Commodity Futures Trading Commission 

Office of External Affairs 

Three Lafayette Centre 

 1155 21st Street, NW 

Washington, DC 20581 

 202.418.5080 

Statement 

Written Statement by Jeffrey H. Harris, Chief Economist, 

Agricultural Markets Roundtable, Commodity Futures 

Trading Commission Headquarters 

April 22, 2008 

I am, Jeff Harris, Chief Economist of the CFTC and I am here today with Dr. Kunda from 

the University of Illinois to focus more closely on issues related to hedging in agricultural 

futures markets. The Office of the Chief Economist works closely with the Division of 

Market Oversight (DMO) in providing analysis and advice in matters that relate to the 

oversight and examination of trading in futures markets. We have seen, from John 

Fenton’s earlier presentation, that the CFTC is keeping close contact with agriculture 

markets on a daily basis during these unprecedented times. 

My role today is to introduce you to the topic of convergence in futures markets. Along 

the way I will discuss the relations between spot and futures prices and forward 

contracting in agricultural markets. Although surely I could talk at length on these 

topics, I will keep us on schedule by relating convergence to price discovery in the 

futures markets. Well functioning futures markets serve a price discovery role. 

Because futures prices are publicly available, private agents can make decisions that 

incorporate the information and insights from the great number of experts who trade in 

our markets. The textbook example of this is a farmer making his or her planting 

decisions at the beginning of a crop year. In those instances, the price signal from corn 

markets is useful in allotting acreage to that crop. Similarly, co-operatives can use 

those price signals as a basis for committing to purchase the produce of their members. 

Such forward contracting alleviates the price risks that individual farmers would 

otherwise bear. Likewise, futures markets enable dealers to offer swap contracts for the 

risk management needs of large-scale commercial operations. Each of these very 

valuable services depend on the efficient price discovery role of futures markets. 

Convergence between spot and futures prices is an issue because many believe the 

lack of convergence is symptomatic of a poorly functioning futures market. I’ll quote 

from one of the many letters the Commission has received on this topic: “The less that 

futures serve as an accurate proxy for cash, the greater the risk for elevators and others 

involved in the grain business” 
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I agree that incomplete convergence of futures and cash prices as contract expiration 

approaches can indicate a poorly functioning market. But an apparent lack of 

convergence can indicate other issues as well. After all, convergence is simply a matter 

of the Law of One Price—that is to say, the prices for identical items in the same place 

and time must equal one another. That Law is fully operative at the moment of contract 

expiration. The commodity delivered according to a future contract can command no 

more or less than the current spot price. Prior to expiration, convergence is a matter of 

four variables and one activity. The four variables are: the spot price at that instant, the 

cost of storing the commodity, the value of having immediate access to the commodity 

and the cost of delivering the commodity according to the contract. The activity is 

arbitrage. All are crucial to obtaining convergence. 

I’ll omit the value of immediate access because that narrows the basis—our mail 

indicates that not to be a problem (but DMO charts showing positive bases at the Gulf 

highlight the value of location). High storage costs such as can be expected when 

storage facilities are scarce will widen the gap between futures and cash prices. 

Likewise, a high cost of delivery can create an apparent convergence failure. I say 

apparent because delivery on a contract incurs both the cost of the commodity and the 

cost of moving it. As noted by my colleague John Fenton, diesel costs and Illinois River 

barge freight rates are at historical highs for this time of year. The futures price, 

because it reflects these costs, will appear to converge less strongly as a result. 

Despite that appearance, the Law of One Price does apply--the all-in cost reflected in 

futures should converge to the cash price. I emphasize storage and delivery costs 

because our reports indicate both may be contributing to weaker convergence. 

Lastly, but also crucial to convergence is arbitrage activity. Arbitrage consists of 

examining the four variables I mentioned for profit potential. Figure 1 illustrates using 

the persistent negative basis in soybeans at expiration during 2007. The negative basis 

results from futures prices that exceed spot prices. If this represented true mispricing, 

arbitrageurs would short futures and buy in the spot market to deliver on these 

contracts. Any costs of buying the spot asset to deliver against a short futures position, 

however, will impede this arbitrage and will result in a relatively weak (negative) basis. 

Increases to freight and storage costs (as we have seen in recent years) exacerbate 

this situation. 
Soybean Basis - January, March, May and July 2007 Contracts

CRB Cash prices

-120

-100

-80

-60

-40

-20

0

20

4/3/06

4/17/06

5/1/06

5/15/065/29/066/12/066/26/067/10/067/24/06

8/7/06

8/21/06

9/4/06

9/18/0610/2/06

10/16/0610/30/0611/13/0611/27/0612/11/0612/25/06

1/8/07

1/22/07

2/5/07

2/19/07

3/5/07

3/19/07

4/2/07

4/16/074/30/075/14/075/28/076/11/076/25/07

7/9/07

Date

Basis (cents)

January March May July

May reflect costs (of arbitrage)

growing over time

Figure 1. The Basis in 2007 Soybean Contracts 

Of course, the prospects that arbitrage is impeded by some other factor is a concern to 

market participants. The CFTC has been closely monitoring new entrants such as 

commodity index traders, hedge funds and other managed money traders in the 

agricultural markets. As highlighted by John Fenton earlier, the 2007-08 price increases

in agricultural commodities have occurred largely under relatively stable participation by 

managed money traders (which include hedge funds). As noted earlier, we do witness 

an increase in net long positions by index traders, but this increase has only marginally 

increased in terms of market share, since overall open interest has been growing 

concurrently. 

Profit opportunities result in the buy and sell pressures that bring about convergence. 

Increased costs of executing arbitrage trades inhibit arbitrage activities. Absent 

evidence that particular traders might artificially or intentionally impede arbitrage in 

agriculture markets, the Office of the Chief Economist would caution against policy 

choices that might further raise the cost of conducting arbitrage activities. Such policies 

can have negative consequences for convergence. Among the more crucial policy 

choices are regulations that raise trading costs or those that limit the extent of arbitrage 

that can be conducted. 

On that note, I will turn it over to my colleague from Illinois, Dr. Kunda. 

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