Let me
give you a very simplistic example of how this might impact a grower.
Last year, I produced about 360,000 bushels of corn. If I did a simple
short hedge on this grain (sell futures contracts to protect against
falling prices), I would need to sell 72 contracts (5,000 bushels per
contract). Let's assume I did all of that on September 4, 2007 (when the
grain was harvested) for delivery in May. On that day, May corn futures
closed at \$3.79/bushel. The typical margin, maintenance margin, and
commission would have cost me between \$110,000 and \$150,000, which is
money up front I send to Chicago. On May 1, 2008, May corn closed at
\$6.05 a bushel, an increase of \$2.26/bushel. Since I had a short
position (lose money if the price goes up), I would have lost \$2.26 per
contract. To maintain my maintenance margin, I would have been required
to lay out an additional \$750,000. Technically, I would have made this
money back on the increased cash price of my physical corn, assuming the
cash and futures prices tracked perfectly and did not diverge. Still, I
would have had to finance and pay interest on this \$813,000 until I
could sell the cash corn. In the end, I would have stayed even at around
the cash price on September 4^th^. Keep in mind this does nothing to
protect me against basis risk.

[]{.mark}

Given the higher current prices on the exchanges, margin requirements
have more than doubled since the end of 2007. In December 2007, for
example, the margin on a corn contract was \$1,080 and the maintenance
margin was \$800 (covers a 16¢ move against my position). Today, that
same contract has a margin of \$2,050 and the maintenance margin is
\$1,500. Once again, that is money I have to spend up front on each
contract.

[]{.mark}

Another alternative is to use the options market and buy a put. While
the options market does not carry margin risks, the premium associated
with that put is cash paid up front regardless of whether or not I
exercise the option. Last September when the futures price for May was
\$3.79, there were no strike prices comparable to today's prices. The
increased market volatility has dramatically increased premiums,
especially for crops well into the future. For another example, let us
assume I wanted to buy a put today for May 2009 contracts. These 72 puts
would cost approximately 237,600 in premium and commissions. As I
mentioned, this is money that is gone regardless of whether or not I
exercise the puts. The question is what corn prices have I guaranteed
for \$237,000? \$5.07/bushel. (May 2009 Corn Futures \$6.58, Option with
\$6.10 strike price has a 65¢ premium reducing the Option price to
\$5.45. The one elevator offering a bid for May 2009 has a 38¢ basis
which equal \$5.07/bushel, assuming that basis does not erode).

The unwillingness of commercial players in the market to offer forward
cash prices has effectively transferred the market risk onto producers
and producers still do not have a means to offset the basis risk. A very
real danger is a significant number of growers will forgo price risk
management out of hope that prices will continue to rise. However, such
a strategy will prove devastating if a significant downturn in corn
prices occurs.

NCGA is not blaming the elevator industry for this recent phenomenon.
The elevators are businesses that must be able to recoup losses and
manage price risk. So, they spread basis to cover losses and build in
additional risk principles; initiate fees on Hedge to Arrive contracts
(HTA) or book the basis contracts; or they just forego future risk by
not offering forward contracts. In the end, these actions transfer the
risk back onto growers. The main risk elevators retain is the inability
to lock in bushels.

What could happen if the "commodity bubble" pops? I can best illustrate
this with an example. During the last several years, we have seen a
tremendous increase in input costs. Fertilizer prices have more than
doubled in the last two years. Likewise, diesel prices are skyrocketing.
I like to consider myself a good manager, so, I try to forward price
half of my expected grain production to at least cover my input costs.
Last fall, I purchased my fertilizer for this year's crop. Anhydrous
Ammonia was \$512/ton, Diammonium Phosphate (DAP) was \$476/ton and
Potash was \$287/ton. Since then, we have seen an explosion in prices
and concerns about availability next year. In March, my fertilizer
dealer asked me to lock in my fertilizer for the crop I will plant in
2009. The prices for Anhydrous, DAP, and Potash were then \$780, \$950,
and \$625/ton, respectively. Coincidentally, between March and May,
those prices have continued to increase to \$830, \$1,150 and \$725. The
trend is clearly pointing to even higher prices by this fall. Once
again, I typically manage the risk of fertilizer prices by forward
contracting a portion of my grain. However, no elevators are offering
bids for new crop 2009 corn. My options are simple and unpleasant. I can
borrow money to buy the fertilizer now, and remain completely exposed to
a down turn in corn prices, or wait and remain completely exposed to the
price of fertilizer continuing to rise. I am left to hope that should a
downturn in grain prices occur, fertilizer prices would drop
proportionally with grain prices, a very unlikely outcome.

As I have mentioned several times, NCGA's concern is the development of
a commodity bubble and now hoping that the bubble doesn't burst. This
bubble was not caused by ethanol. Instead, it has been caused by a
dramatic increase in non-traditional investors in all commodities, not
just corn, specifically, index and hedge funds and swap dealers.
Commodities have traditionally been a prudent investment during periods
of economic uncertainty. With huge influxes of outside money indicating
these investors are returning it is no coincidence the recent run up in
commodity prices coincides with the downturn in the stock market.

More importantly, we are concerned with the general investment pattern
of the Index Funds that have inflated the bubble. These funds take huge
net long positions (buy futures) which given the volume of purchases
naturally drives prices higher. Their claim of being "Passive Longs" is
partially true. They are not playing both sides of the market, only
betting that the price will go up. The funds claim they are not
responsible for the divergence between cash and futures because of the
roll out of their long positions approximately a month before contract
expirations. The latter part of this statement is true. However, one
theory about the lack of convergence is the funds have driven a large
enough wedge between the two markets when they complete their rolls and
that it would take a significant fundamental signal to drive cash and
futures together. The likelihood of this happening in a month's time,
particularly when the crop is not exposed to a production event, is
slight.

The commodity exchanges' strength has always been liquidity, openness,
and fair and transparent rules. Unfortunately, we have seen erosion in
market efficiency. The challenge is to restore efficiency in price
discovery and risk management without jeopardizing market openness and
liquidity. In light of that goal, NCGA would like to submit the
following possible solutions for consideration:

First, to address the current lack of convergence in between Cash and
Futures markets:

Simply to fix convergence in the market, we must fix delivery. The
problem, there are no easy solutions to this task. Here are a few
recommendations; we put forward to the CME Group.

1\) Investigate the development of a method to allow farmers or small
elevators that have taken a short position to actually deliver against
that futures contract. Currently farmers cannot make delivery against
these positions. Farmers can only sell futures and deliver against
shipping certificates, provided the owner of that certificate plans to
make delivery and go to load out. If the delivery stations realized that
a farmer or an elevator could call a clearinghouse and set up delivery,
it would cause the commercials to drive the futures down at contract
expiration to the cash price. A possible hybrid would be to restrict
farmer delivery to only a few points with a 1 or 2 day delivery option.

2\) Investigate implementing a forced Load Out plan whereby some set
percentage of contracts has to go to delivery. During the investigation,
consideration must be given to how these Load Outs would be distributed,
and what impact this may have on liquidity if the non-commercials are
prematurely driven out of the market prior to contract expiration.\
\
3) Investigate increasing the number of shipping stations. By our count,
there are currently 28 shipping stations approved as "regular" for corn
delivery through June 30, 2008. These stations are limited to 9 firms.
Of these 9 firms, only 2 are truly sellers. In other words, they can
write a shipping certificate, but since they cannot use the grain
internally (processing or through their own export facilities) they must
sell the grain, and therefore, may be more inclined to make delivery
against a diverged market. We believe balancing or at least increasing
the number of sellers that can write shipping certificates may help to
re-establish convergence. For example, there are a number of large
ethanol plants operating or being built in proximity to the Illinois
River. Some of these will have docks that can load out, if necessary. A
similar approach would be to investigate adding shipping stations that
are not located on the Illinois River, but are in the same homogenous
market. Specifically, there are a number of unit train rail loaders
which are all within 50 to 100 miles of the Illinois River which could
deliver a train destined for New Orleans which is similar to a loaded
barge on the river.\
\
4) Consider lowering Regularity. If the Working Capital rate was lowered
from \$2 million to \$500,000, and they reduce the volume down from
55,000 bushels, this might encourage some larger country elevators with
existing agreements with docks or maybe railroads connections to able to
be a write shipping certificates.

5\) Consider increasing storage rates. NCGA is not opposed to periodic
adjustments in CBOT's storage rates. These rates should more closely
reflect actual storage costs. In addition, this may help build natural
carry into the market.

6\) Investigate the establishment of basis contracts. CBOT has proposed
establishing a new basis contract to the CFTC. If the current situation
in the grain markets continues, farmers will need a tool to manage basis
risk just like they must now find tools to manage price risk. While this
appears it could be beneficial in managing basis risk, it really has
limited impact convergence

Second and more importantly, we must find a way to head off the
development of a commodity bubble or if it has already occurred, stop it
from bursting. Several possible solutions are:

1\) Redefine hedgers vs. speculators. NCGA recognizes the valuable role
all parties play in providing liquidity in a market. It is NCGA's view
that the large Funds are having a disproportionate influence in the
futures markets and are "non-commercial" traders. While we do not want
to drive the index and hedge funds or swap traders from the market, they
should be treated as "speculators". Counter to several CFTC decisions,
we believe to truly be classified as a "hedger"; an entity must have a
cash commodity position.

We realize that the large index funds are selling a commodity index and
then going long in each of their market basket commodities which could
be construed as a hedge. But, they are selling a market basket of
futures prices, not a market basket of physical commodities. Therefore,
their actions provide no market incentive for convergence and as I
pointed out above, without convergence there is no price discovery.

NCGA proposes that the index funds, hedge Funds, and swap dealers no
longer be afforded the same margin requirements as traditional
commercial hedgers. Specifically, to be classified as a hedger, the
entity must have a cash position. We are not suggesting that they have
an equal or proportional cash position, but somewhere within that
company they must be buying or selling cash grain to retain the "hedger"
classification.

We believe this will have a very limited impact on market liquidity. The
large funds are still welcome to take there net long positions in each
commodity market, but they will have higher margin requirements just the
same as any other "speculators".

2\) Moratorium on hedger determination. Short of redefining all players
without cash positions as "speculators", the CFTC and the exchanges
should not implement a moratorium of providing "hedger" status on any
other non-traditional traders.

3\) Speculative Limits. NCGA supports the CFTC's decision not to
temporarily increase speculative limits. We believe the proposed
increases were ill-advised and would only increase the disparity between
cash and futures markets.

4\) Daily Trading Limits. NCGA formal policy states "NCGA will oppose an
increase in daily trade limits on all commodity exchanges" (Policy IV-C,
14). It is our position that the proposed increase in daily limits will
not aid price discovery as proposed. Instead, this will only increase
volatility. The CME Group should strongly reconsider returning to the
trading limits that existed prior to their March 28, 2008 increase.

5\) Renewable Fuels Standard. Congress must not repeal nor should the
Environmental Protection Agency waive the current RFS. Numerous economic
studies have indicated that the current ethanol demand has had a very
limited role on the increase in corn prices. A repeal or waiver of the
RFS would have a significant psychological impact on the commodity
markets. In fact, this could drive investors from commodities causing
the bubble to burst. Such a change in policy may have a short run impact
on corn prices, but in the face of current high input prices, it would
cause a significant shift of acreage away from corn and other feed
grains in the near future, resulting in another dramatic rise in feed
prices by 2009.

If in fact a "Commodity Bubble" is developing and that bubble was to
pop, the entire grain sector would be devastated. Similar to the
increase in grain prices, other input costs have risen dramatically,
including for seed, fertilizer, fuel, or land rents. Farmers are now
carrying significantly higher financial risk to plant their crops. A
rapid deflation in grain prices would result in tremendous financial
losses to farmers, especially in light of our recent inability for
growers to contract grain at these current prices. If a disconnect
between futures prices and cash (fundamentals) exists as alluded to
earlier, the impact of the bubble bursting would be all the more dire.
For this reason, it is imperative that the CFTC review recent decisions
concerning the market power some of the major players wield and take
into consideration the potential impact pending decisions have from the
perspective of inflating a commodity bubble.

I would like to commend the CME Group, the Minneapolis Grain Exchange,
Kansas City Board of Trade, and the Commodity Markets Council for
hosting a two-day meeting on market convergence in early April. Also, I
would like to thank the CFTC for holding their open forum last month.

On behalf of NCGA, I would like to thank the House Agriculture
Subcommittee for conducting this hearing and helping American farmers
and grain markets to restore market efficiency.