United States Senate

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

Committee on Homeland Security and Governmental Affairs

* * Carl Levin, Chairman

Tom Coburn, Acting Ranking Minority Member

EXCESSIVE SPECULATION

IN THE WHEAT MARKET

MAJORITY AND MINORITY

STAFF REPORT

PERMANENT SUBCOMMITTEE

ON INVESTIGATIONS

UNITED STATES SENATE

JUNE 24, 2009
SENATOR CARL LEVIN

Chairman

SENATOR TOM COBURN, M.D.

Acting Ranking Minority Member

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

ELISE J. BEAN

Staff Director and Chief Counsel

DAN M. BERKOVITZ

Counsel

RACHEL E. SIEGEL

GAO Detailee

CHRISTOPHER J. BARKLEY

Staff Director to the Minority 

TIMOTHY R. TERRY

Counsel to the Minority 

7/15/09

Permanent Subcommittee on Investigations

199 Russell Senate Office Building – Washington, D.C. 20510 

Main Number: 202/224-9505

Web Address: www.hsgac.senate.gov [Follow Link to “Subcommittees,” to “Investigations”] 

EXCESSIVE SPECULATION

IN THE WHEAT MARKET
TABLE OF CONTENTS

I. EXECUTIVE SUMMARY ................................................. 1

A. Subcommittee Investigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

B. The Cash and Futures Markets for Wheat . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

C. Increasing Commodity Index Speculation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

D. Impact of Index Instruments on the Wheat Futures Market . . . . . . . . . . . . . . . . . . . . . . . 6

E. Undue Burden on Interstate Commerce ...................................... 9

F. Trading Limits on Index Traders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

G. Other Commodities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

H. Findings and Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

Findings of Fact . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

1. Excessive Speculation in Wheat . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

a. Index Traders Increased Futures Prices Relative to Cash Prices . . . . . . . . . . . . . 15

b. Index Traders Impeded Price Convergence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

c. Unwarranted Price Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

d. Undue Burden on Commerce . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

2. CFTC Waivers Facilitated Excessive Speculation . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

3. Inflated Futures Prices Affect Crop Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

4. Poor Data Impedes Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

1. Phase Out Existing Wheat Waivers for Index Traders . . . . . . . . . . . . . . . . . . . . . . . . 16

2. Take Further Action If Necessary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

3. Analyze Other Agricultural Commodities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

4. Strengthen Data Collection for Non-Agricultural Commodities . . . . . . . . . . . . . . . . 16

II. THE U.S. WHEAT MARKET . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

A. U.S. Wheat Production . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

B. Types of Wheat . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

C. U.S. Wheat Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

D. The Cash and Futures Markets for Wheat . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

1. Cash Markets for Wheat . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

2. Futures Markets for Wheat . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

E. Recent Trends in U.S. Wheat Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

1. Recent Price Increases and Volatility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

2. Effects of Commodity Price Spikes on Farmers and Grain Elevators . . . . . . . . . . . . 44

III. HEDGING AND SPECULATION IN THE FUTURES MARKETS . . . . . . . . . . . . . . . 50

A. Purposes of the Futures Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

B. Use of Hedging to Manage Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54

1. Hedging versus Speculation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54

2. Example of Hedging: The Grain Elevator . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

3. Importance of Convergence for Hedging . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

C. Key Market Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62

1. Basis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62

2. Price Spreads and “Carry” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
3. Pricing Trends in Carry and Inversion Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

D. Position Limits and Hedge Exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70

1. Position Limits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70

2. Hedge Exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72

IV. COMMODITY INDEXES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76

A. Commodity Index Trading in Agricultural Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

B. Components of a Commodity Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79

C. Three Types of Commodity Index Instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

D. Types of Commodity Index Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88

E. Commodity Index Rationale and Marketing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90

1. The Marketing of Commodity Index Instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . 90

2. Critical Analyses of Index Instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

F. Exemptions from Speculative Position Limits for Commodity Index Trading . . . . . . . . 104

V. IMPACT OF INDEX TRADING ON THE WHEAT MARKET . . . . . . . . . . . . . . . . . . 113

A. Pricing Breakdown in the Wheat Futures Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114

B. The Role of Index Trading in Wheat Pricing Problems . . . . . . . . . . . . . . . . . . . . . . . . . . 120

1. Index Trading and Pricing Trends in the Wheat Market . . . . . . . . . . . . . . . . . . . . . . 120

a. Volume of Index Trading in the Wheat Market . . . . . . . . . . . . . . . . . . . . . . . . . . 120

b. Impact of Index Trading on Short-Term Futures Price Spreads . . . . . . . . . . . . . . 124

c. Impact of Index Trading on Longer-Term Price Spreads . . . . . . . . . . . . . . . . . . . 129

2. Subcommittee Interviews with Market Participants . . . . . . . . . . . . . . . . . . . . . . . . . . 137

3. Testimony Presented to the CFTC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140

4. Recent Market Analyses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143

5. Basic Futures Market Theory: Impact of Speculation on Price . . . . . . . . . . . . . . . . . 152

VI. FUTURES PRICES AND CROP INSURANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158

A. Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158

1. Development of the Federal Crop Insurance Program . . . . . . . . . . . . . . . . . . . . . . . . 158

2. How the Program Works . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160

3. Inadequate Program Oversight . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161

B. Impact of Futures Prices on Crop Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162

1. Increased Insurance Premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164

2. Inaccurate Insurance Payouts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 166

3. Impact of Divergent Futures and Cash Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169

APPENDIX (Exhibits and Charts) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171

 

# # #
1

EXCESSIVE SPECULATION

IN THE WHEAT MARKET

I. EXECUTIVE SUMMARY

For several years, the U.S. Senate Permanent Subcommittee on Investigations has 

been examining the role of speculation in the commodity markets and failures of the 

federal regulatory structure to prevent excessive speculation from causing unwarranted 

changes in commodity prices and an undue burden on interstate commerce. 

In 2006, the Subcommittee released a report showing how the injection of billions 

of dollars from speculation into the commodity futures markets had contributed to rising 

energy prices.

1

 In 2007, the Subcommittee released a report and held a hearing showing 

how excessive speculation by a single hedge fund named Amaranth had distorted natural 

gas prices and contributed to higher costs for natural gas consumers. 2

 1

In its 2006 Report, “The Role of Market Speculation in Rising Oil and Gas Prices: A Need to Put the Cop 

Back on the Beat,” S. Prt. 109-65 (June 27, 2006), the Subcommittee investigation found that influx of 

billions of dollars into the U.S. energy markets through commodity index funds had contributed to the rise 

in energy prices, and that the large influx of speculative investments in these markets had altered the 

traditional relationships between futures prices and supplies of energy commodities, particularly crude oil. 

The Report recommended that Congress enact legislation to “close the Enron loophole,” the provision in 

the Commodity Futures Modernization Act of 2000 (CFMA), which exempted from regulation the trading 

of futures contracts and swaps for energy and metals commodities on electronic exchanges. It also 

recommended legislation to ensure the CFTC had sufficient authority to monitor U.S. traders trading in 

U.S. commodities on foreign exchanges. See the 2006 Subcommittee Report at 

 These and other 

reports offered a number of recommendations for legislative and regulatory actions to 

enable the Commodity Futures Trading Commission (CFTC) to fulfill its mission under 

the Commodity Exchange Act to prevent excessive speculation from “causing 

unreasonable or unwarranted fluctuations in the price of commodities in interstate 

commerce.” 

http://hsgac.senate.gov/public/_files/SenatePrint10965MarketSpecReportFINAL.pdf. 

2 In its 2007 Report, “Excessive Speculation in the Natural Gas Market,” reprinted in S. Hrg. 110-235 (June 

25 and July 9, 2007), at pp. 196-710, the Subcommittee investigation found that Amaranth had distorted the 

price of natural gas futures contracts as a result of its large purchases of contracts on the regulated New 

York Mercantile Exchange (NYMEX) and “look-alike” swap contracts on the then-unregulated 

Intercontinental Exchange (ICE). As a result of several provisions in the CFMA, the CFTC did not have 

authority to limit the positions of traders using ICE rather than NYMEX. Based on this finding, the Report 

recommended that Congress enact legislation to close the Enron loophole in order to fully regulate 

electronic exchanges, like ICE, that are the functional equivalent of futures markets. In the 2008 Farm Bill, 

Congress enacted legislation to close the Enron loophole by providing that commodity contracts traded on 

over-the-counter electronic exchanges that perform a significant price discovery function be regulated in 

the same manner as futures contracts. As a result of this legislation, the CFTC now has the authority – and 

responsibility – to regulate and monitor these electronic markets to prevent excessive speculation. See the 

2007 Subcommittee Report at 

http://hsgac.senate.gov/public/_files/REPORTExcessiveSpeculationintheNaturalGasMarket.pdf. 
2

In the Amaranth investigation, the Subcommittee examined how the activities of a 

single trader making large trades on both a regulated futures exchange and an unregulated 

electronic energy exchange constituted excessive speculation in the natural gas market. 

To prevent this type of excessive speculation, the Subcommittee Report recommended 

that limits on the number of contracts that a trader can hold at one time, known as 

position limits, be applied consistently to both markets in which the same type of natural 

gas contracts are traded. 

In the current investigation, the Subcommittee has examined how the activities of 

many traders, in the aggregate, have constituted excessive speculation in the wheat 

market. To prevent this type of excessive speculation, this Report recommends that the 

CFTC phase out waivers and exemptions from position limits that were granted to

commodity index traders purchasing wheat contracts to help offset their sales of 

speculative financial instruments tied to commodity indexes. 

A commodity index, like an index for the stock market, such as the Dow Jones 

Industrial Average or the S&P 500, is calculated according to the prices of selected 

commodity futures contracts which make up the index. Commodity index traders sell 

financial instruments whose values rise and fall in tune with the value of the commodity 

index upon which they are based. Index traders sell these index instruments to hedge 

funds, pension funds, other large institutions, and wealthy individuals who want to invest 

or speculate in the commodity market without actually buying any commodities. To 

offset their financial exposure to changes in commodity prices that make up the index and 

the value of the index-related instruments they sell, index traders typically buy the futures 

contracts on which the index-related instruments are based. It is through the purchase of 

these futures contracts that commodity index traders directly affect the futures markets.

The Subcommittee investigation examined in detail how commodity index traders 

affected the price of wheat contracts traded on the Chicago Mercantile Exchange. CFTC 

data shows that, over the past three years, between one-third and one-half of all of the 

outstanding wheat futures contracts purchased (“long open interest”) on the Chicago 

exchange are the result of purchases by index traders offsetting part of their exposure to 

commodity index instruments sold to third parties. The Subcommittee investigation 

evaluated the impact that the many purchases made by index traders had on prices in the 

Chicago wheat futures market. This Report finds that there is significant and persuasive

evidence to conclude that these commodity index traders, in the aggregate, were one of 

the major causes of “unwarranted changes” – here, increases – in the price of wheat 

futures contracts relative to the price of wheat in the cash market. The resulting unusual, 

persistent, and large disparities between wheat futures and cash prices impaired the 

ability of participants in the grain market to use the futures market to price their crops and 

hedge their price risks over time, and therefore constituted an undue burden on interstate 

commerce. Accordingly, the Report finds that the activities of commodity index traders, 

in the aggregate, constituted “excessive speculation” in the wheat market under the 

Commodity Exchange Act. 

The futures market for a commodity provides potential buyers and sellers of the 

commodity with prices for the delivery of that commodity at specified times in the future. 

In contrast, the cash market provides potential buyers and sellers with the price for that
3

commodity if it is delivered immediately. Normally, the prices in the futures market 

follow a predictable pattern with respect to the cash price for a commodity. Typically, as 

a contract for future delivery of a commodity gets closer to the time when the commodity 

is to be delivered under the contract (the expiration of the contract), the price of the

futures contract gets closer to the price of the commodity in the cash market. The prices 

are said to “converge.” In recent years in the wheat market, however, the futures prices 

for wheat have remained abnormally high compared to the cash prices for wheat, and the 

relationship between the futures and cash prices for wheat has become unpredictable. 

Oftentimes the price of wheat in the Chicago futures market has failed to converge with 

the cash price as the futures contracts have neared expiration. 

The result has been turmoil in the wheat markets. At a time when wheat farmers 

were already being hit by soaring energy and fertilizer costs, the relatively high price of 

wheat futures contracts compared to the cash price, together with the breakdown in the 

relationship between the two prices and their failure to converge at contract expiration, 

have severely impaired the ability of farmers and others in the grain business to use the 

futures markets as a reliable guide to wheat prices and to manage price risks over time. 

Participants in the grain industry have complained loudly about the soaring prices 

and breakdowns in the market. “Anyone who tells you they’ve seen something like this 

is a liar,” said an official of the Farmers Trading Company of South Dakota. An official 

at cereal-maker Kellogg observed, “The costs for commodities including grains and 

energy used to manufacture and distribute our products continues to increase 

dramatically.” “I can’t honestly sit here and tell who is determining the price of grain,” 

said one Illinois farmer, “I’ve lost confidence in the Chicago Board of Trade.” “I don’t 

know how anyone goes about hedging in markets as volatile as this,” said the president of 

MGP Ingredients which provides flour, wheat protein, and other grain products to food 

producers. “These markets are behaving in ways we have never seen,” said a senior 

official from Sara Lee. A grain elevator manager warned, “Eventually, those costs are 

going to come out of the pockets of the American consumer.”

The inability of farmers, grain elevators, grain merchants, grain processors, grain 

consumers, and others to use the futures market as a reliable guide to wheat prices and to 

manage their price risks over time has significantly aggravated their economic difficulties

and placed an undue burden on the grain industry as a whole. 

This Report concludes there is significant and persuasive evidence that one of the 

major reasons for the recent market problems is the unusually high level of speculation in 

the Chicago wheat futures market due to purchases of futures contracts by index traders 

offsetting sales of commodity index instruments. To diminish and prevent this type of 

excessive speculation in the Chicago wheat futures market, the Report recommends that 

the CFTC phase out existing exemptions and waivers that allow some index traders to 

operate outside of the trading limits designed to prevent excessive speculation. 

A. Subcommittee Investigation

To prepare this Report, the Subcommittee conducted a year-long, bipartisan 

investigation. As a first step, the Subcommittee obtained and analyzed price and trading 
4

data from a variety of agricultural futures and cash markets. The Subcommittee obtained, 

for example, daily and monthly wheat futures and cash price data from the CFTC, U.S. 

Department of Agriculture, Chicago Mercantile Exchange, Kansas City Board of Trade, 

and Minneapolis Grain Exchange. The Subcommittee also examined numerous historical 

materials on the operations and performance of the grain futures markets, and on the 

development and application of relevant statutes, regulations, and guidance. The CFTC 

provided extensive data on index trading, as well as information on the application of 

position limits and the granting of exemptions. The Subcommittee appreciates the 

cooperation and responsiveness of the exchanges and federal agencies. 

To understand the issues, the Subcommittee interviewed numerous experts and 

persons familiar with the wheat markets, agricultural commodity markets as a whole, and 

commodity indexes. The interviews included persons familiar with grain trading and 

actual traders from a wide range of organizations in the grain industry: farm 

organizations, grain elevator operators, grain merchants, grain processors, food 

manufacturers, and agricultural trade groups. The Subcommittee also interviewed 

farmers, market analysts, agricultural economists, academic experts, financial 

institutions, and exchange officials. The Subcommittee also benefited from a number of 

meetings and presentations provided by the CFTC. The Subcommittee appreciates the 

cooperation and assistance of these individuals, organizations, and agencies. 

B. The Cash and Futures Markets for Wheat

Wheat crops change hands primarily through cash transactions. There is no 

centralized cash market for wheat or other grains; the cash market exists wherever a grain 

elevator, grain merchant, grain consumer, or other participant in the grain industry posts a 

price to purchase or sell grain. Cash transactions take place all over the country, at all 

times of the day, either with or without the use of standardized contracts. In a common 

transaction, a grain elevator purchases wheat from a farmer for cash and then stores the 

wheat for sales throughout the year to grain processors. 

Wheat futures are sold on three regulated exchanges: the Chicago Mercantile 

Exchange (CME), the Kansas City Board of Trade (KCBOT), and the Minneapolis Grain 

Exchange (MGEX). Wheat traded on the Chicago exchange, known as “soft red winter” 

wheat, is used mainly for crackers, pie crusts, cakes, and biscuits. Wheat traded in 

Kansas City, known as “hard red winter” wheat, is primarily used to make flour for 

bread. The Minneapolis exchange trades “hard red spring” wheat, which also is used to 

make bread, biscuits, and rolls. 

All three of these futures exchanges offer standardized contracts to buy or sell 

standard amounts and types of wheat for which the only negotiated variable is the price. 

In the vast majority of cases, traders of wheat futures contracts do not take physical 

delivery of the wheat being bought or sold on the futures market. Rather, the primary 

purpose of the futures market is to enable market participants to “discover” the price of 

wheat for delivery at specified times in the future, to purchase or sell such contracts for 

future delivery at such prices, and thereby to enable wheat market participants to protect

their business activities against the risk of future price changes.
5

C. Increasing Commodity Index Speculation

A commodity index is calculated using the prices of the futures contracts for the 

commodities that make up the index. Each commodity within a commodity index is 

assigned a “weight,” and the contribution of each commodity toward the value of the 

index is calculated by multiplying the current price of the specified futures contract for 

that commodity by the assigned weight. All of the major, broad-based commodity 

indexes include soft red winter wheat futures contracts traded on the Chicago exchange 

as one of their component commodities. 

The purchase of a financial instrument whose value is linked to a commodity 

index offers the buyer the potential opportunity to profit from the price changes in futures 

contracts for a broad spectrum of commodities, without having to actually purchase the 

referenced commodities. Typically, hedge funds, pension funds, and other large 

institutions purchase these financial instruments with the aim of diversifying their 

portfolios, obtaining some protection against inflation, and profiting when commodity 

prices are rising. Since they are not involved in selling or buying actual commodities, 

and do not use these instruments to hedge or offset price risks regarding the actual use of 

the underlying commodities, the purchasers of commodity index instruments are making

a speculative investment. 

The large growth in commodity index speculation is a recent phenomenon. It is

only over the past six years that financial institutions have heavily marketed commodity 

index instruments as a way to diversify portfolios and profit from rising commodity 

prices. The total value of the speculative investments in commodity indexes has 

increased an estimated tenfold in five years, from an estimated $15 billion in 2003, to 

around $200 billion by mid-2008.3

The amount of speculation in the wheat market due to sales of commodity index

instruments has, correspondingly, grown significantly over the past five years. CFTC

data indicates that purchases by index traders in the largest wheat futures market, the 

Chicago Mercantile Exchange, grew sevenfold from about 30,000 daily outstanding 

contracts in early 2004, to a peak of about 220,000 contracts in mid-2008, before 

dropping off at year’s end to about 150,000 contracts. (Figure ES-1). The data shows 

that, during the period from 2006 through 2008, index traders held between 35 and 50% 

of the outstanding wheat contracts (open long interest) on the Chicago exchange and 

between 20 and 30% of the outstanding wheat contracts on the smaller Kansas City 

Board of Trade. 

The presence of index traders is greatest on the Chicago exchange compared to 

the other two wheat exchanges, and is among the highest in all agriculture markets. In 

addition, neither of the other two wheat markets, nor any other grain market, has 

experienced the same degree of breakdown in the relationship between the futures and 

cash markets as has occurred in the Chicago wheat market. Accordingly, the 

 3 This estimate reflects both the actual amounts invested in commodity index related instruments and the 

appreciation in value of those investments due to increasing commodity prices. 
6

Subcommittee focused its investigation on the role of index trading on the Chicago 

exchange and the breakdown in the relationship between Chicago wheat futures and cash 

prices. 

Outstanding Chicago Wheat Futures Contracts

Purchased by Index Traders 

2004 - 2009

0

50

100

150

200

250

Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09

thousands of 

contracts

Long open interest due to index 

traders

Figure ES-1. Growth in index fund purchases of Chicago wheat futures contracts. Chart 

prepared by Permanent Subcommittee on Investigations. Data source: CFTC. 

D. Impact of Index Instruments on the Wheat Futures Market

Commodity indexes have an indirect but significant impact on futures markets. A 

commodity index standing alone is a computational device unsupported by any actual 

assets such as futures or commodity holdings. Financial institutions that sell index 

investments, however, have created three basic types of financial instruments tied to 

commodity indexes: commodity index swaps, exchange traded funds (ETFs), and 

exchange traded notes (ETNs). Commodity index swaps are sold by swap dealers and 

are the most common index instrument; ETFs and ETNs offer index-related shares for 

sale on a stock exchange. The value of commodity index swaps, index-related ETFs, and 

index-related ETNs rises and falls with the value of the commodity index upon which 

each is based. 

Speculators who buy index instruments do not themselves purchase futures 

contracts. But the financial institutions who sell them the index instruments typically do. 

In the case of commodity index swaps, for example, swap dealers typically purchase 

futures contracts for all commodities on which an index is based to offset their financial

exposure from selling swaps linked to those futures contracts. CFTC data shows that,
7

over the past five years, financial institutions selling commodity index instruments have 

together purchased billions of dollars worth of futures contracts on the Chicago 

Mercantile Exchange. 

The Subcommittee investigation has found that the large number of wheat futures 

contracts purchased by swap dealers and other index traders is a prime reason for higher 

prices in the wheat futures market relative to the cash market. Commodity traders call 

the difference between the futures prices and the cash price “the basis.” Index traders 

typically do not operate in the cash market, since they have no interest in taking delivery 

or making use of a wheat crop. Instead, index traders operate in the futures markets, 

where they buy futures contracts to offset the index instruments they have sold. The 

additional demand for wheat futures resulting from these index traders is unrelated to the 

supply of and demand for wheat in the cash market. 

In the Chicago wheat market, the result has been wheat futures prices that are

increasingly disconnected from wheat cash prices. Data compiled by the Subcommittee 

shows that, since 2006, the daily gap between Chicago wheat futures prices and wheat 

cash prices (the basis) has been unusually large and persistent. Figure ES-2 presents this 

data for the last eight years. 

Chicago Wheat Prices

Daily Difference Between Futures and Cash Price

(Basis)

-50

0

50

100

150

200

250

Jan-00Jan-01Jan-02Jan-03Jan-04Jan-05Jan-06Jan-07Jan-08

cents/bu.

Figure ES-2. Increase in daily difference between futures and cash prices for Chicago wheat. 

Chart prepared by Permanent Subcommittee on Investigations. Data sources: CME (daily futures 

prices); MGEX (average daily cash prices).

From 2000 through 2005, the average daily difference between the average cash 

and the futures price for soft red winter wheat traded on the Chicago exchange was about 

25 cents. During the second half of 2008, in contrast, the price of the nearest wheat 

futures contract on the Chicago exchange was between $1.50 and $2.00 per bushel higher 
8

than the average cash price, an unprecedented price gap (basis).

4

In addition, increasingly, the wheat futures prices on the Chicago exchange have 

not converged with the cash prices at the expiration of the futures contracts. Figure ES-3

shows the extent of this price gap (basis).

 During that period, the 

average cash price for soft red winter wheat ranged from $3.12 to $7.31 per bushel, while 

the futures price ranged from $4.57 to $9.24. The fundamentals of supply and demand in 

the cash market alone cannot explain this unprecedented disparity in pricing between the 

futures and cash markets for the same commodity at the same time. 

 

0.00

0.50

1.00

1.50

2.00

Mar-05 Mar-06 Mar-07 Mar-08

Chicago Wheat Prices

Difference Between Futures Price and Cash Price 

in Chicago at Contract Expiration $/bushel

Figure ES-3. Increase in difference between futures and cash prices for Chicago wheat at futures 

contract expiration. Chart prepared by Permanent Subcommittee on Investigations. Data sources: 

CME (daily futures prices) and USDA (cash prices at Chicago).

The data underlying this chart shows that the average difference between the cash 

and futures price at contract expiration at the delivery location in Chicago for the Chicago 

wheat futures contract rose from an average of about 13 cents per bushel in 2005 to 34 

cents in 2006, to 60 cents in 2007, to $1.53 in 2008, a tenfold increase in four years. 

In the same period during which these pricing disparities occurred, CFTC data 

shows a very large presence of index traders in the Chicago wheat market. Since 2006, 

index traders have held between one-third and one-half of all of the outstanding 

purchased futures contracts (“long open interest”) for wheat on the Chicago exchange. 

For most of 2008, the demand for Chicago wheat futures contracts from these index 

investors was greater than the supply of wheat futures contracts from commercial firms 

 4 Typically, traders define basis as the difference between the cash and futures price (basis = cash –

futures). In this Report, the basis is defined as the difference between the futures and cash price (basis = 

futures – cash) in order to give a positive value to the basis when the futures price is higher than the cash 

price, as it typically is in the wheat market. 
9

selling grain for future delivery. During July 2008, for instance, index traders buying 

wheat futures contracts held, in total, futures contracts calling for the delivery of over 1 

billion bushels of wheat, while farmers, grain elevators, grain merchants, and other

commercial sellers of wheat had outstanding futures contracts providing for the delivery 

of a total of only about 800 million bushels of wheat. Under these circumstances, the

additional demand from index traders for contracts for future delivery of wheat bid up the 

futures prices until prices were high enough to attract additional speculators willing to 

sell the desired futures contracts at the higher prices. 

The investigation found that, in 2008, the greater demand for Chicago wheat 

futures contracts generated by index traders was a significant factor in the relative 

increase in the wheat futures price compared to the cash price (the basis) during that 

period. In addition, a significant cause of the resulting price disparity between the futures 

and cash markets, which was far greater than the normal gap between futures and cash 

prices, was the purchases of Chicago wheat futures by index traders. 

E. Undue Burden on Interstate Commerce

The ongoing pricing discrepancy between wheat futures and cash market prices 

has exacerbated many of the recent economic difficulties facing farmers, grain elevators, 

grain merchants, and grain end-users. 

Over the past few years, the prices of many agricultural commodities – like the 

prices of commodities in general – experienced an unprecedented spike and subsequent 

collapse. For example, the cash price of wheat rose from just over $3 per bushel in mid2006, to over $11 per bushel in early 2008, before collapsing to about $3.50 per bushel at 

the end of 2008. Figure ES-4 shows the average daily cash price of wheat from 2000 to 

2008, including the spike in the price of wheat during 2007 and 2008. 
10

Daily Cash Price of Wheat

(Soft Red Winter Wheat)

2000-08 

0

2

4

6

8

10

12

14

Jan-00Jan-01Jan-02Jan-03Jan-04Jan-05Jan-06Jan-07Jan-08

$/bushel

Figure ES-4. The average daily cash price of soft red winter wheat, the type of wheat traded on 

the Chicago Mercantile Exchange. Chart prepared by Permanent Subcommittee on Investigations. 

Data source: MGEX (daily cash index price).

A wide variety of factors contributed to the price volatility in the cash market for 

wheat, including poor weather, changes in agricultural productivity, an increasing 

demand for commodities in developing countries, changing dietary habits, increasing 

energy prices, and changes in the value of the dollar compared to other currencies. 

Wheat prices in the cash market rose steadily from 2004 to 2008, in part due to

steep increases in the price of energy, particularly oil, gasoline, natural gas, and diesel 

fuel, which sharply increased the costs of farming, transporting grain to markets, and 

grain processing. Although grain prices in the cash market eventually rose to record 

highs, farmers and grain merchants often were unable to realize the benefits of those 

higher prices due to the higher costs. In March 2009, for example, USDA reported that 

although wheat was selling for very high prices by historical standards, the increase in 

fuel and fertilizer costs had “offset this unprecedented runup in wheat prices for 

producers.” 

During this same period, futures prices also rose. The steep increases in cash and 

futures prices severely affected the grain industry in several ways. First, higher futures 

prices resulted in higher margin calls for wheat farmers, grain elevators, and other sellers 

of wheat that had hedged in the futures markets, requiring them to make much larger cash 

outlays than normal. The National Grain and Feed Association estimated, for example, 

that a typical grain elevator faced a 300% increase in hedging costs in 2008, compared to 

2006. It stated that “recent commodity price increases have led to unprecedented 

borrowing by elevators – and unprecedented lending by their bankers – to finance 

inventory and maintain hedge margins.” According to the Federal Reserve Bank of 

Kansas City, in the first quarter of 2008, the Farm Credit System “raised $10 billion in 
11

funds through the sale of debt securities to meet increasing demand from elevators and 

other processing and marketing entities.” In April 2008, the Federal Reserve Bank of 

Kansas City reported that nearly one-quarter of all grain elevators it surveyed were 

struggling to acquire the cash needed to manage margin calls; about 40% stated they had 

“enough cash to just manage current margin calls.” 

The cash flow problems confronting many grain elevators directly affected 

farmers, as those elevators began to reduce their cash purchases, pull back on forward 

contracts offered to farmers, and lower the cash prices offered for crops. Some began to 

require farmers to pre-pay for seed and fertilizer, causing cash flow problems for farming 

operations. Farmers participating directly in the futures market also were subject to

rising margin calls. One wheat farmer explained, “If you’ve got 50,000 bushels hedged 

and the market moves up 20 cents, that would be a $10,000 day. If you only had $10,000 

in your margin account, you’d have to sit down and write a check. You can see $10,000 

disappear overnight. . . . Everybody has a story about a guy they know getting blown out 

of his hedge.”

Other problems arose from the unusually large and persistent gap between the 

futures and cash prices for wheat and the failure of the two prices to converge as futures 

contracts expired. This persistent pricing difference and lack of convergence meant that 

farmers, grain elevators, grain merchants, and others who had used the futures market to 

hedge their future sales found that when they went to sell their wheat, the cash prices 

were much lower than they had anticipated based upon the futures market. This

persistent price gap significantly impaired the ability of farmers and others to protect 

themselves from declining prices during the dramatic price decreases experienced during

the second half of 2008. It also meant that wheat industry participants could no longer 

rely on the futures markets to reliably price their crops and effectively manage their price 

risks over time. 

In a properly functioning futures market, futures and cash prices converge as 

futures contracts near expiration. Otherwise, if one price were higher, a trader could buy 

the commodity in the lesser-priced market and immediately sell it in the higher-priced 

market for a quick profit. Those types of transactions would soon equalize the two 

prices. But on many occasions during the last few years in the Chicago wheat market, the 

two prices have not converged. 

One key reason is that the large price disparity between the cash and futures price 

makes it much more profitable for grain merchants to buy grain in the cash market, hold 

onto it, and then sell it later – at the price of the higher-priced futures contracts – than 

engage in the type of transactions described above between the cash and futures market 

that would make the two prices converge. In addition, the large price disparity means 

that merchants who already have grain in storage and have hedged that grain by selling 

futures contracts could suffer a loss if they decided to actually sell their grain in the cash 

market, because they also would have to buy back the futures contract at a higher price 

than they could get for selling their grain in the cash market. 

Virtually all of the traders interviewed by the Subcommittee, from all perspectives

within the grain business, identified the large presence of index traders in the Chicago 
12

market as a major cause of the price convergence problem. This ongoing problem

indicates that at a fundamental level the Chicago wheat futures market no longer 

effectively serves the needs of many wheat growers or commercial wheat users.

Still another set of problems caused by excessive speculation in the wheat market 

and the disconnect between wheat futures and cash prices affects the federal crop 

insurance program. Federal crop insurance, which is supported with taxpayer dollars, is 

available to farmers who want to cover potential financial losses due to bad weather or 

crop disease. Several types of federal crop insurance use futures prices to determine how 

much money should be paid to a farmer who has purchased coverage and suffered a loss

in crop income. Futures prices are used in the formulas that calculate both the insurance 

premiums to be paid by farmers and the indemnity payments made to farmers after an 

insurance claim. Because they are included in the calculations, futures market prices that 

are significantly higher than actual cash prices impair the accuracy of the insurance 

formulas and can inflate the final figures. Futures prices that are much higher than the 

prices in the cash market and that do not closely follow the prices in the cash market can 

increase both the crop insurance premiums paid in part by farmers and can either increase 

or decrease the ultimate insurance payout to the farmer – thereby either resulting in too 

large a payout from a taxpayer-funded program or too small a payout to the farmer who 

has paid for the insurance. Either scenario undermines the effectiveness of the crop 

insurance program. 

The ongoing large gap between wheat futures prices and cash prices is a problem 

of intense concern to the wheat industry, the exchanges, and the CFTC. The CFTC has 

conducted several public hearings and recently formed a special advisory subcommittee 

to make recommendations on how best to address the problem. The Chicago exchange 

has amended its wheat contract in several respects – to provide for additional delivery 

locations, to increase the storage rate for wheat, and to change certain specifications for 

deliverable wheat – in an effort to improve trading and create a more active cash market 

that will force cash and futures prices to converge. 

These actions to date, however, do not address one of the fundamental causes of 

the problem – the large presence of index traders in the Chicago wheat market. These 

index traders, who buy wheat futures contracts and hold them without regard to the 

fundamentals of supply and demand in the cash market for wheat, have created a 

significant additional demand for wheat futures contracts that has as much as doubled the 

overall demand for wheat futures contracts. Because this significant increase in demand 

in the futures market is unrelated to any corresponding supply or demand in the cash 

market, the price of wheat futures contracts has risen relative to the price of wheat in the 

cash market. The very large number of index traders on the Chicago exchange has, thus,

contributed to “unwarranted changes” in the prices of wheat futures relative to the price 

of wheat in the cash market. These “unwarranted changes” have, in turn, significantly 

impaired the ability of farmers and other grain businesses to price crops and manage price 

risks over time, thus creating an undue burden on interstate commerce. The activities of 

these index traders constitute the type of excessive speculation that the CFTC should 

diminish or prevent through the imposition and enforcement of position limits as intended 

by the Commodity Exchange Act. 
13

F. Trading Limits on Index Traders

The Commodity Exchange Act (CEA) directs the CFTC to prevent excessive 

speculation in the futures markets. Specifically, Section 4a(a) of the CEA requires the 

CFTC to establish and maintain “position limits” on commodity traders to prevent the 

undue burden on interstate commerce that results from “sudden or unreasonable 

fluctuations or unwarranted changes” in the price of a commodity caused by excessive 

speculation. Pursuant to this statutory mandate, the CFTC has established position limits 

for the agricultural commodities traded on futures markets such as wheat, corn, oats, and 

soybeans. These position limits specify the maximum number of outstanding futures 

contracts that any single trader can hold at any particular time. For example, the CFTC 

has generally prohibited any single trader from holding more than 6,500 wheat futures 

contracts at any one time. Prior to 2005, the maximum number of contracts that could be 

held at any one time was 5,000 contracts. 

Over the course of many years, the CFTC has made a number of decisions that

have enabled certain index traders to hold more than the current limit of 6,500 wheat 

futures contracts. The first set of decisions resulted in the CFTC’s granting position limit 

exemptions to swap dealers selling commodity index swaps. Although the CEA directs 

the CFTC to impose trading limits to prevent excessive speculation, section 4a(c) of the 

Act also states that these limits are not to be applied to “transactions or positions which 

are shown to be bona fide hedging transactions or positions.” The CEA provides the 

CFTC with the discretion to define the term “bona fide hedging transaction” in order to 

“permit producers, purchasers, sellers, middlemen, and users of a commodity or a product 

derived therefrom to hedge their legitimate anticipated business needs for that period of 

time into the future for which an appropriate futures contract is open and available on an 

exchange.” 

Initially, the CFTC limited the concept of a bona fide hedging transaction to 

transactions directly linked to the business needs of the producers, marketers, and users 

of a physical commodity in the cash market. But after Congress directed the CFTC, in 

1986, to consider expanding its definition to include persons using the futures markets to 

manage risks associated with financial investment portfolios, the CFTC issued a series of 

clarifications and interpretations which, in effect, expanded the definition to include

trading strategies to reduce financial risks, regardless of whether a matching transaction 

ever took place in a cash market for a physical commodity. 

In 1991, using this expanded definition, the CFTC granted the first exemption 

from speculative trading limits to a swap dealer seeking to buy futures contracts to hedge 

its financial exposure to commodity index swaps it had sold to third parties. According 

to CFTC data provided to the Subcommittee, the CFTC has currently issued four hedge

exemptions to swap dealers seeking to buy wheat futures. Those exemptions permit the 

swap dealers to exceed the 6,500 position limit and hold up to 10,000, 17,500, 26,000, 

and 53,000 wheat futures contracts to hedge their exposures to commodity index swaps 

that reference wheat futures prices. In addition, in 2006, the CFTC staff took another 

step by issuing two “no-action” letters permitting the manager of one index-related 

exchange traded fund (ETF) to hold up to 11,000 wheat futures contracts and another 

fund manager to hold up to 13,000 wheat futures contracts. 
14

Together, these hedge exemptions and no-action letters permit six index traders to 

hold a total of up to almost 130,000 wheat futures contracts at any one time. Absent 

these waivers from the position limits, these six index traders would have been limited to 

a total of about 39,000 wheat futures contracts at a time, or less than one-third of the 

contracts that they are now permitted to hold. 

CFTC data indicates that, from 2006 to mid-2008, the total number of 

outstanding contracts (long open interest) attributable to commodity index traders 

in the wheat market was about 200,000 contracts. That means that the six index 

traders granted waivers from the trading limits may have held up to about 60% of 

all the outstanding wheat contracts held by index traders. 

In directing the CFTC to consider granting position limit exemptions to firms 

using the futures markets to manage price risks associated with financial portfolios, 

Congress emphasized that the Commission’s actions should remain consistent with its 

mandate to prevent excessive speculation from causing unreasonable or unwarranted 

changes in the prices of commodities traded on the futures exchanges. Because the large 

amount of index investments in the Chicago wheat futures market have been one of the 

major causes of “unreasonable or unwarranted” changes in wheat futures prices relative 

to cash prices, the granting of exemptions and waivers to index traders is inconsistent 

with the CFTC’s statutory mandate to prevent excessive speculation on futures 

exchanges. Accordingly, the Report recommends that the CFTC no longer waive 

position limits for index traders and, in addition, begin an orderly phase-out of the 

existing waivers. 

If the CFTC were to phase out the exemptions and waivers granted to index 

traders in the wheat market, those traders would become subject to the position limits for 

wheat futures contracts that generally apply and would be unable to hold more than 6,500 

wheat contracts at any one time. The strict enforcement of the 6,500 contract limit 

should reduce the presence of index traders in the Chicago wheat futures market and help

bring the futures market into better alignment with the cash market. 

Restoring the 6,500 position limit to index traders may not, however, fully solve 

the pricing problems in the Chicago wheat futures market and eliminate the problems in 

the market exacerbated by excessive speculation. CFTC data indicates that at most 60% 

of the total outstanding wheat contracts (long open interest) which can be attributed to 

index investors would be affected by restoring the 6,500 limit. If pricing problems persist 

in the wheat market after the phase-out of these waivers, and after implementation of 

other actions being taken by the Chicago exchange, the CFTC should consider imposing

additional restrictions on index traders to reduce their presence, such as by restoring the 

pre-2005 position limit of 5,000 wheat contracts per index trader to reduce their

aggregate impact on wheat futures prices. 

G. Other Commodities 

The wheat market illustrates how a large amount of index trading on a futures 

exchange can significantly impair the ability of the futures market to perform its primary 

purposes – to enable commercial market participants, including farmers, grain elevators, 
15

grain merchants, and consumers, to efficiently price their commodities and manage their 

price risks over time. The Subcommittee investigation was made possible in large part 

by the availability of data compiled by the CFTC on index trading in the wheat market. 

Comparable data on index trading in non-agricultural markets, including for crude oil, 

natural gas, and other energy commodities, is not presently available. The data problem 

is due in part to the complexity of the over-the-counter (OTC) energy market, the 

associated difficulty in tracing index trading in that market, and the difficulty in assessing 

the impact of OTC energy trades on regulated energy futures exchanges. To understand 

the role of index trading in energy and other non-agricultural commodity markets, the 

CFTC will need to improve its data collection and analysis efforts for both the OTC 

markets and index trading. Given the importance of this issue, despite the difficulties, the 

CFTC should undertake this effort to bring additional transparency to the impact of index 

trading on energy futures markets. 

H. Findings and Recommendations 

Based upon the Subcommittee’s investigation, the Report makes the following 

findings of fact and recommendations to diminish or prevent excessive speculation in the 

wheat market.

Findings of Fact.

(1) Excessive Speculation in Wheat. The large number of wheat futures 

contracts purchased and held by commodity index traders on the Chicago futures 

exchange over the last five years constituted excessive speculation. 

(a) Index Traders Increased Futures Prices Relative to Cash Prices. 

The large number of wheat futures contracts purchased by index traders on 

the Chicago exchange created additional demand for those contracts and 

was a major contributing factor in the increasing difference between wheat 

futures prices and cash prices from 2006 to 2008. 

(b) Index Traders Impeded Price Convergence. Over the past few 

years, the large number of Chicago wheat futures contracts purchased by 

index investors has been a major cause of the frequent failure of wheat 

futures and cash prices to converge upon contract expiration. 

(c) Unwarranted Price Changes. The additional demand for Chicago 

wheat futures contracts attributable to commodity index traders contributed to “unreasonable fluctuations or unwarranted changes” in wheat futures 

prices, resulting in an abnormally large and persistent gap between wheat 

futures and cash prices (the basis). Largely as a result of index trading, the 

average difference between the cash and futures price at contract 

expiration rose from 13 cents per bushel in 2005, to 34 cents in 2006, to 

60 cents in 2007, to $1.53 in 2008, a tenfold increase in four years. 

(d) Undue Burden on Commerce. The unwarranted changes in wheat 

prices resulting from the large amount of index trading in the Chicago 

wheat futures market created an undue burden on interstate commerce. 
16

This undue burden was imposed on farmers, grain elevators, grain 

merchants, grain processors, and others by impeding useful hedging 

strategies, imposing significant unanticipated costs, and providing 

inaccurate indications of expected prices in the wheat markets. 

(2) CFTC Waivers Facilitated Excessive Speculation. CFTC actions to waive 

position limits for commodity index traders facilitated excessive speculation in 

the Chicago wheat futures market. Waiving position limits for these index traders 

is inconsistent with the CFTC’s statutory mandate to maintain position limits to 

prevent excessive speculation. 

(3) Inflated Futures Prices Affect Crop Insurance. Because federal crop 

insurance, which is backed with taxpayer dollars, uses futures prices in its 

calculations, inflated futures prices can inflate insurance premiums, whose cost is 

shared by farmers and taxpayers, and impair the accuracy of the formulas used to 

determine the payouts to farmers, resulting in either overpayments or 

underpayments. 

(4) Poor Data Impedes Analysis. There is a lack of adequate data on the 

number of futures contracts purchased by commodity index traders for nonagricultural commodities like crude oil. Improved data is essential to analyze the 

extent to which index traders may be contributing to higher futures prices and 

excessive speculation in crude oil and other markets. 

Recommendations. 

(1) Phase Out Existing Wheat Waivers for Index Traders. The CFTC should 

phase out existing waivers, granted through exemptions or no-action letters, 

which permit commodity index traders to exceed the standard limit of 6,500 

wheat contracts per trader at any one time, and re-apply the standard position limit 

designed to prevent excessive speculation in the wheat market. 

(2) Take Further Action If Necessary. If pricing problems in the Chicago 

exchange persist after the phase-out of index trader waivers and after 

implementation of other actions being taken by the Chicago exchange, the CFTC 

should consider imposing additional restrictions on commodity index traders to 

reduce excessive speculation, such as by imposing a position limit of 5,000 wheat 

contracts per index trader.

(3) Analyze Other Agricultural Commodities. The CFTC should undertake an 

analysis of other agricultural commodities to determine whether commodity index 

traders have increased futures prices compared to cash prices or caused price 

convergence problems, and whether position limit waivers for index traders 

should be phased out to eliminate excessive speculation.

(4) Strengthen Data Collection for Non-Agricultural Commodities. The 

CFTC should develop reliable data on the extent to which commodity index 

traders purchase non-agricultural commodity futures contracts, especially crude 

oil and other energy commodities. Once this data is collected, the CFTC should 
17

evaluate the impact of index trading in these markets, and whether position limits 

for index traders should be phased out to eliminate excessive speculation. 

The following sections of this Report present detailed information on how, in 

recent years, the high level of commodity index trading in the wheat market constituted 

excessive speculation. Section II describes the wheat futures and cash markets, and 

recent pricing trends that have caused turmoil among wheat producers, merchants, and 

consumers. Section III provides general information about hedging and speculation in 

the commodity markets, and why price convergence is important to commercial users of 

the wheat market. Section IV explains how commodity index trading works, its impact 

on the futures markets, and how the CFTC has facilitated index trading by waiving 

position limits for wheat and other agricultural commodities. Section V details the 

evidence indicating how commodity index trading has been one of the major causes of 

unwarranted price fluctuations and an undue burden on interstate commerce, and thereby 

constituted excessive speculation in the wheat market. Section VI describes how inflated 

futures prices affect the federal crop insurance program.
18

“No man qualifies as a statesman who is entirely ignorant of the problems 

of wheat.” 

--Socrates (469-399 B.C.E.)

II. THE U.S. WHEAT MARKET

A. U.S. Wheat Production 

Wheat is a commodity of critical importance to the U.S. and global economy. 

Wheat provides essential ingredients for the most basic of foods that we eat: breads, 

cereals, pasta, cakes, cookies, and other baked goods. It is no exaggeration to declare that 

“grain is the only resource in the world that is even more central to modern civilization 

than oil.”5

Wheat is grown on approximately 160,000 farms throughout the United States. 

The largest areas of wheat crops are located in the northern and central plains, the Pacific 

northwest, and the Midwest. Figure 1 shows the number of harvested acres of wheat in 

the United States, by county. 

 

Figure 1. Wheat, harvested acres by county. Data source: USDA National Agricultural 

Statistical Service. 

 5 Dan Morgan, Merchants of Grain, at p. 13 (Penguin, 1980).
19

Since the latter part of the 19th Century, the United States has been one of the 

leading global producers and consumers of wheat. (Figures 2 and 3). 

Global Wheat Production

Top Ten Countries

2008/09 

0

20

40

60

80

100

120

140

160

EU-27

China

India

United States

Russia

Canada

Ukraine

Pakistan

Australia

Turkey

metric tons

(millions)

Figure 2. Wheat production of top ten wheat-producing countries, 2008-09. Total global 

production for 2008/09 is estimated to be 683 million metric tons. Data source: USDA 

Foreign Agricultural Service, World Wheat Production, Consumption, and Stocks, 

estimate as of 2/10/09. 

Global Wheat Consumption

Top 10 Countries

2008/09 

0

20

40

60

80

100

120

140

EU-27

China

India

Russia

United States

Pakistan

Turkey

Egypt

Iran

Ukraine

metric tons

(millions)

Figure 3. Global Wheat Consumption, 2008-09. Total global consumption for 2008/09 is 

estimated to be 652 million metric tons. Data source: USDA Foreign Agricultural 

Service, World Wheat Production, Consumption, and Stocks, estimate as of 2/10/09. 
20

During the 20th Century, the United States was often the primary supplier of 

wheat to other countries suffering through war, drought, and famine. “A number of 

different countries have surpluses of oil or bauxite, or iron ore. But grain surpluses are 

found in only a handful of nations, and the United States is one of them. In agriculture, 

there is only one superpower.”6

 The large amount of wheat exported from the United 

States helps the U.S. trade balance, as well as fosters mutually beneficial relationships 

with other nations engaged in global trade and commerce. Although in recent times the 

United States’ market share of global wheat production and consumption has fallen due 

to increased global consumption and production, the United States remains the leading 

global exporter of wheat. (Figure 4). 

Wheat Exporting Countries

0

20

40

60

80

100

120

140

160

2006/07 2008/09 2010/11 2012/13 2014/15 2016/17

United States

Australia

European 

Canada

Argentina

Russia

Ukraine

Other FSU

China Turkey

Other

metric tons

(millions)

Figure 4. Wheat Exporting Countries, current and projected. Data source: USDA 

Economic Research Service, World Wheat Trade, Table 35. 

U.S. agricultural exports make a significant positive contribution to the nation’s 

balance of trade. In 2007, the value of agricultural commodities exported from the 

United States totaled approximately $81 billion, representing about 8% of total U.S. 

exports. In a year when the United States ran a trade deficit totaling over $900 billion, 

 6 Id., at p. 35.
21

the net trade of agricultural commodities generated an $18 billion surplus.7 Among U.S. 

agricultural exports, wheat ranks third, following soybeans and corn. (Figure 5). 

U.S. Agricultural Exports

Top 10 Commodities

0 

4 

8 

12 

16 

Soybeans

Corn

Wheat

Red meats

Animal feeds & oil meal

Fruits

Vegetables

Poultry meats

Cotton & linters

Vegetable oils

billions of 

dollars

Figure 5. Value of top 10 U.S. agricultural exports, 2008. Export values for red meats, 

fruits, vegetables, and poultry meats include export values of derivative products. Data 

source: USDA, Economic Research Service, Foreign Agricultural Trade of the United 

States, U.S. agricultural exports, year-to-date and current months, 

http://www.ers.usda.gov/Data/FATUS/#monthly. 

According to the most recent Census of Agriculture, in 2007, U.S. farms 

generated a total of nearly $11 billion in sales of wheat.8 In 2008, the wheat crop 

produced over $16 billion in sales. Corn and soybeans were the only individual crops 

that produced greater revenue for U.S. farmers. (Figure 6). 

 7 U.S.D.A. Economic Research Service, Foreign Agricultural Trade of the United States (FATUS), Value 

of U.S. trade – agricultural, nonagricultural, and total – and trade balance, by calendar year, last visited 

3/9/09. 

8 U.S.D.A. Census of Agriculture, 2007, Volume I, Chapter I: U.S. National Level Data, Table 2. 
22

U.S. Farm Income: Leading Crops

Corn

Soybeans

Vegetables

Fruits & nuts

Wheat

Hay

Cotton

Rice

Peanuts

Barley, oats, & 

sorghum

0 10 20 30 40 50 60

billions of dollars

Figure 6. U.S. Farm Income, Leading Crops. The USDA estimates that greenhouses 

and nurseries generated an additional $17.5 billion in income in 2008. All other crops 

generated an estimated $26 billion in farm income. Data source: USDA Economic 

Research Service, Data Sets, Farm Income: Data Files. 

B. Types of Wheat

Five basic types of wheat are grown in the United States: hard red winter (HRW), 

hard red spring (HRS), soft red winter (SRW), durum, and white. Figure 7 shows the 

relative amounts of the wheat varieties grown in the United States during the crop year 

2007-08.

U.S. Wheat Production

Hard Red Spring

448 m bu

22%

Hard Red Winter

962 m bu

47%

Soft Red Winter

358 m bu

17%

White

227 m bu

11%

Durum

72 m bu, 3%

Total U.S. Wheat 

Production: 

2.067 million 

bushels

Figure 7. Types and amounts of wheat grown in the United States in 2007-08. Source: 

USDA, Economic Research Service, Wheat Data: Yearbook Tables, Table 6. 
23

The varieties of wheat are differentiated primarily by the hardness, color, and 

protein content of the grain. Table 1 describes the various types of wheat, their protein 

content, and most common uses. 

Wheat Varieties, Characteristics, and Uses

Type of Wheat Physical 

Characteristics Protein Content Uses

Durum

Very hard; 

translucent, light 

color

High

(14-15%)

Pasta, couscous, 

Middle Eastern 

flat breads

Hard Red Spring Hard; brownish High

(13-14%)

Bread, bagels, 

hard rolls

Hard Red Winter Hard; brownish Medium-High

(11-12%)

Bread; bread 

flours

Soft Red Winter Soft Low

(9-10.5%)

Cakes, pie 

crusts, biscuits, 

crackers

Hard White Hard; light color, 

opaque, chalky

Medium-High

(similar to HRW)

Bread, brewing, 

Asian noodles

Soft White Soft, light-color Low

(10%)

Pie crusts, 

pastry, noodles, 

flat breads

Table 1. U.S. Wheat Varieties, Characteristics, and Uses.9

The protein content of the wheat largely determines its suitability for various 

products such as breads, cakes, pastries, pastas, noodles, and other foods. Flour milled 

from wheat with a relatively high content of protein, or gluten, such as hard spring wheat, 

produces thicker breads that are relatively difficult to tear apart. Flour milled from wheat 

with a relatively low content of gluten, such as soft winter wheat, is used for products that 

do not need to stick together well, such as crackers and cookies.10

 9 The data sources for the protein content of the various wheat varieties are: Sally Sologuk, Durum Wheat 

101: An Overview, Milling Journal, 4th Quarter 2004, at p. 48, available at 

 Although the protein 

http://www.northerncrops.com/technical/introdurum.pdf (durum wheat); Kansas Wheat Commission – Kansas Association of 

Wheat Growers, Classes of Wheat, at http://www.kswheat.com/general.asp?id=118. See also Kyle 

Stiegert and Brian Balzer, Food System Research Group, Kansas State University, Evaluating the U.S. 

Wheat Protein Complex, at p. 6, available at http://www.aae.wisc.edu/fsrg/publications/wp2001-5.pdf (hard 

red spring and hard red winter wheats); U.S. Wheat Associates, Soft Red Winter Wheat Quality Survey, 

2006, available at 

http://www.uswheat.org/cropQualityReports/doc/26BC80F1BC58414385257214004695D0/$File/SRW200

6.pdf?OpenElement (soft red winter wheat).

10 In Merchants of Grain, Dan Morgan describes how Cadwallader Washburn (founder of the company that 

was the predecessor of General Mills) developed an innovative milling process, powered by the St. 

Anthony Falls on the Mississippi River, to separate the dark specks of bran that would discolor the white 

wheat flour during the milling of hard spring wheat. Hard spring wheat is the variety of wheat most 

suitable for survival in colder, northern climates. Morgan relates the significance of this invention:
24

content of hard white wheat is similar to that of hard red wheat, its white color and less 

bitter taste make it a preferable alternative to hard red wheat for certain uses. Because 

consumers tend to prefer whiter and sweeter tasting breads and pastas, hard white wheat 

often is a preferred source of flour for these products.11

Figure 8 displays the geographic locations where each type of wheat is grown. 

Figure 8. U.S. Wheat Production, by Variety by County. Data source: USDA, 

Economic Research Service, Briefing Rooms, Wheat: Maps; at 

http://www.ers.usda.gov/Briefing/Wheat/maps.htm. 

 

“The ‘new process’ milling reversed the economic position of Minnesota flour on the bakers’ scale 

of preferences, not only in the United States but in England as well. Once it could be sold as a 

whole product free from impurities, Minneapolis flour became the premium flour of the United 

States. The reason was that the spring planted wheats of Minnesota and the Dakotas, ripened as 

they were in the dry, sunny climate, contained a higher percentage of protein, or ‘gluten,’ than soft 

eastern wheats. This was an advantage of enormous economic significance. Gluten gives flour 

the capacity to absorb water and, when yeast is added, to rise. To bakers this meant that hard, 

spring wheat flour produced more loaves per pound. To consumers, the benefit was bread that 

tended to stay fresh longer.”

Washburn’s innovation soon “leaked out” and was also adopted by Charles Pillsbury, founder of the 

company that bears his name. Merchants of Grain, at 86. 

11 It also is a preferred choice for Asian noodles. See, e.g., USDA, Economic Research Service, Hard 

White Wheat: Changing the Color of U.S. Wheat?, Agricultural Outlook, August 1998; Whole Grains 

Council, Whole White Wheat FAQ, at http://www.wholegrainscouncil.org/whole-grains-101/whole-whitewheat-faq.

Hard Red 

Winter

Hard Red 

Spring

Soft Red 

Winter

White 

Durum
25

Figure 9 displays the uses of these wheat varieties. 

Wheat Types and Uses

2007/08

0

200

400

600

800

1000

1200

Hard red

winter

Hard red

spring

Soft red

winter

White Durum

Feed and residual use

Ending Stocks

Food

Exports

millions of

bushels

Food

 Export

 Stocks

 Feed & residual

Figure 9. Uses of five main wheat varieties, 2007-08. Data source: USDA, 

Economic Research Service, Wheat Data: Yearbook Tables, Table 6: Wheat 

Classes, Supply and Disappearance. 

C. U.S. Wheat Supplies 

The amount of a particular crop that is grown is highly sensitive to the price 

signals in the market for that crop. When the price of a crop such as wheat is relatively 

high – such that the returns for planting wheat are expected to be higher than the returns 

from planting other crops – farmers will plant more wheat; when prices are relatively 

low, farmers will devote fewer acres to wheat than to other crops. 

Figure 10 shows the sizes of the three largest U.S. wheat crops – hard red winter, 

hard red spring, and soft red winter – planted over the past nine crop years. Due to 

extremely dry conditions in the Great Plains states, the hard red winter wheat crop for 

2005/06 was the second-smallest in 30 years. As a result of the record-high wheat prices 

over the previous two crop years, in late 2007, farmers planted more acres of all types of 

wheat. A near-record amount of soft red winter was produced for the 2008/09 crop year. 

(Figure 11). 
26

U.S. Wheat Production

0

200

400

600

800

1,000

1,200

2000/012001/022002/032003/042004/052005/062006/072007/082008/09

Hard Red Winter Hard Red Spring Soft Red Winter

millions of 

bushels

Figure 10. U.S. wheat production, 2000-2008. Data source: USDA Economic Research 

Service, Wheat Data: Yearbook Tables, Table 1. 

Soft Red Winter Wheat Production

1970/71 - 2008/09

0

200

400

600

800

1970/711975/761980/811985/861990/911995/962000/012005/06

millions of 

bushels

2008/09

1981/82

Figure 11. The 2008/09 soft red winter wheat crop is anticipated to be the second 

largest on record. Data source: USDA Economic Research Service, Wheat Data: 

Yearbook Tables, Table 1. 
27

The near-record crop of soft red winter wheat harvested in the summer of 2008 

helped accelerate the fall of the price of wheat during the latter half of 2008. With such a 

large harvest, inventories of wheat rose, prices fell, and large amounts of wheat were 

used as animal feed. (Figure 12). 

Uses of Soft Red Winter Wheat

1990 - 2008 

0

200

400

600

800

2000/012001/02

2002/03

2003/042004/052005/062006/072007/082008/09

Food Seed Exports Feed and Other Ending Stocks

millions of 

bushels

Figure 12. A near-record crop of soft red winter wheat in 2008/09 resulted in 

additional use of wheat for animal feed and greater-than-normal amounts of 

wheat placed in storage at the end of the crop year. Data source: USDA 

Economic Research Service, Wheat Data: Yearbook Tables, Table 9. 

D. The Cash and Futures Markets for Wheat 

The development of the wheat market in the United States has followed the 

general economic and political development of the nation as a whole. As the frontiers of 

the nation expanded westward throughout the 19th Century, settlers in the new territories 

found the land highly suitable for growing grains such as wheat and corn. As farmlands 

progressed westward, new canals and railroads were built to carry these crops to the 

population centers back east, mills were built near those routes to process the wheat into 

flour, and centralized markets developed in Chicago and elsewhere to facilitate the 

buying and selling of wheat and wheat products. Much of the basic structure of the U.S. 

wheat markets today traces its origin to the manner in which these markets evolved 

during the 19th Century. 
28

1. Cash Markets for Wheat 

The primary market for the buying and selling of wheat is the cash market. 

Virtually all transactions that result in a physical transfer of wheat take place between 

sellers and buyers exchanging cash for wheat. The futures market is rarely used for the 

actual buying and selling of wheat, or for the delivery of wheat from a seller to a buyer. 

There is no centralized cash market for wheat or other types of grain. Rather, the 

cash market exists wherever a grain elevator or grain merchant posts a price or makes an 

offer to purchase grain, wherever a farmer or grain merchant makes an offer to sell, or 

wherever grain is bought, sold, or stored. These types of transactions take place all over 

the country, at all times of the day. Transactions in the cash market may or may not be 

accomplished through standardized contracts, although oftentimes they are. 

Typically, country elevators, grain merchants, and millers will post prices on a 

daily or regular basis for the amounts of grain that they anticipate for their immediate or 

near-term needs. Elevators and merchants often will post a schedule of prices, depending 

on when the crop is to be delivered. Cash market prices vary considerably from season 

to season and from location to location. At any particular time, factors influencing the 

cash price at a particular location may include local soil and weather conditions as they 

may affect the quantity or quality of the wheat at that location, local supply and demand 

factors, such as the availability of alternative or substitute grains at that location, the 

particular needs of local elevators or processors, and transportation costs to markets or 

processing facilities. 

Cash prices may be quoted as an absolute price, particularly if the contract is for 

immediate delivery of wheat. For example, the cash price for immediate delivery might 

be $4 per bushel. A contract for wheat that is to be delivered at a specified time in the 

future (termed a “forward” contract) often is based upon the current price of the futures 

contract that is closest in time to the time of delivery. Some forward contracts specify a 

particular discount or premium to be applied to the futures price; others provide that the 

discount or premium is to be determined at the time of delivery, based upon prevailing 

market conditions when the wheat is delivered. 

Farmers often have the option of selling their crop in the cash or futures market, 

according to the current prices in either market, or storing it themselves or at an elevator 

for later delivery and sale. A farmer’s income depends to a large degree on the farmer’s 

ability to determine the most profitable option for the sale of his or her crops. 

To foster transparent and efficient markets, the U.S. Department of Agriculture 

publishes daily, weekly, monthly, and annual reports on the price of wheat and numerous 

other crops in various cash markets. Other organizations also provide pricing reports. 
29

Because of the highly localized nature of the cash market, these types of reports are a 

valuable source of information about the prevailing prices at or near a particular location. 

For hard red winter, hard red spring, and soft red winter wheats, as well as for 

corn and soybeans, the Minneapolis Grain Exchange (MGEX) offers a daily “cash index” 

contract for trading as a futures contract. The daily index prices for these commodities is 

determined by surveying and calculating the average of numerous cash prices for each 

crop around the region in which it is grown. The Minneapolis exchange explains: “DTN 

[a large publisher of real-time market data] collects nearly 700 bids each day for hard red 

winter wheat, 325 bids for hard red spring wheat, 550 bids for soft red winter wheat, 

2,450 bids for corn and 2,250 bids for soybeans with representation from elevators 

around the country.”12

Cash Price of Wheat: 

MGEX Indexes

0

5

10

15

20

25

Jan-00Jan-01Jan-02Jan-03Jan-04Jan-05Jan-06Jan-07Jan-08

Hard Red Spring (MGE)

Soft Red Winter (CME)

Hard Red Winter (KCBOT)

$/bushel

 The MGEX agricultural index contracts can therefore be 

considered to represent a national average cash price for each of the covered 

commodities. Figure 13 presents the value of the MGEX index price over the last eight 

years for each of the three types of wheat traded on futures exchanges: hard red winter, 

hard red spring, and soft red winter. The data shows, for all three types of wheat, a 

significant price spike in 2007-08. 

Figure 13. Average cash prices of wheat traded on futures exchanges, as calculated by 

the MGE index. Data source: MGEX. 

 12 Minneapolis Grain Exchange, MGEX Agricultural Index Futures and Options, FAQ; at 

http://www.mgex.com/documents/2007indexFAQ4.08.pdf. Although the Minneapolis exchange offers 

these contracts for trading as futures contracts, there is virtually no trading in any of these futures contracts. 
30

2. Futures Markets for Wheat

Following the Civil War, the rapid expansion of the country westward, together 

with the industrial revolution, transformed the United States into a global agricultural and 

industrial power, often with wrenching consequences for American farmers, workers, and 

communities.13

As the U.S. wheat market expanded and U.S. farmers and merchants began to 

market their wheat globally, futures markets evolved as a means to manage the 

unpredictable risks merchants faced in buying, storing, and selling wheat in a global 

market. When it was first established in 1848, the Chicago Board of Trade (CBOT) was 

primarily a cash market for a wide variety of agricultural commodities, including grains

 American farmers no longer produced wheat just for their own 

sustenance or a local market, but rather became part of a much larger international 

network for buying and selling grains and other foodstuffs. The price a farmer could get 

for grain was no longer the result of a simple bargain between the farmer and the local 

grain dealer, but rather was based on many factors totally out of the farmer’s control, 

such as the latest trends in global supply and demand. 

14

“As commerce developed and required the accumulation of inventories, 

particularly of seasonally produced crops, merchants and processors found 

themselves with problems that were best managed by forward contracting. This 

forward contracting developed into standard procedures that were eventually 

codified and formalized into futures trading.”

 

During the 1850s, increasing supplies of grain and other crops coming into Chicago due 

to the expansion of farmlands, the building of railroads and canals connecting the new 

territories to Chicago and other cities, and increasing international demands for U.S. 

wheat, fostered the increased use of forward contracts to store and market that wheat. A 

leading professor of agricultural economics, Thomas Hieronymus, explains:

15

 13 “Farmers, no longer relatively self-sufficient, were bewildered by the new economic conditions. They 

were involved now in a world-wide economic network, the impersonal price-and-market system, which 

they understood only dimly. Slowly and with great difficulty they learned to cope with these new 

problems, to calculate costs and prices with business-like efficiency, and to join together to deal with 

powerful market forces.” Samuel P. Hays, The Response to Industrialism, 1885-1914 (University of 

Chicago Press, 1957), at p. 31. “Between 1815 and 1860 the character of American agriculture was 

transformed. The independent yeoman, outside of exceptional or isolated areas, almost disappeared before 

the relentless advance of commercial agriculture.” Richard Hofstadter, The Age of Reform (Alfred A. 

Knopf, 1955), at p. 38. 

14 William G. Ferris, The Grain Traders, The Story of the Chicago Board of Trade (Michigan State 

University Press, 1988), at p. 9. 

15 Thomas A. Hieronymus, Economics of Futures Trading (Commodity Research Bureau, 1977), at p. 93. 

(available at University of Illinois farmdoc archives, at 

http://www.farmdoc.uiuc.edu/irwin/links_archive.asp; hereinafter cited as “farmdoc archives”). The CBOT 

began to trade forward contracts in 1851. In 1859, it received a charter from the State of Illinois to 
31

Once the making of a contract became separated from the delivery of the 

commodity, as is the case with forward contracts, it became possible for grain merchants 

and other middlemen to speculate as to the ultimate value of those contracts, and to 

attempt to profit from the changing value of those contracts. As the amount of forward 

contracting grew, so did the amount of speculation in the value of those contracts. 

During the Civil War, speculation became so rampant that the CBOT developed rules to 

govern the conduct of its members and to ensure the performance of contracts made on 

the exchange.16

The CBOT Annual Report for 1864 reflects how the nature of trading already had 

shifted from strictly cash transactions to speculative trading:

 

“It is true that speculation has been too much the order of the day, and 

buyers and sellers of ‘long,’ ‘short,’ and ‘spot,’ have passed through all 

the gradations of fortune from the lower to the higher ground, and in many 

instances have returned to the starting point, if not to a step lower, but it is 

to be hoped that with the return to peace this fever of speculation will 

abate and trade will be conducted on a more thoroughly legitimate 

basis.”17

From the beginning of futures trading in the mid-19th Century until 2008, the 

CBOT was the leading futures exchange for wheat, other grains, and agricultural 

commodities, including corn and soybeans.18

 

establish and enforce grain standards. Id. The development of grain standards and grain quality control 

methods in grain warehouses greatly facilitated the usefulness of standardized contracts. See Ferris, at p. 

19.

 In 2008, the CBOT merged with the 

Chicago Mercantile Exchange (CME). 

16 In 1863, the CBOT adopted a rule to authorize the expulsion of any member who failed to comply with 

the terms of a contract. In 1865, the CBOT published the “General Rules of the Board of Trade” which 

included, for the first time, the requirement to post margins, and rules for the standardized delivery and 

payment procedures for future deliveries under contracts. “By this time all of the essential elements of 

futures trading were present. . . . We could date the origin of modern commodity futures trading as 

October 13, 1865 if it is, indeed, desirable to attach a single date to what was actually an evolutionary 

process.” Hieronymus, at p. 76. In 1883, the CBOT introduced the first clearinghouse to facilitate the 

offsetting of trades amongst its members. In 1891, the Minneapolis Grain Exchange created the first 

complete clearinghouse system, by also making the clearinghouse the counterparty to each transaction on 

the exchange. Anne E. Peck, The Economic Role of Traditional Commodity Futures Markets (American 

Enterprise Institute, 1985), at p. 4-6 (available in farmdoc archives).

17 Reprinted in G. Wright Hoffman, Future Trading Upon Organized Commodity Markets in the United 

States, University of Pennsylvania Press (1932), at p. 30. 

18 See, e.g., Ferris, The Grain Traders, The Story of the Chicago Board of Trade.
32

Three Futures Exchanges. Today, there are three futures markets for wheat in 

the United States, each specializing in a particular type of wheat.19

Wheat Futures Exchanges and Contracts

 Soft red winter wheat 

is traded on the CME, hard red winter wheat is traded on the Kansas City Board of Trade 

(KCBOT), and hard red spring wheat is traded on the MGEX. 

Exchange: Chicago Mercantile 

Exchange (CME)

Kansas City Board of 

Trade (KCBOT)

Minneapolis Grain 

Exchange (MGEX)

Type of Wheat 

Traded: Soft Red Winter Hard Red Winter Hard Red Spring

Contract Size: 5,000 bushels (bu.) 5,000 bu. 5,000 bu.

New Crop 

Month: July July September

Delivery 

Months: Jul, Sep, Dec, Mar, May Jul, Sep, Dec, Mar, 

May

Mar, May, Jul, Sep, 

Dec

Delivery 

Locations:

Chicago, IL; Toledo, OH; 

NW Ohio; Ohio River 

between Cincinnati and 

Mississippi River; 

Mississippi River below St. 

Louis to Memphis.20

Kansas City MO-KS; 

Hutchinson, KS; 

Wichita, KS; 

Salina/Abilene KS.

Minn./St. Paul, MN; 

Red Wing, MN; 

Duluth MN/Superior 

WI.

Daily Volume 

(2/09)21 79,439 10,403 2,871

Position 

Limits:

Spot month 600 600 600

Single month 5,000 5,000 5,000

All months

combined 6,500 6,500 6,500

Table 2. Wheat Futures Exchanges and Contracts. Data source: CME, KCBOT, MGEX.

 19 At one time, futures exchanges for the trading of grain were also located in Baltimore, Buffalo, 

Cincinnati, Duluth, Indianapolis, Milwaukee, New York, Omaha, Peoria, Philadelphia, Portland, Seattle, 

St. Louis, and Toledo. Report of the Federal Trade Commission on The Grain Trade, Vol. II, Terminal 

Grain Markets and Exchanges (1920), at p. 204. Several exchanges, including the MGEX, have offered 

futures contracts for durum wheat and white wheat but have been unable to sustain sufficient liquidity to 

continue trading those types of wheat. 

20 In 2009, a 12-county area of northwest Ohio and the Ohio River and Mississippi River delivery locations 

were added by the CME as part of the CME’s effort to improve the convergence of the CME wheat 

contract. 

21 CME Group, Monthly Agricultural Update, February 2009; Kansas City Board of Trade, Historical Data, 

at http://www.kcbt.com/historical_data.asp#kcbt_monthly; Minneapolis Grain Exchange, Market 

Information, Monthly/Weekly Reports, at http://www.mgex.com/reports.html. 
33

Table 2 describes key features of each of these futures contracts. As the Table 

indicates, the structures of the three wheat futures contracts, as well as the rules under 

which they are traded, are very similar. 

Although the amount of soft red winter wheat produced annually is significantly 

less than the amount of either hard red winter or hard red spring wheat, there is 

significantly more liquidity – meaning a greater amount of trading – in the wheat futures 

market in Chicago than on the other wheat futures exchanges. This increased liquidity 

can be seen in both the daily volume of wheat contracts traded on each exchange, as 

shown in Table 2, or by comparing the open interest (number of contracts outstanding) on 

each exchange, as shown in Figure 14.

22 

Wheat Futures and Options Contracts

Total Open Interest 

0

200

400

600

800

Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08

CME (SRW)

KCBOT (HRW)

MGEX (HRS)

contracts

(thousands)

Figure 14. Open interest in the three wheat futures markets. Data source: 

CFTC. 

Delivery Terms. Futures contracts are rarely used to provide for the actual 

delivery of a commodity from a seller to a purchaser. Typically, only one or two% of all 

futures contracts result in the delivery of the commodity.23

 22 According to traders and grain market analysts interviewed by the Subcommittee, there is no intrinsic 

reason why any particular wheat contract should be more liquid than the others. However, once a contract 

becomes highly liquid it tends to stay that way – “liquidity begets liquidity.” Moreover, many traders who 

trade futures contracts in other agricultural commodities on the CME find it more convenient to use the 

CME wheat futures contract rather than move to a wheat contract on another exchange.

 

23 “In markets that work, delivery is rarely made and taken; futures contracts are entered into for reasons 

other than exchange of title.” Hieronymus, at p. 340.
34

Even though actual deliveries under futures contracts are rare, it is nonetheless 

critical that the delivery terms in the futures contract facilitate such deliveries. In his 

classic 1977 textbook on futures markets, Professor Hieronymus explained the 

importance of easy delivery terms:

“The objective in writing a futures contract is to obtain such even balance 

that only an amount to test the price – to keep it honest – is delivered; to 

make the contract so readily deliverable and receivable that there is no 

incentive to make or take delivery. The terms of the contract must be 

precisely representative of the commercial trading practices of the 

commodity.”24

Experience with futures markets has shown that it is very difficult to maintain 

trading in a futures contract with delivery terms that do not reflect commercial reality and

facilitate delivery. Commercial traders are reluctant to participate in a market where it is 

difficult to obtain or dispose of the actual commodity.25

The three wheat futures contracts specify the type and quality of the wheat to be

delivered, the date or time frame for delivery, the possible locations for delivery, and the 

required price at the time of delivery. The CME soft red winter wheat contract, for 

example, provides for the delivery of #2 soft red winter wheat, at an approved terminal 

elevator in Chicago, Toledo, or another approved delivery location (see Table 2). The 

Kansas City and Minneapolis exchanges have similar rules.26

 24 “Markets can be destroyed by the wrong delivery terms.” Hieronymus, at p. 340. 

 The exchange rules specify 

25 Id., at p. 342. The defunct futures market for Maine potatoes provides a good example of how an 

inadequate delivery process helped cause the demise of the market. The problems in the Maine potato 

futures market included highly volatile futures prices and a failure of the cash and futures prices to 

converge at contract expiration. This lack of convergence resulted from the relatively small amount of 

potatoes that could be delivered under the terms of the contract. “Many people have concluded that the 

supply of Maine potatoes deliverable on the current NYME contract is too small for healthy trading.” 

Allen E. Paul, Kandice H. Kahl, and William G. Tomek, Performance of Futures Markets: The Case of 

Potatoes, USDA Economics and Statistics Service, Technical Bulleting No. 1636 (1981), at p. viii 

(available in farmdoc archives). This USDA study warned that traders would stop using the contract unless 

the performance of the contract was improved, particularly with respect to convergence at contract 

expiration. It recommended adoption of a cash settlement process (whereby the settlement price at the 

expiration of a futures contract is set at the price at that time in the cash market) to “sidestep delivery 

difficulties and ensure that futures price and cash price converge at contract maturity.” Id. at p. ix. The 

default in the delivery of 50 million pounds of potatoes in 1976, and the failure of deliveries to pass 

inspection under the March 1979 contract hastened the loss of confidence in this futures market. After 

years of declining volume, the NYMEX delisted the Maine futures potato contract in 1986. 

26 The Kansas City wheat contract specifies the delivery of #2 hard red winter wheat, or #1 hard red winter 

wheat at a 11⁄2 cent premium over the price for #2 hard red winter wheat. The evolution of the Kansas City 

futures market into a futures market solely for hard red winter wheat provides another illustration of the 

importance of the contract delivery mechanism. In 1940, the KCBOT began to allow the delivery of soft 

winter wheat, at the seller’s option. Prior to this, only hard winter wheat could be delivered. In the 1950s, 

the price of soft winter wheat dropped relative to the price of hard winter wheat. Given the alternative, 

sellers preferred to deliver the lower-priced wheat, so that by early 1953, the KCBOT contract became, in 
35

the procedure for the person making delivery to notify the exchange that delivery will be 

made, and for notifying the person or persons taking delivery. 

For grain futures contracts, the rules of the exchanges specify a narrow category 

of sellers who may make an actual delivery of grain pursuant to those contracts. For 

wheat, only “warehouses or shipping stations” approved by an exchange may deliver 

wheat to satisfy a futures contract.27 Presently, the CME has approved only one 

warehouse in Chicago (operated by Chicago & Illinois River Marketing, LLC, a Nidera

subsidiary), two facilities in Toledo (operated by ADM and The Andersons), one in 

Burns Harbor, Indiana (operated by Cargill), two in St. Louis (operated by ADM and 

Cargill), and one in Alton, Illinois (operated by Gavilon) for delivery of wheat under the 

CME contract.28

Deliveries under a wheat futures contract follow a multi-step process over several 

days prior to the expiration of the contract. Wheat futures contracts expire in the middle 

of the month – on the first business day prior to the 15th calendar day of the contract 

month. Beginning on the second-to-last business day of the month prior to the month in 

 The requirement that a potential deliverer of wheat under the futures 

contract first be approved by the board of trade partly stems from the need to ensure that 

the quality of wheat delivered under the contract meets the contract specifications and 

partly to ensure that the persons supposed to make or accept delivery are capable of doing 

so. The fact that there are so few approved warehouses in Chicago and Toledo is due 

largely to the expense and difficulty of constructing and operating grain warehouses in 

the current delivery locations, particularly in an urban area like Chicago, and the fact that 

Chicago and Toledo are no longer major centers for commerce in wheat. 

 

effect, a soft winter wheat contract. The contract became a less effective tool for hedging for the producers 

and users of hard winter wheat, and the millers who used hard winter wheat petitioned the KCBOT to once 

again restrict deliveries to hard red winter wheat. At first, the proposal was rejected, largely due to the 

belief that a soft winter wheat contract would result in a larger volume of trading. Once the would-be 

physical hedgers began to use the KCBOT less frequently as a result of the loss in the ability to hedge hard 

winter wheat, and overall trading volumes declined significantly, the KCBOT reversed itself and, since 

1954, has restricted deliveries to hard winter wheat. Holbrook Working, Whose Markets? Evidence on 

Some Aspects of Futures Trading, reprinted in Selected Writings of Holbrook Working (Chicago Board of 

Trade, 1985), at pp. 165-176.

27 The CME Rulebook sets forth the requirements for regular warehouses and shipping facilities. Among 

other requirements, the facility must be inspected by the Exchange, the USDA, and other governmental 

agencies; be provided with “modern improvements and appliances for the convenient and expeditious 

receiving, handling and shipping of product in bulk”; furnish accurate information to the Exchange; permit 

its books to be inspected; “not engage in unethical or inequitable practices”; and comply with the rules of 

the Exchange. CME Rulebook, Chap. 7. 

28 The CME has received about 40 applications for approval for warehouses as a result of its recent decision 

to approve delivery locations in northwest Ohio and along the Ohio and Mississippi Rivers beginning with 

the July 2009 contract. CME Group, Special Executive Report, S-4876, Reminder: Upcoming Approved 

Changes to the Wheat Futures Contract, May 15, 2009; at 

http://www.cmegroup.com/company/membership/membernet/files/20090518S-4876.pdf. 
36

which expiration occurs, an approved firm may give notice of the firm’s intent to make a 

delivery under the futures contract. The day on which a seller first gives notice is called 

“position day.” On the day following a position day, the exchange examines the 

outstanding long open interest (buyers) and selects those positions that have been held for 

the longest period of time to accept delivery. This second day of the delivery process is 

called “notice day.” On notice day, the holder of the long position identified by the 

exchange to accept delivery may either accept the delivery or decide to pass it on to 

another buyer.29

Delivery of wheat under the Chicago wheat futures contract (or any of the other

wheat futures contracts) from an approved warehouse does not require the physical 

movement of any grain. Rather, the rights to the grain pass to the buyer in the form of a 

shipping certificate. Possession of a shipping certificate entitles the holder of the 

certificate to demand that the warehouse load the wheat upon the mode of transportation 

provided by the certificate holder (“load-out”), generally barge or rail. Once the holder 

of a shipping certificate requests load out, the warehouse then must load the grain within 

a period of time specified by the rules of the exchange. Until the holder of a shipping 

certificate requests the load out, the holder of the shipping certificate must pay the 

warehouse storage fees for the amount of grain stored, also at a rate specified by 

exchange rules. 

 The day following notice day is delivery day, when the shipping receipt 

passes to the purchaser. Once delivery is made, both the long and short open interests are 

closed. Any contracts still outstanding on the last day of trading are settled through 

delivery, at the settlement price, on the following day. 

Through this delivery process, traders may acquire grain through the contract 

delivery process without actually physically handling any grain. Rather, simply by 

holding futures contracts until expiration, traders may acquire the rights to grain stored in 

grain elevators, in the form of shipping certificates. These traders may then hold onto 

these shipping certificates, pay the storage fees, and then sell the grain later at a higher 

price. 

E. Recent Trends in U.S. Wheat Prices

1. Recent Price Increases and Volatility

Because the United States is a large exporter of wheat, U.S. wheat prices are 

strongly influenced by global supply and demand. The price of wheat in Kansas may be 

 29 If the holder of the long position identified by the exchange does not want to accept delivery and notifies 

the exchange of his or her intent to pass it on to another buyer, on the following day the exchange will 

select and notify the next-oldest holder of a long position to accept delivery. The day the next-in-line 

holder of a long position is notified becomes the new notice day. This process can continue until the day 

the contract expires. 

 
37

influenced just as much by locusts in Australia as by a local drought. Over the past few 

years, a wide variety of global and domestic factors have led to unprecedented price 

increases and volatility in wheat and other agricultural commodities. 

Figures 15a and 15b show the climb to record heights by energy, food, and wheat 

prices over the past several years, peaking in mid-2008, and then falling sharply during 

the latter half of 2008. As these figures show, over the past 15 years, the price of energy 

(largely mirroring the price of crude oil) has increased far more than the price of wheat or 

food in general. Over the past four years, however, the increases in wheat prices were 

nearly as steep as the increases in the price of oil. (Figure 15b). 

Commodity Price Increases Since 1992

0

200

400

600

800

Jan-92Jan-94Jan-96Jan-98Jan-00Jan-02Jan-04Jan-06Jan-08

Food Index

Energy Fuel Index

Hard Red Wheat

Index Value

(1992=100)

Energy

(Oil)

Wheat

Food

Figure 15a. Commodity Price Increases since 1992. The energy price index includes 

the price of crude oil, natural gas, and coal, and closely follows the price of crude oil. 

Data source for Figures 15a and 15b: International Monetary Fund, Primary Commodity 

Prices; at http://www.imf.org/external/np/res/commod/index.asp. 
38

Commodity Price Increases Since 2005

50

100

150

200

250

300

350

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08

Jul-08

Jan-09

Food Index

Energy Fuel Index

Hard Red Wheat

Index Value

(2005=100)

Wheat

Energy

(Oil)

Food

Figure 15b. Relative prices of wheat, energy fuel, and food since 2005. 

The large price increase, subsequent collapse, and abnormal price volatility during 

2008 caused turmoil in the wheat markets. Media reports conveyed complaints, worries, 

and warnings from many sectors of the grain industry, from producers to consumers. 

“Anyone who tells you they’ve seen something like this is a liar,” said an official of the 

Farmers Trading Company of South Dakota.30 An official at cereal-maker Kellogg 

observed, “The costs for commodities, including grains and energy used to manufacture 

and distribute our products, continues to increase dramatically.”31 “I can’t honestly sit 

here and tell who is determining the price of grain,” said one Illinois farmer. “I’ve lost 

confidence in the Chicago Board of Trade.”32 “I don’t know how anyone goes about 

hedging in markets as volatile as this,” said the president of MGP Ingredients which 

provides flour, wheat protein, and other grain products to food makers.33 “These markets 

are behaving in ways we have never seen,” said a senior official from Sara Lee.34

 30 David Streitfeld, In Price and Supply, Wheat Is the Unstable Staple, New York Times, February 13, 

2008.

 A 

31 Sephanie Antonian Rutherford, Kellogg shrinks boxes, Battle Creek Enquirer, June 17, 2008.

32 Diana B. Henriques, Price Volatility Adds to Worry on U.S. Farms, New York Times, April 22, 2008.

33 Ben Levisohn, Butcher, Baker – Commodities Trader?, Business Week, July 14, 2008.

34 Id.
39

grain elevator manager warned, “Eventually, those costs are going to come out of the 

pockets of the American consumer.”35

Although the rise in wheat prices to record heights occurred steadily over a span 

of several years, the subsequent drop in prices took place over a much shorter period, 

about six months. Despite the sharp drop in the latter half of 2008, prices did not fall all 

the way back to their pre-spike levels. Many analysts project that the new equilibrium 

price will be higher than the equilibrium price before the spike. For example, Professors 

Good and Irwin write: “[U]nfolding evidence suggests that prices are indeed likely 

establishing a higher average than that experienced in recent history. The factors 

supporting this conclusion include generally tight world inventories, growing world 

demand for food and biofuels, and escalating cost of production.” They also state: 

“[C]urrent market fundamentals center on large amounts of corn used for ethanol 

production, suggesting that corn prices will continue to be closely tied to energy prices in 

the immediate future and that the price of the other two crops [wheat and soybeans] will 

have to be competitive with the price of corn.”

 

36

Figure 16 shows how the price of wheat over the past decade has 

compared to the prices of other agricultural commodities. During this period the 

prices of wheat, corn, and soybeans all have followed similar patterns.

 35 Diana B. Henriques, Price Volatility Adds to Worry on U.S. Farms, New York Times, April 22, 2008.

36 Darrel Good and Scott Irwin, The New Era of Corn, Soybean, and Wheat Prices, Marketing & Outlook 

Briefs, Department of Agricultural and Consumer Economics, University of Illinois at Urbana-Champaign, 

September 2, 2008. See also Ronald Trostle, Global Agricultural Supply and Demand: Factors 

contributing to higher food commodity prices, and prospects for the future, Economic Research Service, 

U.S. Department of Agriculture, Presentation to Russian Agricultural Outlook Forum, September 23-24, 

2008.
40

Food Commodity Prices

0

100

200

300

400

Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08

Corn (U.S. exports)

Rice (Thailand)

Soybeans (U.S. futures)

Sugar (U.S. futures)

Wheat (U.S. HRW futures)

Wheat

Rice

Sugar

Soybeans

Corn

1998=100

Figure 16. Prices of selected food commodities, 1998-2009. Data source: 

International Monetary Fund, Primary Commodity Prices; at 

http://www.imf.org/external/np/res/commod/index.asp. 

The causes of the steep rise in commodity prices in 2008, including the role of 

increasing speculation in the commodity markets, became the subject of intense public 

scrutiny and debate.37

 37 See, e.g., Kevin G. Hall, Speculators’ role in crude-oil prices under examination, Seattle Times, 

September 11, 2008; Jeffrey Korzenik, Energy policy and the speculator, Boston Globe, August 21, 2008; 

Sam Zuckerman, Spotlight on investors as commodities slide, San Francisco Chronicle, August 18, 2008; 

Katherine Yung, Causes of Oil Price Swings are Debated: Is it Greedy Speculation or Simply Supply and 

Demand?, Detroit Free Press, August 7, 2008; Roger Bootle, Commodities could be the latest bubble to 

burst, The Daily Telegraph, July 28, 2008; Dwight R. Sanders and Scott H. Irwin, Futures Imperfect, New 

York Times, July 20, 2008; Craig Pirrong, Restricting Speculators Will Not Reduce Oil Prices, Wall Street 

Journal, July 11, 2008; Adam Shell, Are big bets by speculators driving up oil? Experts disagree on what’s 

behind rising crude prices, USA Today, July 1, 2008; Paul Krugman, Fuels on the Hill; Congress Loves to 

Blame Speculators For the High Price of Oil, Pittsburgh Post-Gazette, June 28, 2008; Joe Nocera, Easy 

Target, But Not the Right One, New York Times, June 28, 2008; Ed Wallace, High Oil Prices: It’s All 

Speculation, Business Week, June 27, 2008; Jon Birger, Don’t blame the oil ‘speculators’, Fortune, June 

27, 2008; Jad Mouawad and Diana B. Henriques, Why Is Oil So High? Pick a View, New York Times, June 

21, 2008; Dale Kasler, CalPERS profits as costs surge; While consumers fume over commodity prices, 

pension fund makes killing in market, Sacramento Bee, June 20, 2008; Diana B. Henriques, A Bill Market 

Sees the Worst in Speculators, New York Times, June 13, 2008; Editorial, Betting on the bubble, St. Louis 

Post-Dispatch, June 9, 2008; Rising tide becomes a surge that could wreck every boat; Oil prices have 

nearly doubled over the past two years, Fort Worth Star-Telegram, June 7, 2008; David Cho, Investors’ 

Growing Appetite for Oil Evades Market Limits; Trading Loophole for Wall Street Speculators is Driving 

up Prices, Critics Say, Washington Post, June 6, 2008; Alan Bjerga and Matthew Leising, Tighter 

Agriculture Investing Rules; Regulator to Watch Futures Markets After Spike in Food Prices, The 

Washington Post, June 4, 2008; Margot Habiby and Edward Klump, Pickens Says CFTC Probe of Oil a 

‘Waste of Time,’ Bloomberg.com, June 3, 2008; David Nicklaus, It’s simple supply and demand, not a 

conspiracy, St. Louis Post-Dispatch, June 1, 2008; David Ivanovich, Are Speculators Fueling Oil Run-Up? 

 In the first half of 2008 alone, Congress held more than 40 
41

hearings examining commodity prices, including the impact of increasing levels of 

speculation, most often with respect to crude oil and energy prices.38 Some analysts told 

Congress there was a direct cause-and-effect relationship between increasing speculation 

in the commodity markets and higher market prices. For example, Michael W. Masters, a 

hedge fund manager, testified before the Senate that “institutional investors are one of, if 

not the primary, factors affecting commodities prices today.”39 Masters noted that “in 

2007 Americans consumed 2.22 bushels of wheat per capita,” while the 1.3 billion 

bushels represented by the 2008 wheat futures contracts stockpiled by “Index Speculators

is enough to supply every American citizen with all the bread, pasta and baked goods 

they can eat for the next two years!”40 Other analysts categorically denied that 

speculative investments influenced 2008 prices. For example, one 2008 federal 

interagency task force stated that “the activity of market participants often described as 

‘speculators’ has not resulted in systematic changes in price of the last five and a half 

years.”41

 

Debate centers on investors’ rush to cash in on crude, Houston Chronicle, May 25, 2008; Steven Mufson, 

Skyrocketing Oil Prices Stump Experts, Washington Post, May 22, 2008; Lananh Nguyen and Nick Heath, 

Crude Logic: Spot-Market Supplies Are Plentiful, But Futures Extend Surge, Wall Street Journal, May 21, 

2008; Mark Shenk, Crude Oil Rises Above $130 as Banks Increase Price Forecasts, Bloomberg.com, May 

21, 2008; Gene Epstein, Commodities: Who’s Behind the Boom?, Barron’s, March 31, 2008. 

 

38 Diana B. Henriques, Bills to Rein in Energy Speculators Worry Financial Industry, New York Times, 

July 18, 2008, at p. 1. 

39 Testimony of Michael W. Masters before the Senate Committee on Homeland Security and 

Governmental Affairs, May 20, 2008, at p. 1 (available at 

http://hsgac.senate.gov/public/_files/052008Masters.pdf). See also Statement of Tom Buis, President, 

National Farmers Union, Before the House Agriculture Committee, February 3, 2009 (available at 

http://nfu.org/wp-content/2-3-09-cftc-regulation-expansion_house-ag.pdf) (“As speculators created a 

market bubble and attitude that higher prices were set to stay, crop, livestock and dairy producers locked in 

higher inputs and feed costs.”). 

40 Id., at p. 2.

41 Interagency Task Force on Commodity Markets, Interim Report on Crude Oil, July 2008, at p. 1. See 

also, e.g., Merrill Lynch, Are speculators driving commodity prices higher?, Global Energy Weekly, June 

17, 2008 (“After analyzing the available data in detail, we find no link between spec[ulative] activity and 

systematic price increases in commodity markets.”). 

Still others took a middle position. For example, Professor Christopher L. Gilbert writes, “Because indexbased investment is still a relatively recent development, empirical evidence [of price effects] remains 

sparse.” Gilbert then states:

“The two polar positions on the effects of futures market activity on agricultural prices both 

appear too simple. On the one hand, the efficient markets view that transactions which do not 

convey information can have no price impact is contradicted by both market experience and 

econometric evidence. On the other hand, purely speculative episodes, in which price movements 

become self-reinforcing, tend to be of short duration. Although discussion tends to focus on 

speculation, it is investment flows that may have resulted in the most marked effects on food 

prices. The size of these flows can be large relative to overall market capitalization and liquidity. 

Since commodity investors tend to look at the likely returns to commodities as a class, and not as 
42

In a study that concentrated on agricultural commodities, published just prior to 

the price collapse near the end of 2008, the U.S. Department of Agriculture’s Economic 

Research Service reported that no single factor, but rather “many factors have contributed 

to the runup in food commodity prices.”42 USDA provided a long list of those factors, 

including “increased global demand for biofuels feedstocks43 ... adverse weather 

conditions in 2006 and 200744 ... the declining value of the U.S. dollar, rising energy 

prices, increasing agricultural costs of production, growing foreign exchange holdings by 

major food-importing countries, and policies adopted recently by some exporting and 

importing countries to mitigate their own food price inflation.”45 The USDA report also 

cited a slowdown in growth in agricultural production, the increased difficulty in 

obtaining water for agricultural uses, rising populations, increased economic growth, and 

dietary shifts in developing nations, including increased meat consumption resulting in 

increased demand for grain and protein feeds for livestock, as prime reasons for these 

price increases.

46

 

likely returns on specific markets, their activities may tend to transmit upward (or downward) 

movements in one market across the entire range of commodity futures markets. This is likely to 

have resulted in upward pressure in the less liquid agricultural markets and to increased price 

correlation across markets. It may also have transmitted upward price movements in energy and 

metals markets into the agricultural commodities.” 

 

Christopher L. Gilbert, Universita Degli Studi Di Trento, Dipartmento Di Economia, How to Understand 

High Food Prices, revision 17 November 2008; available at http://portale.unitn.it/bpmappupload/download/fstore/7f0000016c9f2f72_186c6b2_11e1bdac6d3_-765b/23_08_Gilbert.pdf.

42 Ronald Trostle, USDA Economic Research Service, Global Agricultural Supply and Demand: Factors 

Contributing to the Recent Increase in Food Commodity Prices (July 2008, Revised).

43 The Energy Policy Act of 2005 mandated the use of 7.5 billion gallons of renewable fuel by 2012. Sec. 

1501, P.L. 109-58, 119 Stat. 594 (109th Cong., 1st Sess.). In the Energy Independence and Security Act of 

2007, Congress increased the requirement for biofuels to 36 billion gallons by 2022, and specified that 21 

billion gallons of this total must be derived from non-cornstarch products, such as sugar or cellulose. P.L. 

110-140, 121 Stat. 1492 (2007). 

44 The adverse weather conditions in 2006 included droughts in Russia, Ukraine, Australia, and South 

Africa. In 2007: Northern Europe experienced a dry spring and harvest-time floods; southeast Europe, 

northwestern Africa, and Turkey experienced drought; the drought in Russia and Ukraine continued for a 

second year; it was unusually hot and dry during the growing season in Canada; late freezes significantly 

reduced the yield of U.S. hard red winter wheat crops and the corn and barley crops in Argentina; and 

Australia experienced a third year of its worst drought in a century. Trostle, at pp. 20-21.

45 Id.

46 A recent study by the Farm Foundation identified similar factors. “The real and much more complex 

answer involves economic growth, international trade, currency markets, oil prices, government policies, 

and bad weather.” Farm Foundation, Issue Report, What’s Driving Food Prices? (by Philip C. Abbott, 

Christopher Hurt, Wallace E. Tyler), July 2008, at p. 5. The Farm Foundation listed the following factors 

as underlying the price increases: growing food demand and dietary transition to more animal protein in 

developing countries resulting in global consumption increasing faster than production; lower level of 

investment in agricultural research leading to lower growth in productivity in commodity production; bad 

weather and crop disease issues in 2006-2007; increasing mandates and subsidies for biofuels; depreciation 
43

On the question of speculation, the USDA report noted the presence of increasing 

investments in agricultural commodity markets by hedge funds, commodity index funds, 

and others. The report observed that these speculative investments had constituted an 

increasing share of agricultural futures contracts and might have increased short-term 

price volatility, but stopped short of reaching any conclusion about the extent to which

speculation contributed to the 2008 rise and fall in commodity prices. The USDA report 

stated:

“The funds held an increasingly large percentage of open interest in the futures 

market for agricultural commodities, as well as of nonagricultural commodities 

such as metals and energy. These investors only had a financial interest in the 

markets and did not intend to take delivery of the agricultural commodities. 

Indeed, it is likely that in general, neither the investors nor the financial managers 

that directed the funds’ investments knew much about the fundamentals of 

agricultural commodity markets. It is unclear to what extent the effect of these 

new investor interests had on prices and the underlying supply and demand 

relationships for agricultural products. However, computerized trend-following 

trading practices employed by many of these funds may have increased the shortterm volatility of agricultural prices.”47

In September 2008, in response to mounting concerns that speculators were 

pushing up commodity prices to levels that had no relationship to supply or demand for 

the commodities involved, the U.S. House of Representatives passed legislation to 

 

of the dollar relative to the Euro and other world currencies; increases in the price of crude oil; and other 

production cost increases. Id., at p. 48-9. 

47 Trostle, at p. 20. Like the USDA, the Farm Foundation identified increased speculation as a possible 

cause, but declined to draw any conclusions: “There is no doubt that the amount of hedge fund and other 

new monies in the commodity markets has mushroomed. Price volatility has increased, partly due to 

increased trading volumes. Based on existing research, it is impossible to say whether price levels have 

been influenced by speculative activity.” Id., at p. 20. Generally, there have always been substantial 

analytical challenges using the available market data in attempting to determine the effects of different 

levels of speculation on commodity prices. In its 2006 Report, The Role of Market Speculation in Rising 

Oil and Gas Prices: A Need to Put the Cop Back on the Beat, the Subcommittee found that the recent 

influx of billions of dollars into hedge funds, index funds, and other commodity investments had indeed 

contributed to rising energy prices, but also “gaps in available market data currently impede analysis of the 

specific amount of speculation, the commodity trades involved, the markets affected, and the extent of 

price impacts.” “It is likely that economists will continue to search for direct links between imbalances in 

hedging needs, speculative positions, and speculative returns. The intuitive appeal of the connection is 

almost inviolate although the empirical evidence is at best mixed.” Peck, Futures Markets: Their 

Economic Role, at p. 28. In 1941, G. Wright Hoffman, consulting economist to the USDA’s Commodity 

Exchange Authority (predecessor to the CFTC), wrote of the difficulty in measuring the effect of 

speculation on grain prices: “It is extremely difficult to measure with accuracy the relative importance of 

underlying trade facts as price determinants; because of this fact, it is equally difficult to measure precisely 

the importance of those forces which are generated largely within the market.” G. Wright Hoffman, U.S. 

Department of Agriculture, Technical Bulletin No. 747, Grain Prices and the Futures Market: A 15-year 

Survey, 1923-1938 (January 1941), at p. 9. 
44

impose more stringent limits on speculation in the commodity markets. 48 Among other 

provisions, the bill directed the CFTC to establish position limits for all commodities 

traded on CFTC-regulated futures exchanges, and authorized the CFTC to impose such 

limits on over-the-counter commodity transactions. While the House-passed bill was not 

taken up in the Senate, 10 other bills were introduced by more than 30 Senators to stop 

excessive speculation in the commodity markets.49

2. Effects of Commodity Price Spikes on Farmers and Grain 

Elevators

 

Much of the reason for Congressional attention to the commodity markets is the 

dramatic impact that commodity price increases have on the U.S. economy. The steep 

rise and sudden collapse in grain prices, for example, severely strained farmers and other 

participants in the grain industry. In particular, the increase in crude oil prices, which 

peaked at a record-high of $147 per barrel in July 2008, pushed up the price of other 

refined products like gasoline and diesel fuel to record highs, and contributed to increased 

prices for natural gas and fertilizer. Record-high fuel and fertilizer prices significantly 

increased the costs of farmers growing grain, the farmers and grain merchants

transporting grain crops to markets, the processors of these crops, and, ultimately, the 

consumers of those crops and the foods produced from them. 

At some points during 2008, grain prices rose to record highs, but farmers and 

grain merchants often were unable to realize the benefits of those higher prices. In March 

2009, for example, the USDA reported that although U.S. wheat prices had remained 

high by historical standards, high farming costs, particularly for energy and fertilizer, had

“offset this unprecedented runup in wheat prices for producers.”50 Moreover, in some 

instances prices fell sharply before the affected crops could be sold or hedges locked in. 

In other instances, rising prices led to higher margin calls and cash outlays for farmers, 

grain elevators, and grain merchants who had sold futures to hedge their cash crops. 

 48 H.R. 6604 (September 22, 2008).

49 S. 3122 (Cantwell, Snowe); S. 3130 (Durbin, Reid, Levin, Bingaman, Dorgan, Feinstein, Klobuchar, 

Menendez, Brown, Casey, Kerry, Leahy, Murray, Mikulski, Obama, Reed); S. 3131 (Feinstein, Stevens); S. 

3134 (Nelson-FL); S. 3183 (Dorgan, Nelson-FL, Carper); S. 3185 (Cantwell, Whitehouse, Sanders, Kerry, 

Wyden, Nelson-FL); S. 3248 (Lieberman, Collins, Cantwell); S. 3255 (Levin, Feinstein); S. 3268 (Reid, 

Durbin, Dorgan, Murray, Schumer, Casey, Mikulski, Carper, Klobuchar, Brown, Cardin, Leahy, 

Menendez, Reid, Lautenberg, Wyden, Johnson, Dodd); and S. 3577 (Levin, Bingaman, Harkin). 

50 Mir Ali and Gary Vocke, Consequences of Higher Input Costs and Wheat Prices for U.S. Wheat 

Producers, USDA Economic Research Service, March 2009, at p. 2.
45

The National Farmers Union described the financial impact upon many farmers: 

“As speculators created a market bubble and attitude that higher prices 

were set to stay, crop, livestock and dairy producers locked in higher 

inputs and feed costs. The false signals were not reserved for agricultural 

producers, but extended beyond production agriculture to the ethanol and 

biodiesel industries and input suppliers, all locking in higher feedstocks 

and supplies. The 2008 economic collapse and bursting of [the] bubble 

have jeopardized the economic livelihoods of all these players, which will 

ripple throughout our rural communities. . . . 

“As you can imagine, it was very frustrating for farmers who were paying 

record amounts for inputs, but could not implement effective marketing 

plans or strategies to take advantage of the higher prices for their crops.”51

The general increase in commodity prices also severely impaired the ability of 

many grain elevators to buy and sell grain. Elevators are a critical link in the marketing 

chain for wheat and other grains. A publication by the Federal Reserve Bank of Kansas 

City explains:

“Since their emergence in the mid-1800s, grain elevators have earned 

income by collecting, storing, and readying grain for transportation. 

Smaller, country grain elevators collect grain from farmers, hold it in 

storage, and coordinate transportation to final end users or larger terminal 

elevators, which coordinate larger shipments to other domestic or 

international users. The grain held in storage is either owned by the 

elevator or by the farmers, who pay storage fees.”52

Grain elevators usually purchase grain from farmers with cash purchases or 

forward contracts which set a specified date in the future for the delivery of the 

commodity.

 

“In a forward contract, an elevator agrees to purchase a quantity of grain from a 

farmer at a specified quality or grade to be delivered on a future date at an agreedon price. Forward contracts are typically consummated pre-harvest, allowing 

farmers to guarantee a crop price and eliminate the risk of falling crop prices as 

harvest approaches.”53

 51 Testimony of Tom Buis, National Farmers Union, before the U.S. House of Representatives Agriculture 

Committee, February 3, 2009. 

 

52 Jason Henderson and Nancy Fitzgerald, Can Grain Elevators Survive Record Crop Prices?, The Main 

Street Economist, Federal Reserve Bank of Kansas City, Vol. iii, Issue III (2008). “According to the 2002 

Economic Census, grain elevators operated in almost 6,000 locations and employed over 61,000 workers. 

Grain elevators generated almost $90 billion in sales and revenue.” Id. 

53 Id. 
46

Many grain elevators, particularly co-operatives owned by farmers, also sell seed, 

fertilizer and other items that farmers need. 

In order to protect themselves from the risk of falling crop prices, elevators 

usually hedge their cash or forward purchases by entering into futures contracts on the 

futures exchanges to sell the grain at a price they expect will cover their expenses. Grain 

elevators that possess grain in storage are said to be “long” in the cash market; when they 

enter into futures contracts to sell that grain in a future month, they are said to be “short” 

in the futures market. Once the purchase of a cash crop is hedged with a futures contract, 

any decline in the value of the crop in the cash market should be offset with a gain in the 

futures market.54

Even if an elevator is completely hedged – so that the elevator will have “locked 

in” a gain regardless of the direction of the market – a steeply rising market can impose 

significant additional costs upon the elevator operator. In a rising market, grain elevators 

and merchants that have hedged by selling futures may be subject to margin calls from 

the exchanges to cover the loss in value of their “short” positions. These margin calls, 

which are made at the end of each trading day, require payments by the grain elevator or 

other party to the futures exchanges into a margin account. The amounts in the margin 

account are not recovered by the elevator until the short position is closed out – in this 

case, until the elevator sells its grain and terminates the hedge. If a grain elevator cannot 

make the requisite margin payments, the exchange will close out its position at the 

current market price, possibly causing further losses. 

 

In 2008, rising grain prices in the cash markets, together with rising margin calls, 

required many grain elevators to make much larger cash outlays than normal. The 

National Grain and Feed Association estimated that a typical grain elevator faced a 300% 

increase in hedging costs in 2008, compared to 2006.55 It stated that “recent commodity 

price increases have led to unprecedented borrowing by elevators – and unprecedented 

lending by their bankers – to finance inventory and maintain hedge margins.”56

According to the Federal Reserve Bank of Kansas City, in the first quarter of 

2008, the Farm Credit System “raised $10 billion in funds through the sale of debt 

 

 54 At the same time, any gain in the cash market due to an appreciation in the price of the commodity in the 

cash market should be offset by a loss in the futures market. That is why a hedging strategy prevents gains 

as well as losses due to changes in the value of the commodity and should leave the hedged party 

indifferent to price changes. Hedging is more fully described in Section III of this Report. 

55 National Grain and Feed Association, Effects of a Changed Marketplace on Elevators, Producers

(document provided to the Subcommittee). 

56 Id.
47

securities to meet increasing demand from elevators and other processing and marketing 

entities.”57 In April 2008, the Federal Reserve Bank of Kansas City reported that nearly 

one-quarter of all grain elevators it surveyed were struggling to acquire the cash needed 

to manage margin calls; about 40 percent stated they had “enough cash to just manage 

current margin calls.”58

Another factor compounding the financial difficulties of farmers, grain elevators, 

grain merchants, and producers during much of 2008 was the large difference between 

the price of wheat on the futures market and the price of wheat in the cash market. For 

much of the year, futures prices for wheat were significantly higher than prices in the 

cash market – up to $2 per bushel more. During the seven-month period from May 

through December when the price of wheat in the cash market ranged from $3.12 to 

$7.31 per bushel, the price of wheat ranged from $4.57 to $9.24 in the futures market.

 

59 

Hence, when farmers and elevators actually sold their wheat in the cash market, they 

actually received up to $2 per bushel less than they had initially expected based upon the 

prices in the futures market.60

In January 2008, the National Grain and Feed Association reported on the dire 

consequences throughout the grain marketing system from the failure of the futures 

markets to provide reliable hedging of future crop prices:

 As explained in the following sections of this Report, the 

persistence of this large price difference between the futures price and the cash price has 

seriously impaired the basic function and purpose of the futures markets, which is to 

provide a means for commodity producers, marketers, and consumers to manage their 

price risks. 

“As banks have begun to question hedging performance in futures 

positions, borrowing lines have been stretched to the limit or beyond. 

Banks are beginning to restrict financing to some companies. Elevators 

and other grain buyers have been forced by market conditions to liquidate 

inventories. Cash basis levels [the difference between the futures and cash 

prices] are widening in reflection of much higher financing costs that now 

are being forced into the system – if, indeed, financing remains available 

 57 Can Grain Elevators Survive Record Crop Prices?, at p. 4. 

58 Esther George, Senior Vice President, Supervision and Risk Management, Federal Reserve Bank of 

Kansas City, Remarks for CFTC Public Meeting on April 22, 2008. One bank reported to the Federal 

Reserve that the line of credit to one elevator had risen from $7 million to $57 million and required the 

participation of three banks. Can Grain Elevators Survive Record Crop Prices?, at p. 3. 

59 Cash market prices are based upon the MGEX index price. 

60 As explained in the Section III, this loss to the farmers and elevators was due to the large difference 

between the futures and cash prices (basis) together with the lack of convergence between the cash and 

futures prices as the futures contracts expired. 
48

at all. In some cases companies have eliminated deferred cash bids 

altogether.”61

The National Grain and Feed Association attributed the large differences between 

the futures prices and the cash prices for grain, in part, to the influx of futures purchases

being made by commodity index investors and other speculators. “We also believe that 

the poor market performance we are experiencing is influenced by new investors 

targeting agriculture with the aid of the hedge exemption.”

 

62 Similarly, the American 

Bakers Association informed the CFTC of its concern that, as a result of increasing 

commodity index trading, “the commodity exchanges have moved away from their 

original intent – to allow producers to sell their product in a transparent, regulated 

manner to physical users of the commodity.”63 One grain market analyst likened 

commodity index trading to a “900-pound gorilla” in the commodity futures markets: “A 

900-pound gorilla doesn’t intend to level things in its path, but that may be the result 

simply due to its sheer size.”64

The cash flow problems of many grain elevators directly affected many farmers. 

As grain elevators struggled to find cash to meet margin calls, they began to reduce their 

cash purchases, pull back on the forward contracts offered to farmers, and lower the 

prices offered to farmers for their crops. The National Association of Wheat Growers 

reported in April 2008:

 

“The result of financial pressure on country elevators can be withdrawal of 

bids (no local market for cash grain), withdrawal of forward pricing 

opportunities (because the elevators can’t hedge those forward prices) and 

wider basis levels. Basis levels have increased by more than 50 cents in 

recent weeks because of the increased cost and risk being borne by grain 

merchants as well as a perception that the futures price was in some cases 

overinflated.” 65

The Federal Reserve Bank reported that as a result of increased margin calls and 

constrained credit lines, “some grain elevators have limited (and in some cases 

eliminated) their offerings of forward, basis and other contracts to limit further strains on 

 

 61 Letter from Rod Clark, Chair, Risk Management Committee, to David Stawick, Secretary, Commodity 

Futures Trading Commission, January 21, 2008.

62 Id. 

63 Letter from American Bakers Association to The Honorable Walt Lukken, Chair, Commodity Futures 

Trading Commission, May 7, 2008.

64 Diana Klemme, When Gorillas Migrate, feedandgrain.com, July 8, 2008, at 

http://www.feedandgrain.com. 

65 National Association of Wheat Growers, NAWG Comments on Futures Markets, Prepared for 

Commodity Markets Council forum, April 3, 2008 and CFTC forum, April 22, 2008.
49

cash flows.”66 The Federal Reserve Bank also reported that some elevators had begun to 

require farmers to pre-pay for seed and fertilizer.67

Farmers who used the futures markets themselves to hedge the sales of their crops 

were subject to the same financial stresses as the elevators.

 

68 “If you’ve got 50,000 

bushels hedged and the market moves up 20 cents, that would be a $10,000 day,” one 

farmer observed. “If you only had $10,000 in your margin account, you’d have to sit 

down and write a check. You can see $10,000 disappear overnight. . . . Everybody has 

a story about a guy they know getting blown out of his hedge.”69 “This is something the 

farmer didn’t have to worry about before,” a broker noted. “It’s a cruel and unforgiving 

system.”70

The following sections of this Report examine the interaction of the cash and 

futures markets that contributed to this financial turmoil, the role of speculation through 

commodity index trading that has helped disrupt the functioning of these markets, and 

how regulatory actions to date have contributed to these market problems. 

 66 Id.

67 Can Grain Elevators Survive Record Crop Prices?, at p. 3. 

68 Several recent estimates indicate that a relatively small percentage of farmers directly use the futures 

markets for hedging. Instead, most farmers rely upon grain elevators and other grain buyers to obtain 

forward contracts for their crops. The National Corn Growers Association recently stated: “By one 

estimate, probably less than 10% of farmers are directly using the futures market for risk management.” 

Statement of Garry Niemeyer, National Corn Growers Association, Agricultural Markets Roundtable, 

Commodity Futures Trading Commission, April 22, 2008. Another article reported: “in a sample of 

Kansas producers ... only 11% hedged any of their grain using futures. [Several studies] consistently 

showed that more producers used forward contracts than used futures hedges. These studies showed that 

42-74% of producers used forward contracts to price any of their grain.” Darrell R. Mark, B. Wade 

Brorsen, Kim B. Anderson and Rebecca M. Small, Price Risk Management Alternatives for Farmers in the 

Absence of Forward Contracts with Grain Merchants, Choices, 2nd Quarter 2008. Grain industry

participants interviewed by the Subcommittee generally concurred with these statistics. The Mark-Brorsen

article, written in mid-2008, also stated: “At the same time when farmers have a greater demand for cash 

forward contracts, grain merchants and elevator operators now have limited capacity to offer these 

contracts. The extra costs associated with margin accounts and extra working capital have been reflected in 

lower forward basis bids for corn, soybeans, and wheat in many Midwest and Corn Belt states.” Id. 

69 Diana B. Henriques, Price Volatility Adds to Worry on U.S. Farms, The New York Times, April 22, 

2008.

70 Id. 
50

“During the seven years of plenty the land brought forth abundantly. . . . Thus

Joseph stored up grain in great abundance like the sand of the sea, until he 

stopped measuring it, for it was beyond measure.”

--Genesis 41: 47-9

III. HEDGING AND SPECULATION IN THE FUTURES MARKETS

Wheat farmers, grain merchants, millers, commercial wheat users, speculators, 

and others use a variety of trading strategies in both the cash and futures markets for 

wheat to deal with changing prices in these markets. To understand some of these basic 

strategies and the breakdown in the relationship between these two markets over the past 

several years, this section provides additional information about the purposes of 

commodity futures markets, the meaning of certain market terms, and the role of CFTC 

position limits and exemptions. It discusses in particular the risk management and price 

discovery functions of the commodity markets, the concepts of hedging versus 

speculation, the importance of price convergence between the cash and futures markets, 

and key terms such as basis, price spreads, and carry. This section also discusses the 

development and application of CFTC position limits on agricultural commodity trades 

and the hedging exemption that allows some market participants to exceed those limits. 

A. Purposes of the Futures Market 

U.S. commodity futures markets developed in the mid-nineteenth century to meet 

the commercial needs of expanding U.S. grain markets. As local grain markets supplied 

wheat and other grains across the nation and then around the world through improved 

transportation and technology, grain merchants relied increasingly on forward contracts 

to manage price risks and sell grain across ever-increasing distances and periods of time. 

Forward contracts, like spot or cash transactions, typically call for delivery of a 

specified quantity and quality of a commodity at a particular time and place, and at an 

agreed-upon price. Forward contracts can call for any amount or type of grain to be 

delivered at any time or location. Particularized forward contracts are, however, 

relatively illiquid, meaning they cannot be easily traded to other parties who may not 

want delivery at the specified amount, time, and place. 

Futures contracts developed as essentially standardized forward contracts. A 

noted expert on commodity markets, Professor Anne Peck, explained: “Futures contracts 

are standardized forward contracts, and futures markets are organized trading of those 

contracts.”71

 71 Peck, The Economic Role of Traditional Commodity Futures Markets, at p. 11. 

 Futures contracts offer a standard quantity and quality of a commodity for 

delivery at a standard time and location. The only variable to be negotiated in a 
51

standardized futures contract is price. Standardized futures contracts are therefore of 

broader utility than forward contracts, and the market for these contracts is more liquid, 

meaning that it is easier to find a counterparty with which to trade. 

The ultimate purpose of commodity markets is to help buyers and sellers price 

their goods efficiently and manage risks associated with price changes. Professor 

Hieronymus put it this way:

“The basic impetus for futures markets related to inventory risks, and 

financing and pricing problems. As commerce developed and required the 

accumulation of inventories, particularly of seasonally produced crops, 

merchants and processors found themselves with problems that were best 

managed by forward contracting. This forward contracting developed into 

standardized procedures that were eventually codified and formalized into 

futures trading.”72

One key problem in the commodity futures markets is that typically there are an 

insufficient number of purchasers of a commodity who have the need and ability to trade 

futures contracts to match the number of sellers of futures contracts in the futures market. 

The ultimate purchasers of a commodity are often smaller in size, need smaller quantities 

of the commodity, and have less capital than the producers of the commodity. Smaller 

end-users often do not have a sufficient need or the resources to participate in the futures 

markets. For example, while oil companies that refine gasoline trade on the futures 

markets to hedge their sales of gasoline, it would be prohibitively expensive for the 

average driver to use the futures market to hedge his or her weekly purchases at the 

pump.73

To make up for the shortage of purchasers, commodity markets rely on other 

types of participants in the market – namely, speculators – to provide a sufficient number 

of counterparties to the physical producers, processors, and merchants in the market. The 

typical definition of a speculator is a market participant who does not produce, use or 

consume the commodity in its ordinary course of business, but rather enters the futures 

market solely to profit from changes in commodity prices.

 

74

 72 Hieronymus, at p. 93.

 

73 The standard futures contract for gasoline calls for delivery of 42,000 gallons of gasoline. For a car that 

gets 24 miles per gallon, this would be a sufficient amount of gasoline to drive about 1 million miles. 

Presently, the margin deposit required for a typical consumer to purchase a single futures contract would be 

about $9,400. 

74 The CFTC defines the term “speculator” as “one who does not produce or use a commodity, but risks his 

or her own capital trading futures in that commodity in hopes of making a profit on price changes.” CFTC, 

The Economic Purpose of Futures Markets and How They Work (CFTC website).
52

Although buying and selling futures contracts by speculators is often essential to 

provide sufficient liquidity to a futures market, the participation of these speculators does 

not change the fundamental nature or purpose of these markets, which is to enable the 

producers, merchants, and users of the commodity to price the commodity efficiently and 

manage their price risks over time. The ability and willingness of the physical producers, 

merchants, and end-users of a commodity to use the futures market to establish prices and 

manage their price risks is a prerequisite for the participation of speculators. 

The history of the commodity futures markets demonstrates that futures markets 

cannot exist if they do not accomplish their intended purpose of enabling the producers, 

merchants, and end-users of a commodity to establish prices and effectively manage their 

price risks. Holbrook Working, one of the pioneers in the field of the economics of the 

futures markets, observed: “A futures market [can] succeed only to the degree that it 

[can] attract business from handlers of the commodity.”75 There are many examples of 

markets that lost liquidity and went out of existence because the producers and end-users 

of the commodity lost confidence in the ability of the market to help them price their 

goods and manage risk.76

“Futures markets in agricultural and metals products have become the 

primary markets determining underlying values, and all other transactions, 

spot and forward, are priced in relation to these prices with due allowance 

for time, place, and quality differences. Both spot and forward market 

transactions remain important since they are the primary means by which 

commodity ownership is actually transferred. These transactions are not 

 In a 1980 study, commodities expert Professor Peck 

summarized the contemporary importance of the futures markets to setting prices in the 

cash markets for agricultural commodities:

 75 Holbrook Working, Economic Functions of Futures Markets, reprinted in Selected Writings of Holbrook 

Working (Chicago Board of Trade, 1985), at p. 274. 

76 The demise of the futures market for Maine potatoes is the classic example of this proposition. Another 

example is the futures market for onions, which Congress prohibited by legislation in 1958, at the request 

of the onion growers. Following an outcry from onion farmers that the “the gyrations of the futures 

market” were unreasonably affecting the cash price for onions, the Congress first attempted to subject the 

onion futures market to regulation under the Commodity Exchange Act. Prohibiting Futures Trading in 

Onions, H. Rept. 1036, 85th Cong., 1st Sess. (1957). When that failed to stop the price fluctuations, 

Congress completely prohibited onion futures. The Senate report on the bill to prohibit the trading of onion 

futures declared: “It now appears that speculative activity in the futures markets causes such severe and 

unwarranted fluctuations in the price of cash onions as to require complete prohibition of onion futures 

trading in order to assure the orderly flow of onions in interstate commerce.” Prohibiting Futures Trading 

in Onions, S. Rept. 1631, 85th Cong., 2nd Sess. (1958). The futures markets for cured pork, durum wheat, 

and eggs are additional examples. See Holbrook Working, Speculation on Hedging Markets, Food 

Research Institute Studies, Stanford University, Vol I., No. 2 (May, 1960) (available in farmdoc archives); 

Holbrook Working, Economic Functions of Futures Markets, reprinted in Selected Writings of Holbrook 

Working (Chicago Board of Trade, 1985), at pp. 267-9; Diane S. Miracle, The Egg Futures Market: 1940 

to 1966, Food Research Institute Studies, Stanford University (1972) (available in farmdoc archives). 
53

made independently of market prices, however, and futures positions are 

often necessary components of the total transactions.”77

Professor Peck also described managing price risk as the central function of the 

futures markets:

“Futures markets are hedging markets. Their use reflects the commercial 

needs of firms simultaneously operating in the cash markets. Speculation 

is required on futures markets as a response to commercial needs and can 

be best understood as offsetting both the long and the short hedging 

positions of commercials, not their net positions. Measures of minimum 

speculative needs on a market ought to reflect total hedging requirements 

of the commercial users of that market.”78

In drafting the Commodity Exchange Act, Congress established a regulatory 

framework which reflects the principle that the primary purposes of a commodities 

futures market are to enable market participants to manage and assume price risks and to 

discover and establish prices for commodities traded on the market. Section 3 of the 

Commodity Exchange Act states:

 

“The transactions subject to this Act are entered into regularly in interstate 

and international commerce and are affected with a national public interest 

by providing a means for managing and assuming price risks, discovering 

prices, or disseminating pricing information through trading in liquid, fair 

and financially secure trading facilities.”79

 77 Peck, The Economic Role of Traditional Futures Markets, at p. 13. 

78 Peck, The Influence of Hedging on Futures Markets Activity: Some Further Evidence, Stanford 

University (1980), at p. 19 (available in farmdoc archives). In arriving at this conclusion, Peck referenced 

similar findings of previous research done by Hoffman, Working, Sandor, and others, and examined more 

recent data (from 1972-77) from the wheat, corn, soybean, potato, live cattle, pork belly, T-bill, and GNMA 

markets. Working comments: “One can imagine existence of futures trading purely on the basis of desire 

of people to speculate; but apparently futures trading cannot long persist except on the basis of conditions 

that create speculative risks which somebody must carry, and which some people are led to transfer to 

others by hedging.” Holbrook Working, Futures Trading and Hedging, reprinted in Selected Writings of 

Holbrook Working (Chicago Board of Trade, 1985), at p. 140. 

79 7 U.S.C. §5 (2006). 
54

B. Use of Hedging to Manage Risks

1. Hedging versus Speculation 

“Hedging” is the term used to describe the activity of someone who is using the 

futures market to manage the price risks associated with the sale, purchase, or use of a 

commodity. Hedging has sometimes been described as an activity undertaken by the 

producer, merchant, or end-user of a commodity as opposed to a speculator who does not 

produce, use, or consume the commodity. Since there are numerous strategies and 

approaches to managing price risks, however, it often is impossible to distinguish, from 

an economic perspective, whether a particular transaction is, in fact, hedging or 

speculation.80 The line between minimizing risks – which is what the term “hedge” 

connotes – and maximizing profits – which is what the term “speculation” connotes – can 

be exceedingly difficult to draw.81

 80 In a recent report, the CFTC stated that the term “speculator” means “a trader who does not hedge, but 

who trades with the objective of achieving profits through the successful anticipation of outright price 

movements or through relative price movements in the case of spread trades.” CFTC, Staff Report on 

Commodity Swap Dealers & Index Traders with Commission Recommendations, September 2008, at p. 68. 

A distinction between hedging and speculating based on trader motive or intent is problematic, however, 

for several reasons. First, producers, merchants, and end-users of a commodity often use the futures market 

in a manner similar to many speculators “in hopes of making a profit on price changes.” Hedgers often 

trade with the “objective of achieving profits through the successful anticipation of . . . relative price 

movements.” Second, it often is impossible to discern a trader’s intent or motive, which in any event does 

not alter the economic consequences of the trader’s actions. 

 

Another view is that hedging and speculative transactions are inherently similar: “It is sometimes said that 

hedging is the opposite of speculation. This is not so. They are different kinds of the same thing. The 

thing that is usually identified as speculation – that is, long or short positions in futures contracts – is 

speculation in price level. The thing that we identify as hedging – that is, long cash and short futures or 

vice versa – is speculation in price relationships. . . . Thus hedging and speculation are not opposite; in 

fact, they are conceptually similar. They are just different kinds of speculation.” Hieronymus, at p. 151.

81 Whether or not to initiate a hedge may in fact involve speculation about the future course of the market, 

and may not, in fact, reduce costs. For example, as oil prices rose over $100 per barrel during the first half 

of 2008, oil-consuming businesses were faced with the decision of whether to hedge their future fuel 

purchases and lock-in record-high prices, or not to hedge, thereby facing the risk that oil prices and fuel 

costs would continue to rise. In light of the subsequent fall in prices in the latter half of the year, a firm that 

hedged its future fuel purchase with oil futures that were over $100 per barrel would have fared much 

worse than a firm that chose not to hedge and was therefore able to purchase their fuel at much lower costs 

as oil prices fell. 

Furthermore, speculation by hedgers regarding anticipated price levels can have the same effect on market 

prices as outright speculation by speculators. For example, a large increase in the amount of hedging 

undertaken by commercial firms to “lock in” the purchase price of a commodity in the belief that prices 

will increase will have the same effect upon absolute price levels as the purchases of the same number of 

futures contracts by speculators holding that same belief.

One former trader has described how he and other traders exploited the ambiguity between hedging and 

speculation to disguise the amount of speculative trading they had undertaken:

“The trading desks took more risk: instead of hedging, they took open positions, hoping to profit 

from movements in market prices. This risk taking was well disguised initially. We all found the 
55

Although a precise definition of hedging is elusive, one accepted definition is “the 

purchase or sale of a futures contract by a handler of commodities.”82 Another widely 

recognized definition of hedging is “the use of futures contracts as a temporary substitute 

for a merchandising contract that is to be made later.”83

2. Example of Hedging: The Grain Elevator 

 Both definitions encompass a 

variety of risk-management strategies. If the futures market is functioning properly, these 

hedging strategies can help manage price risks and improve the commercial profitability 

of the market participants employing them. If the futures market is not functioning 

properly, then these strategies will be ineffective, commodity producers, merchants, and 

end users will face increased financial risks, and the futures market will not be able to 

fulfill one of its primary purposes. 

To understand how the futures markets help manage risk and why lack of 

convergence between the futures and cash markets on prices is important, consider a 

straightforward example of hedging by a grain elevator.84

 

concept of a ‘hedge’ conveniently ambiguous. Traders would put on a ‘heavy’ hedge (we were 

overhedged) or a ‘light’ hedge (we were underhedged). As time went on, management and 

controls caught up. In a belated acknowledgment of the verities of the derivatives business, they 

put trading limits in place, recognizing that we actually needed to speculate to make budgets. 

‘Revenue is enhanced by judicious positioning on the back of natural trading flows,’ is how I put 

it in a more eloquent moment.”

 

Satyajit Das, Trader Guns & Money (FT Prentice Hall, 2006), at p. 42.

82 Jeffrey Williams, The Economic Function of Futures Markets (Cambridge University Press, 1986), at p. 

18. Williams also writes: “Hedging operations, which comprise one transaction in a futures market and a 

simultaneous transaction in the cash market, are central to futures markets. From the very word itself, it 

can be seen that hedging is commonly associated with risk aversion. That association, however, results 

from confusion on the part of observers who have failed to understand the nature of hedging as one of two 

simultaneous transactions. . . . It is by no means obvious that risk aversion motivates dealers’ hedging 

operations.” Id., at p. 19. 

83 Working, Whose Markets? Evidence on Some Aspects of Futures Trading, at p. 252. In another article, 

Working states: “[T]he general concept of hedging as taking offsetting risks wholly, or even primarily, for 

the sake of reducing net risks, serves so badly as applied to most hedging on futures markets that we need 

another concept for that most common sort of hedging. To put it briefly, we may say that hedging in 

commodity futures involves the purchase or sale of futures in conjunction with another commitment, 

usually in the expectation of a favorable change in the relation between spot and futures prices.” Working, 

Futures Trading and Hedging, at p. 149 (emphasis in original). Peck comments that, “Working’s summary 

definition is perhaps as all-encompassing as is possible.” Peck, The Economic Role of Traditional Futures 

Markets, at p. 13. Hieronymus defines hedging more narrowly, but is still consistent with Working’s 

formulation: “To hedge is to take a position in futures equal and opposite to an existing cash position . . . 

[and] to insulate one’s business activities from price level speculation while retaining the opportunity to 

speculate in basis variation. This definition takes hedging out of the context of risk shifting and puts it in 

the business context of trying to make a profit.” Hieronymus, at p. 150. 

84 Other participants that buy and sell unprocessed or processed grain, such as farmers, grain processors, 

merchants, and commercial end-users often employ similar strategies to manage their price risks. For the 
56

When a grain elevator purchases a crop from a farmer and stores it, that elevator 

is said to be “long” in that crop in the cash market. Typically, grain elevators are filled 

shortly after a crop is harvested; the crops in the elevators are then sold throughout the 

year. Once grain is purchased and loaded into storage in the elevator, the value of the 

stored grain is fully exposed to the changes in the value of that crop in the cash market. 

As the price of the crop in the cash market increases, the value of the crop in storage 

increases, and as the price in the cash market decreases, the value of the crop in storage 

decreases. In a declining market the elevator could face significant losses. 

To protect itself against a potential loss in value of a cash crop in storage prior to 

the date the crop will actually be sold, the elevator can sell a contract for the future 

delivery of that commodity on a futures exchange. In determining which futures contract 

to use, the elevator would typically select the futures contract that calls for delivery of the 

commodity in the month that is closest to the date on which the elevator anticipates 

making the actual sale of the stored grain. Rather than waiting for the actual date of sale 

in the cash market to determine the sales price, by selling a futures contract the elevator 

would immediately know how much it would receive for the sale of the grain – namely 

the price of the futures contract it had just sold. By selling a futures contract to deliver 

the commodity, at a price determined today for delivery at a specified time in the future, 

the elevator can use the futures market to protect the value of its stored grain. The 

elevator is then said to be “hedged,” because it has both a long position in the cash 

market and an equal and opposite “short” position in the futures market. 

 

sake of simplicity, the example refers solely to a grain elevator and not to other participants in the grain 

trade. 
57

 

2

3

4

5

6

7

8

7/1 8/1 9/1 10/1 11/1 12/1 1/1

$/bushel

Price of December 

futures contract

Cash 

price

+$2

July 15

Dec 15

Example of a Hedge 

(With Convergence)

0 BUY @ 

$3/bu.

SELL @ 

$3/bu. Dec. 15 

+$2/bu. SELL @ 

$6/bu.

BUY @ 

$4/bu. July 15 

Net Futures 

Market 

Cash 

Market 

Net gain: +$2/bu.

The futures price and cash 

price converge at expiration 

of the futures contract

Figure 17a. In this example, the futures price and the cash price have converged to 

exactly the same price. 

For example, consider the case of a grain elevator that purchases a crop from a 

farmer on July 15 for $4 per bushel, as illustrated in Figure 17a. The grain elevator wants 

to ensure that the value of its crop in storage will not fall before it sells the wheat in 

December. The elevator looks up the price of wheat futures on the Chicago exchange 

and sees there are futures contracts for March, May, July, September, and December. 

The price of the December futures contract is currently $6 per bushel. The grain elevator 

figures that if it can sell the crop for $6 per bushel in December, then it will be able to 

realize a decent profit after subtracting the purchase price of the grain and the costs of 

storing the grain from July to December. The elevator operator calls a commodities 

broker (technically, a “futures commission merchant”) and puts in an order to sell 

December futures at $6 per bushel. As of July 15, therefore, the elevator has bought 

grain in the cash market for $4 per bushel, and sold it in the futures market for $6 per 

bushel, for a net gain of $2 per bushel. 

The grain elevator is now hedged, having both a long position in the cash market 

and a short position in the futures market. Any gain or loss in the elevator’s long position 

in the cash market from increasing or decreasing prices between July and December 

should be offset by a loss or gain in the elevator’s short position in the futures market 
58

over that same time period. Thus, the elevator can expect a net gain of $2 per bushel 

from its hedging strategy. 

Hedging requires two sets of transactions. The first set of transactions is when the 

commodity is bought and a futures contract is sold. After the first transaction, the 

elevator’s books will reflect that it has acquired grain for $4 and that it has sold a futures 

contract for $6, for a net gain of $2 per bushel.85

The futures contract that the elevator sold in July requires grain to be delivered to 

an approved warehouse in December. The elevator, however, would prefer to sell its 

grain to a local elevator rather than incur the expense of shipping the grain to an approved 

warehouse. The purpose of its obtaining the futures contract was not to make an actual 

grain delivery in Chicago or Toledo in December, but to help the elevator manage its 

price risk. Accordingly, in December, the grain elevator will act to “unwind” the hedge it 

initiated in July. 

 The second set of transactions is just 

the opposite of the first set of transactions: the commodity is sold and a futures contract 

is bought. After these two sets of opposite transactions, the grain elevator will have 

bought and sold both the grain and the futures contracts used to hedge that grain. The 

success of the hedging strategy can be determined only after both sets of transactions are 

completed – the grain has been bought and sold and the elevator no longer has any 

outstanding futures contracts. 

To unwind its hedge, the elevator needs to buy a futures contract obligating it to 

take delivery of the same amount of wheat in December that its earlier futures contract 

obligated it to deliver in December. The December obligation to take delivery of the 

wheat would then cancel out its earlier obligation to make delivery of the wheat; since the 

two obligations would cancel each other out, the elevator would no longer have any 

obligations in the futures market. 

In the example depicted in Figure 17a, the price of a futures contract for 

December delivery is $3 per bushel. To unwind the hedge, therefore, the elevator would 

buy a futures contract for $3 per bushel. Its delivery obligations to make and take 

delivery would cancel out, and the elevator would be left with a $3 gain in the futures 

market – in July it had sold a December futures contract for $6 and in December it 

purchased a December futures contract for $3. 

At the same time, the elevator would sell the grain in the local cash market for $3 

per bushel. Overall, in the cash market the elevator would have lost $1 per bushel – it 

 85 Although the grain elevator will have to make an immediate outlay of $4 in the cash market to obtain the 

grain, it will not receive anything from the sale of its futures contract until it closes out this contract on the 

futures exchange in December. In the interim, the net gain or loss from the sale of outstanding futures 

contract, using a daily mark-to-market accounting, remains within the margin account of the elevator on the 

exchange. 
59

had bought the grain for $4 in July and then sold it for $3 in December. Since it gained 

$3 in the futures market, however, the grain elevator’s hedge resulted in a total gain of $2 

per bushel – the same net gain that it sought to obtain when it initiated the hedge in July. 

As this example shows, the convergence of the wheat futures and cash prices in 

December is critical to the success of the elevator’s hedging strategy.86 Because the cash 

and futures prices were equal at contract expiration in December, it cost the elevator the 

same amount to “buy back” the futures contract as it received from selling its grain in the

cash market. That meant the two transactions in December to unwind the hedge – the $3 

per bushel transaction in the futures market and the $3 per bushel transaction in the cash 

market – resulted in no additional gain or loss, leaving the elevator with the same $2 per 

bushel gain on its wheat that it had sought to obtain in July when it initiated the hedge. In 

this manner, the elevator’s hedging strategy produced a net gain exactly equal to the 

amount that the elevator planned for when it initiated the hedge back in July.87

By simultaneously taking equal and opposite positions in the cash and futures 

markets, the grain elevator’s aim is to protect itself against fluctuations in the absolute 

price of wheat in the cash market. Instead of being exposed to the risk of price changes 

in the cash market, the grain elevator would then be subject only to the relative changes 

between the price in the cash market and the price in the futures market.

 

88

 86 In an actual futures market that is functioning properly, due to transaction costs the cash price usually 

varies from the futures price by a few cents at contract expiration, which would add to or reduce the return 

to the hedger by that amount. Additionally, the costs of storing and insuring the grain between the time the 

crop is purchased in the cash market and it is sold in the cash market would reduce the elevator’s total 

return, as would the foregone interest on the cash used to purchase the crop. To the extent that the cash sale 

occurred in a different location from the contract delivery point, the difference in the cash price between 

the point of sale and the delivery point would also either reduce or enhance the net return. 

 

87 In commercial reality, the dates on which grain elevators actually sell or deliver grain in the cash market 

rarely match up exactly with the expiration dates of futures contracts. Typically, an elevator sells grain on 

many dates to merchants or processors who have a continuing need for delivery of grain. These merchants 

or processors will not want the grain to be delivered at the standard time and place specified in a 

standardized futures contract, such as a December delivery of 5,000 bushels of soft red winter wheat to an 

approved warehouse in Chicago. The grain merchant will instead specify a delivery date and location 

dictated by its commercial needs, such as delivery of the wheat on a specific date to a specific mill. This 

commercial reality means that a grain elevator typically purchases multiple futures contracts to match its 

hedging needs, and that it will typically need to unwind one or more of its hedges at some time prior to the 

actual expiration of the relevant futures contracts. 

88 As explained below, this type exposure to price risk is termed “basis risk.” This hedging strategy can be 

used even if the producer, merchant, or end user of a commodity has not yet acquired the commodity. A 

producer, merchant, or end user may, for example, initiate a hedge by selling a futures contract in the 

futures market prior to buying the commodity. In this instance, the sale of the futures contract is called an 

“anticipatory hedge.” “[T]he anticipatory hedge serves as a temporary substitute for a merchandising 

contract that will be made later. In the one case it serves as a substitute for immediate purchase of the raw 

material on a merchandising contract; in the other case it serves as a substitute for a forward sale of the 
60

3. Importance of Convergence for Hedging 

The hedging strategy just described is effective only when the futures price and 

the cash price converge to approximately the same amount as the futures contract 

approaches expiration. If the futures price and the cash price are not approximately equal 

at the time the elevator sells the cash commodity and buys back its futures contract, the 

elevator’s hedging strategy will not be fully effective, and the elevator would still be 

exposed to some risk. For example, if the futures price is higher than the cash price, the 

elevator will lose money in the second set of transactions, since it will pay more to buy 

back the futures contract than it will realize from selling the cash contract. 

Figure 17b shows how the lack of price convergence at contract expiration 

reduces the effectiveness of hedging. 

2

3

4

5

6

7

8

7/1 8/1 9/1 10/1 11/1 12/1 1/1

$/bushel

Price of December 

futures contract

Cash 

price

+$2

July 15

Dec 15

Example of a Hedge 

(Without Convergence)

-$1.50/bu BUY @ 

$4.50/bu.

SELL @ 

$3/bu.

Dec. 

15 

+$2/bu. SELL @ 

$6/bu.

BUY @ 

$4/bu.

July 

15 

Net Futures 

Market 

Cash 

Market 

Net gain: +$0.50/bu.

+$1.50 Lack of convergence 

reduces effectiveness of the 

hedge

Figure 17b. In this example, there is a lack of convergence at contract expiration. A 

lack of convergence reduces the effectiveness of the hedge. 

Figure 17b differs from Figure 17a in that the price of the December futures 

contract does not converge to the price of the commodity in the cash market. Instead, the 

 

specific goods that are in course of production.” Working, New Concepts Concerning Futures Markets and 

Prices, at p. 252. See also Peck, The Economic Role of Traditional Futures Markets, at pp. 19-21. 
61

futures price remains above the cash price. When the December contract expires, the 

final futures settlement price is $4.50, rather than the $3 in the cash market. As in Figure 

17a, when the hedge was initiated in Figure 17b, the grain elevator anticipated receiving a 

$2 per bushel gain. However, unlike in Figure 17a, where the cash price and the futures 

price converged at contract expiration, in Figure 17b it costs the elevator $4.50 to buy 

back the futures contract it had sold, while at the same time receiving $3 in the cash 

market for the grain it is selling. The result is that, in the second example, the elevator 

loses $1.50 per bushel on the second pair of transactions in the cash and futures market to 

“unwind” the hedge. Subtracting the $1.50 loss from the $2 initial gain results in a net 

gain of only 50 cents for the grain elevator. 

In this example, although the futures price and the cash price both fell over the 

life of the hedge, the hedge failed fully to protect the grain elevator from price risk, 

failing to do so precisely by the amount of the lack of price convergence. In the real 

world, the expenses of storage (about 5 cents per bushel per month) and insurance for the 

grain would have further reduced the elevator’s profits. In this example, the lack of 

convergence would likely have taken away much of the elevator’s expected profit. 

The ability to successfully hedge against price risk, therefore, depends upon the 

convergence of the cash price and the futures price as a contract approaches expiration. 

If these two markets converge, then farmers, elevators, and other hedgers can reliably 

anticipate their net gains (or losses) at the time they initiate a hedge. But if the two 

markets do not converge in a predictable manner, then hedgers are unable to anticipate 

their net gains or losses from the hedging strategy and lose the ability to protect 

themselves from price fluctuations. 

In theory, the futures price and cash price should always converge at contract 

expiration, absent minor variations due to different timing and transaction costs in the 

two markets. In his classic textbook on commodities, Professor Hieronymus offers an 

explanation of why cash and futures markets should converge:

“The price of the cash commodity and its futures price must be equal in 

the delivery month. If the futures price were above the cash price, the 

cash commodity would be bought, the futures sold, and delivery made. If 

the cash price were above the futures price, users would buy futures and 

stand for delivery as the cheapest source of supply. Thus, arbitrage in 

cash and futures markets forces the two prices to be equal.”89

The need to provide a simple mechanism to force the cash and futures prices 

together near the expiration of a futures contract means that workable delivery 

mechanisms are critical to a well-functioning futures market. While actual deliveries 

 89 Hieronymus, at pp. 152-3. 
62

may be rare under a futures contract, delivery must be feasible and easily executed if 

necessary to force convergence between the cash and futures prices – “to keep the market 

honest.”90 A futures contract “must be so readily deliverable and so easily takable that 

neither party has reluctance to make or take and, thus, no desire to make or take delivery. 

Delivery is made and demanded to test markets and to force price relationships into line 

but the better the contract, the less this occurs.”91

Professor Hieronymus also noted, however, that “even the most casual student is 

aware that cash prices of storable commodities, particularly grains, are nearly always 

higher than the futures during delivery month. These differences arise out of technical 

considerations of delivery, are limited in their possible size, and do not violate the 

principle.”92

C. Key Market Terms

 Limited price differences are to be expected, while large discrepancies 

between the cash price and futures price – a lack of convergence – indicate that the 

futures market is not functioning properly. Once the price discrepancies are of such 

magnitude that it is no longer possible to use the futures market to effectively manage 

price risks in the cash market, the futures market would no longer be performing its 

primary function. The increasing lack of price convergence over the past few years in the 

wheat market has caused a great deal of turmoil within the grain industry and has led to 

several major efforts to determine the cause of the breakdown and proposals for effective 

solutions. 

To understand the reasons for the lack of price convergence in the wheat market 

in recent years, its impact on commodity trading, and the contributing role of speculation, 

this section provides additional information on key market terms such as basis, price 

spreads, and carry.

1. Basis 

The difference between the cash price of a commodity and the futures price of 

that same commodity is defined as the “basis.”93

 90 Hieronymus, at p. 351.

 The basis is expressed mathematically 

as:

91 Id. 

92 Id., at p. 153. These technical considerations include differences in the price time of delivery under the 

futures contract, the precise quality (several grades may be deliverable), and differing costs associated with 

the physical delivery of the commodity under different delivery procedures. Id. 

93 For a general description of basis, futures trading, and hedging strategy, see CME Group, Self-Study 

Guide to Hedging with Grain and Oilseed Futures and Options. In the Executive Summary and Section V 
63

Basis = Cash – Futures

At contract expiration, the basis at the contract delivery location should be zero, or close 

to zero. In other words, the two prices should converge. 

In the previous example of a grain elevator’s hedging its cash purchase of wheat 

through the futures market, Figure 17a showed the cash and futures prices of the wheat 

held by the elevator over a six-month period from July to December. At the time the 

hedge was initiated in July, the cash price was $4 and the futures price was $6 for a 

resulting basis of -$2 per bushel. This is commonly referred to as the basis being “2 

under.” In this example, when the December futures contract expired, the cash price and 

futures price had converged at $3, for a resulting basis of zero. 

Because both the cash price and the futures prices of a commodity vary with time, 

the basis varies with time as well. In addition, at any particular time, there may be 

multiple different cash prices for a commodity, depending upon the precise grade of the 

commodity, the location of the commodity, and the costs of transporting the commodity 

to market. The basis will vary, therefore, according to the commodity’s attributes and 

location. At any given time, the same crop could give rise to a variety of basis 

calculations, depending upon specific variables in the crop and the market where it is to 

be sold. A buyer or seller of a crop must take into account each of those variables when 

computing the basis for a particular sale or purchase. 

In addition, many crop sales do not take place at exactly the same time as a 

futures contract expires – in the case of wheat, for example, there are only five contract 

expiration dates per year. Timing differences mean that, on the date that a grain elevator 

actually sells a portion of its grain and lifts its hedge, the basis will not be zero, but rather 

some other value, either positive or negative. In the previous example of a wheat hedge 

placed by a grain elevator on July 15, when the basis was 2 under, if the subsequent basis 

at the time the hedge is lifted is positive – meaning the cash price is greater than the 

futures price – the grain elevator will receive additional gains because the sale of the cash 

commodity will produce more money than is needed to buy back the futures contract. If 

the basis is negative at the time the crop is actually sold – meaning the futures price is 

greater than the cash price – then the grain elevator will lose money, because the sale of 

the cash commodity will not generate sufficient money to cover the cost of buying back 

the futures contract. In short, whether the hedging strategy produces gains or losses 

 

of this Report, basis is calculated as Basis = Futures – Cash in order to give a positive value to the basis, 

which makes display and interpretation of the trends in basis easier to follow. 
64

depends how the basis has changed from when the hedge was initiated to when it is 

lifted.94

Although the cash price and the futures price generally can be expected to 

converge as a contract nears expiration, significant variations can and do occur. Crop 

shortages in the cash market, for example, may suddenly elevate cash prices and cause 

the basis to rise sharply. In other instances, such as when a future shortage of wheat is 

expected, the prices in a futures market can rise more rapidly than in the cash market. 

Price increases in the futures market relative to the cash market will narrow the basis or 

even produce a negative value, disrupting price convergence at contract expiration. Price 

volatility in the futures market may also disrupt the normal relationship between the cash 

and futures markets, thereby causing the basis to become volatile as well.

 

95

Traders often measure the effectiveness of hedging strategies by examining the 

behavior of the basis. If the futures and cash markets behave as predicted – converging at 

contract expiration with a basis that approaches zero as the contract ends – a 

straightforward hedging strategy should result in positive returns. If, contrary to 

expectations, the basis does not behave as predicted, the hedging strategy may result in a 

loss. The ability to accurately forecast the relationship of the futures and cash prices –

the behavior of the basis – is critical to being able to successfully hedge.

 

96 Professor 

Hieronymus emphasizes: “[H]edging is not insurance. Hedging is an intricate activity, 

requiring substantial knowledge and operational skill. . . . The essence of hedging is 

speculation in basis.”97

 94 More generally, the profitability of a hedge depends upon whether the hedger is “long” the basis (i.e., 

buying in the cash market and selling futures) or “short” the basis (i.e., selling in the cash market and 

buying futures) and the subsequent movement of the basis. If a hedger is long the basis and the basis 

increases (i.e., the cash price increases relative to the futures price), the hedger will gain the amount of the 

increase in basis. If the hedger is long the basis and the basis narrows (i.e., the cash price decreases relative 

to the futures price), then the hedger will lose the amount of the decrease in basis. Conversely, if a hedger 

is short the basis and the basis increases, then the hedger will lose the amount of the increase in basis, and if 

the basis decreases the hedger will gain the amount of the decrease. In the previous example, the elevator 

was “long” the basis (buying in the cash market and selling futures) and the basis increased from 2 under to 

0, so the hedger realized $2 in gains. 

 

95 “True basis risk is the movement in the basis not attributable to the convergence of spot and futures 

prices.” Williams, The Economic Function of Futures Markets, at p. 107.

96 Commercial participants who believe that the basis will behave in a predictable way may purchase a

commodity and initiate a hedge solely to capture the gains from the expected movement in basis. In this 

instance, a hedger may actually be speculating in basis. Similarly, a speculator may acquire physical assets 

in order to be able to capture these types of gains from the more predictable movement in basis rather as 

compared to the highly speculative changes in absolute prices. Thus, it can be difficult to determine 

whether a hedger is hedging, a speculator is speculating, a hedger is speculating, or a speculator is hedging. 

In all instances, the trader is seeking to profit from the relative changes in the futures and cash prices. 

97 Hieronymus, at pp. 150-1. 
65

Even though the basis can be volatile, because convergence does occur in 

properly functioning markets, the basis is far more predictable than the absolute level of 

prices for a commodity in either the cash or the futures markets. Put another way, 

although the futures market and the cash market are each totally unpredictable, the 

relationship between the two markets is generally predictable because they are closely 

tied to each other. The two markets should converge as a futures contract nears 

expiration, with arbitrage trades possible between the two markets to force convergence 

if necessary. 

Research shows that there is much less uncertainty and risk in attempting to 

speculate on or predict the relationship between the cash and futures market – the basis –

than in speculating on or predicting the absolute level of prices.98 According to Professor 

Peck, hedging “is done to profit from the reliably predictable difference in prices in the 

two markets. ... To the extent that the basis is both more stable and more predictable 

than absolute price levels over relevant storage periods, [hedging] reduces the business 

risks inherent in commodity storage.”99

At the same time, if a once predictable basis relationship becomes unpredictable, 

then hedging becomes as risky as outright speculation in absolute price levels. “In fact, 

in those cases where the basis is as volatile as the spot price of the commodity, the hedger 

moves naturally into holding inventories unhedged, i.e., into ordinary speculation, 

because there is no risk reduction from hedging.”

 

100

 98 In Optimal Grain Marketing: Balancing Risks and Revenue (1999), the National Grain and Feed 

Foundation advised that seasonal price spread patterns appear “very predictable. In 78 of 89 years, the 

record shows that the farm price [for corn] at harvest will not be exceeded later in the year by an enormous 

amount – just the 10 to 15 percent carrying charge.” In the other 11 years, however, “the farm price at 

harvest could be dramatically exceeded later in the year by as much as 40 to 100 percent,” due to war 

politics, drought, and wetness, “factors which must surely be deemed unpredictable.” Id. at pp. 4-5. See

also Kevin C. Dhuyvetter and Terry L. Kastens, Marketing Grain – Things to Think About, paper prepared 

for Risk and Profitability Conference, Kansas State University, August 19-20, 2004 (“While price levels 

vary considerably from year to year due to supply and demand conditions, the difference between futures 

prices and cash prices (i.e., basis) tends to be more stable. The important implication of this year-to-year 

stability in basis is that historical basis levels often are a relatively good indicator of future basis levels and 

thus a historical average is a reasonable forecast. Research generally has shown that there is little benefit to 

complex models compared to historical averages.”).

 

99 Peck, The Economic Role of Traditional Commodity Futures Markets, at p. 15. Professor Peck, like 

Professor Hieronymus, describes hedging not as insurance but as a form of speculation, but of much less 

risk and uncertainty than the traditional characterization of speculation as pertaining to absolute price 

levels. In this instance Professor Peck was describing a hedger that stores a commodity – as opposed to 

selling it – to take advantage of changing price relationships. Working observed: “Most hedging is done in 

the expectation of a change in spot-future price relations, the change that is reasonably to be expected being 

often indicated quite clearly by the current spot-future price relation.” Working, Futures Trading and 

Hedging, at p. 148. 

100 Paul H. Cootner, Speculation and Hedging, Proceedings of a Symposium on Price Effects of 

Speculation in Organized Commodity Markets, Food Research Institute Studies, Stanford University, Vol. 
66

2. Price Spreads and “Carry”

The difference between two commodity prices – such as between a cash price and 

futures price, or between the prices of two futures contracts – is often called a “price 

spread.” The basis is one particular type of price spread: it is the difference between the 

cash price and the nearest futures contract that is about to expire. Just as an 

understanding of the behavior of the basis helps to evaluate hedging strategies, 

understanding the behavior of a larger set of relationships between futures prices aids in 

the understanding of other trading strategies, speculation, and commodity storage 

patterns. 

A key principle behind price spreads in the futures markets is that, in an idealized, 

properly functioning futures market, the price of one futures contract should not exceed 

the price of another futures contract by more than the cost of storing the commodity over 

the period of time between the two contracts. This storage cost, often referred to as the 

“carrying cost,” encompasses the expenses that a seller would incur to store the 

commodity for a specified period of time.101

If the price difference between two successive futures contracts were greater than 

the cost of storing the commodity over the time period involved, then a firm could profit 

by purchasing the earlier futures contract at the lower price, while simultaneously selling 

it at the higher price of the later futures contract. Traders would theoretically engage in 

sales based upon the price spread between the two contracts until the demand for the 

earlier futures contract pushed up its price and sales of the later futures contract reduced 

 A futures market is said to be at “full carry” 

when the price spread between the second and first month futures contracts is large 

enough to cover the full costs of storing the commodity over the time period between 

those two futures contracts. If that price spread provides less than the full costs of storing 

the commodity over that time period – such that it provides only a certain percentage of 

the full costs of storage – that market is often described as providing that percentage of 

full carry. Many traders prefer to express price spreads in terms of the percentage of 

storage costs it provides – the percentage of full carry – rather than in terms of dollars 

and cents, since it provides a uniform measure of the size of a price spread. 

 

VII Supp. (1967), at p. 75 (available in farmdoc archives). “[N]o hedging policy and no future contract 

maturity can assure a merchant that he will receive the opportunity rate of return on his inventory. . . . In 

most circumstances, hedging is really a form of speculation – speculation on the basis. It has all the 

characteristics of speculation even though it is an essential normal aspect of doing business. It differs from 

the speculation of buying or selling futures only because the variance of the outcome is usually much less.” 

Id. at pp. 74-5.

101 The true carrying cost consists of not only payments to an elevator to store the grain, but also additional 

expenses such as the loss of interest that could have been earned on the cash used to purchase the 

commodity, and insurance to cover the value of the commodity during the period of storage. Hieronymus, 

at p. 155. 
67

its price, bringing them into a new equilibrium. For this reason, the price of futures 

contract for the delivery of a commodity in a later month should never exceed the price of 

a futures contract for an earlier month by more than the full cost of holding the 

commodity between those months.102

The opposite situation, however, is not true. Longer-term futures contracts may 

sell at a price that is too low to recover the carrying costs for commodities. In the cash 

market there are significant transaction costs and potential bottlenecks in procuring 

commodities, and there are severe economic consequences for any firm that runs out of 

inventory. Many firms therefore keep commodities in inventory even if they cannot fully 

recover the costs of storing that inventory through the sale of later futures contracts. 

Professor Williams explains:

 

“Firms hold stocks of physical commodities for much the same reason they hold 

money. Because of the great difficulty and expense in moving commodities like 

wheat and copper quickly to where they are needed, firms will hold commodities 

despite spreads below full carrying charges.” 103

In fact, empirical data indicates that futures markets rarely provide for the full 

carrying costs between futures contracts. Except for instances in which the supplies of 

the cash commodity are unusually large, and near-term prices are falling relative to later 

prices as firms seek to unload their inventories, futures spreads have tended to be 

somewhat less than full carry.

 

104

 Carrying costs are only one factor in commodity pricing. Price spreads between 

cash and futures markets should be understood to be a function, not only of the costs of 

storing a commodity, but also existing prices in the futures market, pricing expectations, 

 

 102 The difference between the cash price and the price of the nearest futures contract (i.e., the basis) is not 

subject to this constraint. “[T]his upper limit on the carry in futures spreads does not necessarily apply to 

cash market carry, which includes a local basis. If a harvest is exceptionally large and grain supplies 

pressure the market to either purchase or find a storage location, cash market spreads can temporarily 

widen considerably to reward anyone offering grain a ‘home’ – either through purchase or storage.” 

Optimal Grain Marketing: Balancing Risks and Revenue, at p. 3.

103 Williams, The economic function of futures markets, at p. 19. Why firms have held onto stocks of 

commodities when the futures prices were lower than full carry has puzzled economists for many years. 

Keynes postulated the theory of “normal backwardation” – that the lower futures price that hedgers were 

willing to pay to speculators reflected a premium that commodity producers were willing to pay to the 

speculators to assume the risks that the producer-hedgers desired to transfer. Years of research, however, 

failed to detect any evidence of “normal backwardation.” Charles S. Rockwell, Normal Backwardation, 

Forecasting, and the Returns to Commodity Futures Trading, Food Research Institute Studies, Stanford 

University, Supplement to Vol. VII (1967) (available in farmdoc archives). Working was one of the first to 

develop what is now the prevailing theory that price spread necessarily depend upon the costs of storage of 

a commodity. See, e.g., Working, Theory of the Inverse Carrying Charge in Futures Markets, reprinted in 

Selected Writings of Holbrook Working, at pp 3-24. 

104 Optimal Grain Marketing: Balancing Risks and Revenue, at p. 4.
68

and the demand for the commodity in the cash market.105

3. Pricing Trends in Carry and Inversion Markets

 If the supply of a commodity is 

plentiful, and no future shortages are foreseen, then the spot price of the commodity in 

the cash market will likely fall relative to the futures price. The greater the supply of the 

commodity, the more the spot price and near-term futures prices will fall relative to the 

price of farther out futures contracts. 

In addition to “basis,” “spreads,” and “carry,” there are several other related 

concepts and terms that describe the relationships between the prices of various futures 

contracts. 

When the prices of grain futures contracts are higher than the current cash price, 

the futures market is said to be “a carry market.” In energy markets, this pattern is called 

“contango.” As explained previously, the price of a later futures contract should not 

exceed the price of an earlier futures contract by more than the cost of holding the 

commodity between those two contracts. If the difference in price between successive 

futures contracts is at this maximum – the cost of holding the commodity between these 

two contracts – then the market is said to be at “full carry.” When the market is at full 

carry, a grain producer or merchant that hedges can store grain from the expiration of one 

futures contract to another and fully recover the costs of storage. In a full carry market, 

persons holding a commodity are able to recover the full costs of storing the commodity 

and thus tend to accumulate inventories of the commodity. 

When the prices in the grain futures market are lower than the current cash price, 

the market is said to be an “inverse market.” The corresponding term in the energy 

markets is “backwardation.” In an inverse or backwardated market, a producer or 

merchant cannot recover any of the costs of storing a commodity through a hedging 

strategy. Most producers and merchants reduce inventories during an inverse or 

backwardated market, choosing to sell the commodity rather than store it at a loss. 

 105 Put another way, “the spot price is determined as the sum of the futures price dependent primarily on 

expectations, plus a premium dependent on the shortage of currently available supplies.” Working, New 

Concepts Concerning Futures Markets and Prices, at p. 254. 
69

Pricing Structures in the Futures Market

Carrying Market

(contango)

Inverse Market

(backwardation) price of 

futures 

contract

date of expiration of 

futures contract

spot 

price

spot 

price 

futures 

prices

futures 

prices

Figure 18. Basic relationships between spot and futures prices.

Commercial firms and traders base many of their hedging strategies and inventory 

management decisions on the relative prices of the various contracts in the futures 

markets. Simply put: “Commodities move into storage when the price of storage is 

favorable and move out of storage when the price is unfavorable.”106 The greater the 

carrying charge provided by the futures market, the more inventory firms will hold in 

storage and hedge those inventories through additional sales of futures contracts. To the 

extent that the market will “pay” for a firm’s costs in holding inventory through the price 

relationships in the futures markets, that firm will attempt to take advantage of such 

opportunities through hedging. In an inverse (or backwardated) market, firms will reduce 

their inventories as much as practicable, while still ensuring that they have sufficient 

inventories to meet anticipated demands.107

 106 Hieronymus, at p. 160.

 

107 Professor Peck summarizes the critical importance of futures markets to inventory management as 

follows:

“[F]utures markets do not determine whether storage will occur but affect the decision to store and 

the predictability of storage returns.

“In the absence of a futures market, the storage return is speculative and depends entirely on 

events that occur after the decision to store or not is made. With a futures market, storage returns can 

largely be determined at the time the decision to store is made if that decision is hedged with a classic, 

arbitrage hedge. ... [Futures markets] guide inventory decisions in a rational way. In periods of 

surplus the market reflects fully carrying charges and thus induces storage. In periods of shortage less 
70

D. Position Limits and Hedge Exemptions

To understand the nature and extent of hedging, and speculation in the commodity 

markets, it is also important to understand the statutory and regulatory limits imposed on 

the amount of speculation in these markets. 

Section 4a(a) of the Commodity Exchange Act declares that excessive speculation 

in the price of a commodity traded on an exchange can create an undue burden on 

interstate commerce and directs the CFTC to establish limits on the positions held by 

traders on futures markets in order to prevent “sudden or unreasonable fluctuations or 

unwarranted changes” in the price of commodities traded on an exchange. The 

Commodity Exchange Act states:

“Excessive speculation in any commodity under contracts of sale of such 

commodity for future delivery made on or subject to the rules of contracts 

markets or derivatives transaction execution facilities causing sudden or 

unreasonable fluctuations or unwarranted changes in the price of such 

commodity, is an undue and unnecessary burden on interstate commerce 

in such commodity. For the purpose of diminishing, eliminating, or 

preventing such burden, the Commission shall . . . fix such limits on the 

amounts of trading which may be done or positions which may be held by 

any person.”108

The statute states that these limits shall not be applicable to “bona fide hedging 

transactions,” and authorizes the CFTC to define the term “bona fide hedge.” 

1. Position Limits

For many years, to prevent price manipulation and excessive speculation, the 

CFTC has maintained and enforced position limits for futures contracts related to certain 

agricultural commodities, including wheat.109

CFTC Regulation 

150.2

 The CFTC explains: “For several markets 

(corn, oats, wheat, soybeans, soybean oil, soybean meal, and cotton), the limits are 

determined by the Commission and set out in Federal regulations (

, 17 CFR 150.2). For other markets, the limits are determined by the exchanges.”110

 

than full costs are available, inducing merchants to sell unneeded stocks. . . . That the storage 

decision can be hedged implies that risks are reduced and more storage is likely at all prices.” 

Peck, The Economic Role of Traditional Commodity Futures Markets, at pp. 44-5.

108 7 U.S.C. §6a(a) (2006). 

109 See CFTC, Notice of Proposed Rulemaking, Revision of Federal Speculative Position Limits, 70 Fed. 

Reg. 12621 (March 15, 2005). 

110 These position limits also apply to options on futures. CFTC, Speculative Limits, CFTC website, at 

http://www.cftc.gov/industryoversight/marketsurveillance/speculativelimits.html. 
71

Position limits restrict the number of futures contracts that a commodity trader 

can hold at a time. 111

Spot month limit. Because the potential for price manipulation and market 

congestion is highest in the month in which a futures contract expires and deliveries may 

occur (termed either the “spot,” “expiration,” or “delivery” month), the CFTC applies and 

requires the exchanges to apply more stringent position limits during the spot month than 

during other months. CFTC regulations pertaining to exchange-set limits state: “For 

physical delivery contracts, the spot month limit level must be no greater than one-quarter 

of the estimated spot month deliverable supply.”

 These limits restrict the amount of trading that can be conducted 

by a single person on the regulated futures markets to prevent corners, squeezes, and 

other trading activities that can artificially inflate or depress commodity prices – so-called 

unwarranted or undue price fluctuations. The CFTC has established three basic types of 

position limits: spot month, single-month, and all-months combined, each of which 

applies to wheat contracts. 

112 Under existing CFTC-set position 

limits for wheat, no trader may hold more than 600 wheat contracts due to expire in the 

spot month. Table 3 provides the CFTC position limits for four grain commodities.

CFTC Position Limits for Wheat, Corn, Soybean, and Oats

Commodity Spot Month Single Month All Months 

Combined

Wheat 600 5,000 6,500

Corn 600 13,500 22,000

Soybeans 600 6,500 10,000

Oats 600 1,400 2,000

Table 3. CFTC position limits for selected agricultural commodities. Data source: CFTC.

 111 To calculate a particular trader’s position for purposes of applying these limits, the CFTC and the 

exchanges aggregate multiple positions subject to common ownership as if they were held by a single 

trader, and combine futures and option positions on those futures to obtain an aggregate future-equivalent 

position in a futures contract. 17 C.F.R. §§150.4, 150.5 (2008). 

112 17 C.F.R. §150.5(b)(1) (2008). For the spot month in cash-settled contracts, an exchange must establish 

speculative position limits “no greater than necessary to minimize the potential for manipulation or 

distortion of the contract’s or the underlying commodity’s price.” Id. 
72

Single month limit. The CFTC applies less stringent position limits in months 

other than the spot month because the potential for congestion, price distortion, and 

disruption of the cash market is lower than in the spot month. Nonetheless, single month 

limits are necessary to prevent individual traders from acquiring large positions that could 

distort the price of a particular futures contract.113

All-months combined. The CFTC also imposes and requires the exchanges to 

impose an all-months combined position limit for agricultural commodities, which is a 

limit on the total number of contracts across all months that a trader may hold. CFTC 

regulations state that the all months-combined levels must be no greater than 10% of the 

average total open interest (outstanding contracts) in futures and options, up to an open 

interest of 25,000 contracts, with a marginal increase of up to 2.5% of the total open 

interest thereafter. The CFTC’s regulations also allow the exchanges to establish allmonths combined position limits based on other factors related to the customary size of 

speculative positions in the particular market, provided that such totals do not have 

significant potential for market distortion.

 Under existing CFTC position limits, 

for example, no trader may own more than 5,000 wheat contracts that expire in the same 

month.

114

2. Hedge Exemptions

 Under existing CFTC position limits for 

wheat, no trader may hold a total of more than 6,500 wheat contracts for all months 

combined.

The purpose of position limits is to diminish or prevent the burdens on interstate 

commerce that result from excessive speculation in the commodity futures markets. The 

Congress has made it clear, however, that position limits should not apply to the 

legitimate use of the futures markets by commodity producers, merchants, or end-users to 

price their goods efficiently or to manage their price risks. The Commodity Exchange 

Act directs the CFTC to grant an exemption from established commodity position limits 

for “bona fide hedging transactions or positions.” Section 4a(c) of the Commodity 

Exchange Act states: 

 113 That unusually large positions in a single month can distort futures prices, even when the month is other 

than the spot month, was demonstrated in the Subcommittee’s investigation into the trading practices of 

Amaranth, a hedge fund active in the natural gas market. See 2007 Report, Excessive Speculation in the 

Natural Gas Market. 

114 CFTC regulations state that such positions “shall not be extraordinarily large relative to total open 

positions in the contract, the breadth and liquidity of the cash market underlying each delivery month and 

the opportunity for arbitrage between the futures market and the cash market in the commodity underlying 

the futures contract.” 17 C.F.R. §150.5(c)(2) (2008).
73

“No rule, regulation, or order issued under subsection (a) of this section 

shall apply to transactions or positions which are shown to be bona fide 

hedging transactions or positions.”115

The Commodity Exchange Act provides the CFTC with the discretion to define 

the term bona fide hedging transaction, “consistent with the purposes” of the CEA, in 

order to “permit producers, purchasers, sellers, middlemen, and users of a commodity or 

a product derived therefrom to hedge their legitimate anticipated business needs for that 

period of time into the future for which an appropriate futures contract is open and 

available on an exchange.”

 

116

The purpose of this exemption is to allow commodity producers, merchants, and 

end-users to hedge their crops in the futures markets to protect against price risks arising 

from their commercial activities involving that commodity. The objective is to allow 

them to enter into a sufficient number of futures contracts to meet the legitimate needs of 

their commercial operations. One of the rationales underlying the exemption is that since 

hedgers are price neutral – because they are hedged they will neither gain nor lose money 

as the prices in the futures market change – they would have no motive to attempt to 

manipulate prices through large trades. 

 

The CFTC first issued a regulation defining a bona fide hedging transaction in 

1936, immediately following passage of the Commodity Exchange Act. The original 

definition essentially defined hedging as a sale or purchase of a contract for future 

delivery of a commodity if the sale or purchase was offset, in terms of quantity, by 

ownership or fixed-price purchases or sales of the same commodity in the cash market.117 

Since that time, the types of transaction that qualify for the bona fide hedge exemption 

have been expanded both by Congress and by CFTC administrative action.118

The current CFTC regulation states that the term “bona fide hedging transactions 

and positions” means transactions or positions in a futures contract or option: 

 

 115 7 U.S.C. §6a(c) (2006).

116 Id. In recognition of the concern that large hedgers can affect prices in the same manner as large 

speculators, to help determine whether the CFTC has adequate authority and regulations to “prevent 

unwarranted price pressures by large hedgers,” in this section of the CEA, Congress also directed the CFTC 

“to monitor and analyze the trading activities of the largest hedgers . . . operating in the cattle, hog, or pork 

belly markets,” and report its findings to Congress. Id. 

117 Allen B. Paul, Treatment of Hedging in Commodity Market Regulation, USDA Economic Research 

Service, Technical Bulletin No. 1538 (April 1976), at p. 2 (available in farmdoc archives).

118 For example, in 1956, Congress amended the Commodity Exchange Act to include the “anticipatory 

hedge” as a bona fide hedging transaction, meaning that at the time of the purchase or sale of a futures 

contract the trader did not actually have to own, purchase, or sell a physical commodity, but rather only 

anticipate doing so. Id. 
74

“where such transactions or positions normally represent a substitute for 

transactions to be made or positions to be taken at a later time in a 

physical marketing channel, and where they are economically appropriate 

to the reduction of risks in the conduct and management of a commercial 

enterprise . . . .”119

The CFTC regulation also requires that a bona fide hedging transaction 

arise from either: (1) a potential change in the value of an asset that a person 

owns, produces, processes, or sells or anticipates owning, producing, processing, 

or selling; (2) the potential change in value of liabilities that the person owes or 

anticipates incurring; or (3) the potential change in the value of services that the 

person provides or purchases, or anticipates providing or purchasing.120

“no transactions or positions shall be classified as bona fide hedging for 

purposes of section 4a of the Act unless their purpose is to offset price 

risks incidental to commercial cash or spot operations and such positions 

are established and liquidated in an orderly manner in accordance with 

sound commercial practices [and the additional requirements pertaining to 

anticipatory hedging or exemptions from spot month limits]. . . .”

 In 

addition, the CFTC regulation includes another overall qualification that: 

121

While there has been longstanding, broad consensus on the need to grant hedge 

exemptions for commodity producers, merchants, and end users to manage their price 

risks, granting similar exemptions to financial firms seeking to use the futures markets to 

manage their financial risks has been the subject of longstanding debate and controversy. 

In 1986, Congress urged the CFTC to consider expanding the hedge exemption to 

include financial firms using the futures markets to manage various types of financial 

risks. The committee report by the House Committee on Agriculture on the Futures 

Trading Act of 1986, stated:

“The Committee wishes the Commission to consider giving certain 

concepts, uses, and strategies ‘non-speculative’ treatment under the Act 

and relevant Commission regulations, whether under the hedging 

definition or, if appropriate, as a separate category similar to the treatment 

given certain spread, straddle, or arbitrage positions: one, the concept of 

‘risk management’ by portfolio managers as an alternative to the concept 

 119 17 C.F.R. §1.3(z) (2008). 

120 Id. 

121 Id. The regulation allows hedges of the actual amount of the sale or purchase of an anticipatory hedge (a 

hedge placed in advance of the actual sale or purchase of the commodity) up to the amount of the 

commodity typically bought or sold over a 12-month period. The CFTC permits these bona fide hedgers to 

apply for exemptions from the spot month limits. Id. at §§1.47, 1.48. 
75

of ‘risk reduction’; two, futures positions taken as alternatives rather than 

temporary substitutes for cash market positions; three, other trading 

strategies involving the use of financial futures.”122

The report of the Senate Committee on Agriculture, Nutrition and Forestry 

emphasized that any actions taken by the CFTC in this regard should be consistent with 

its fundamental mission to prevent excessive speculation which causes unreasonable or 

unwarranted changes in commodity prices.

 

123

In 1991, a firm asked the CFTC to grant it an exemption from the position limits 

in order to purchase and hold futures contracts to hedge its exposure to commodity 

futures prices from certain financial instruments, called swaps, which it planned to sell to 

pension funds and other institutional investors. The value of these swaps was to be 

linked to an index calculated from the prices of specified commodity futures contracts 

and so would fluctuate with the values of the underlying futures contracts. Because of 

this exposure to the price of specified futures contracts, the firm requested a hedge 

exemption so that it could purchase a sufficient number of futures contracts to hedge its 

swaps exposure. Based on its interpretation of the direction provided by Congress in the 

Futures Trading Act of 1986, the CFTC granted this request, even though the firm’s 

trading on the futures market was not in connection with the production, sale, or use of 

any physical commodity. 

 

According to the records provided to the Subcommittee by the CFTC, four swap 

dealers selling index-related swaps currently operate with hedge exemptions that allow 

them to hold much larger positions on the Chicago wheat futures market than would 

otherwise apply under the CFTC’s speculative position limits. Two other firms that 

market index-related instruments have received permission from the CFTC to exceed the 

position limits by a specified amount under formal decisions by the CFTC to not enforce 

the standard limits with respect to the futures contracts held by these firms. 

The next two sections of the Report trace the rise of commodity index trading, 

how the exemptions from position limits have facilitated index trading in the wheat 

market, and how index trading, in the aggregate, has contributed to unreasonable and 

unwarranted changes in the futures prices for wheat and constituted excessive 

speculation. 

 122 H. Rept. 624, 99th Cong., 2nd Sess., at pp. 45-6 (1986). 

123 S. Rept. 291, 99th Cong., 2nd Sess., at pp. 21-2 (1986).
76

“If you can look into the seeds of time, 

And say which grain will grow and which will not,

Speak then to me . . .”

--MacBeth, Act I, Scene III 

IV. COMMODITY INDEXES

One of the most significant developments in commodity markets in recent years has been 

the increasing amount of trading in financial instruments whose value is linked to the value of a 

commodity index. Commodity indexes are typically calculated using a wide range of 

commodity futures contracts, such as futures contracts for agriculture, energy, and metal 

commodities. Although instruments linked to a broad-based commodity index have existed for 

several decades, it is only within the past few years that these index instruments have become a 

popular vehicle to speculate in commodity prices. Since 2000, a number of academic 

publications, financial trade journals, and marketing presentations by swap dealers have touted 

the alleged benefits of index instruments. As a result, the total value of index instruments –

purchased mainly by financial institutions, insurance companies, pension funds, foundations, 

hedge funds, and wealthy individuals – has grown more than tenfold in five years, from an 

estimated $15 billion in 2003, to at least $200 billion in mid-2008.124

This section explains how commodity indexes work; how persons commonly make 

investments based upon a commodity index using swaps, exchange traded funds, or exchange 

traded notes; how speculative purchases of index instruments affect the futures markets; and how 

the standard commodity trading limits have been waived for swap dealers and other index traders 

through hedge exemptions and no-action letters issued by the CFTC. This section also discusses 

recent CFTC actions pertaining to index trading. 

 The purchases of these 

index instruments have resulted in the injection of billions of dollars in passive, long investments 

into the agricultural, energy, and metals futures markets.

Section V of this Report presents evidence indicating that the large amount of index 

trading in the Chicago wheat futures market is one of the major reasons for the increasing gap 

between the futures prices and cash prices (the basis), and for the frequent failure of wheat 

futures prices and cash prices to converge as the futures contracts expire. These pricing 

distortions and breakdowns have imposed significant additional costs upon farmers, grain 

elevators, grain merchants, and wheat users, thereby resulting in an undue burden on commerce 

which necessitates regulatory action to alleviate. 

 124 CFTC, Staff Report on Commodity Swap Dealers and Index Traders with Commission Recommendations, at p. 3 

(preliminary data). This estimate reflects both the actual amounts invested in commodity index related instruments 

and the appreciation in value of those investments due to increasing commodity prices.
77

A. Commodity Index Trading in Agricultural Markets

The full extent of the explosive growth of commodity index trading has only recently 

become apparent, since it is only within the last few years that the CFTC has collected and 

publicly reported data on the extent of index traders purchasing commodity futures. Prior to 

2007, index-related trades were included in the overall data reported by commercial and noncommercial traders in the CFTC’s traditional Commitment of Traders Report, its key 

compilation of information on the extent and nature of the participation on regulated commodity 

futures exchanges.125 In January 2007, in response to requests from Congress, the agriculture 

industry, and others, the CFTC began to publish weekly data on the total or aggregate positions 

of index traders in agricultural futures contracts traded on those exchanges.126

This data appears in the CFTC’s “Supplemental Commodity Index Trader Report.” That 

CFTC report now provides the total positions in agricultural futures contracts of managed funds, 

pension funds, and “other institutional investors that generally seek exposure to commodity 

prices as an asset class in an unleveraged and passively-managed manner using a standardized 

commodity index.” In addition, it includes the aggregated positions of swap dealers “holding 

long futures positions to hedge short OTC commodity index exposure opposite institutional 

traders such as pension funds.”

 

127

When it began publishing this weekly data in 2007, the CFTC also released data on index 

trading that it had acquired for the calendar year 2006. This older data enabled the CFTC weekly 

data series on index trader positions in commodity futures markets to extend back to January 

2006. The CFTC staff then took another step by extrapolating its data on index positions held by 

swap dealers back to January 2004. Although the CFTC has not included this extrapolated data 

 Together, this data provides the best available information on 

the volume of commodity index trading in U.S. agricultural futures markets.

 125 For the CFTC’s explanation and description of its Commitment of Traders Report, see

http://www.cftc.gov/marketreports/commitmentsoftraders/index.htm. 

126 Commodity Futures Trading Commission, Commission Action in Response to the “Comprehensive Review of the 

Commitments of Traders Reporting Program” (June 21, 2006), December 5, 2006. The CFTC concluded it was 

able to calculate the aggregate positions of index traders in agriculture futures markets, because: “A careful review 

of swap dealer positions shows that, with respect to agricultural commodities, swap dealers’ OTC trading activities 

are generally limited to taking short OTC positions opposite pension funds or other index-based traders seeking to 

diversify portfolios by adding long commodities exposure. Thus, the swap dealers’ futures positions are generally 

limited to long futures hedges offsetting their short OTC exposure to those pension funds or other index-based 

traders.” Id., at p. 11. At the same time, the CFTC concluded it could not perform a similar analysis with respect to 

index trading in the energy or metals markets. For energy and metal commodities, the CFTC found that the swap 

dealers’ positions on the futures exchanges resulted from the netting of a variety of OTC exposures, many of which 

were not due to purchases or sales of commodity indexes. The CFTC found it was “difficult, if not impossible, to 

link these residual futures positions with any part of the underlying activity that makes up the book of the swap 

dealer. The Commission has concluded, therefore, that at present, including the energy and metal markets in the 

[Commitment of Traders-Supplemental] report would seriously mislead the public as to the actual amount of index 

trading and the amount of commercial trading that was present in those market.” Id., at pp. 11-12. 

 

127 Id.
78

for the years 2004 to 2005 in its formal Supplemental Commodity Index Trader Report, the 

Commission has presented select portions of it to the public. At the Subcommittee’s request, the 

CFTC provided the complete extrapolated data series to the Subcommittee for use in this 

investigation. 

The CFTC data provides useful information on the extent and history of commodity 

index trading in agricultural futures markets. Figure 19 presents, for example, CFTC data on the 

number of outstanding purchased futures contracts (long open interest) held by commodity index 

traders in the wheat, corn, and soybean markets over the past five years. The data shows a 

substantial volume of contracts in the corn futures market, with about half as many contracts in 

the wheat and soybean futures markets. Index trading in the corn market, for example, grew 

sevenfold from about 70,000 corn contracts in 2004, to a peak of almost 500,000 corn contracts 

in early 2008, before sharply dropping by half to about 270,000 contracts at year’s end. Index 

trading in the Chicago wheat market was smaller on an absolute level, but just as steep, growing 

sevenfold from about 30,000 contracts in early 2004, to a maximum of about 220,000 contracts 

in mid-2008, before dropping off at the end of the year to about 150,000 contracts. The amount 

of index trading in the Kansas City wheat market was substantially less, varying from about 

15,000 contracts to 35,000 contracts. 

Index Fund Participation

2004 - 2009

0

100

200

300

400

500

600

Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09

Chicago Wheat

Kansas City Wheat

Corn

Soybeans

Open Interest 

(thousands of 

contracts)

Figure 19. Total open interest due to index investments. Data source: CFTC. 

Figure 20 breaks the data down a different way, showing the percentage of outstanding 

purchased contracts (total long open interest) held by index traders in the wheat, corn, and 

soybean markets. This data indicates that although there is a greater overall number of index 

fund contracts in the corn market, index traders have a relatively greater presence in the Chicago 
79

wheat market. In addition, the data shows that index trading constitutes a significantly larger 

share of the Chicago wheat futures market than the Kansas City futures market. It shows, for 

example, that in 2008, index traders held a significant share of the outstanding futures contracts –

between 40 and 45% of the long open interest in the Chicago wheat futures market, and between 

20 and 30% of the long open interest in the Kansas City wheat futures market. 

Index Fund Participation

Percent of Total Long Open Interest

0

20

40

60

80

Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09

Chicago Wheat

Kansas City Wheat

Corn

Soybeans

Percent of Total 

Long Open 

Interest 

Figure 20. Percent of long open interest held by index traders. Data source: CFTC.

B. Components of a Commodity Index

Speculation in commodity index instruments has grown over the past five years, as they

have become a popular investment strategy for large institutional investors, including hedge 

funds, pension funds, and university endowments, seeking to diversify their portfolios and profit 

from rising commodity prices. Purchasing a financial instrument whose value is linked to a 

commodity index enables an investor to get broad exposure to commodities without having to 

actually purchase quantities of each commodity or manage a portfolio of commodity 

investments. One investment consulting firm explains: “Commodity indices attempt to replicate 

the returns available to holding long positions in agricultural, metal, energy, or livestock 

investment, without the investor having to actively manage the positions.”128

A commodity index functions like an equities index such as the S&P 500 or the Dow 

Jones industrial average, in that it is computed on the basis of the value of its components. The 

value of a commodity index is derived from calculating the total value of a specified “basket” of 

 

 128 See, e.g., Alternative Investment Analytics, Comparing Commodity Indices: Multiple Approaches to Return, 

AIA Research Report, updated June 18, 2008. 
80

commodities. Each commodity within the basket is assigned a specified weight, or percentage, 

and the value of each commodity within the index is obtained by multiplying the current price of 

a specified futures contract for the commodity by the assigned weight for that commodity. The 

value of the index varies daily, along with the values of its component commodity futures. 

There are a variety of commodity indexes, which are sometimes divided into “firstgeneration” and “second-generation” commodity indexes. The first-generation indexes have 

been around the longest, and differ from later indexes primarily in the manner and frequency 

with which the futures contracts are replaced (“rolled”) as they approach expiration.

The second-generation indexes were developed within the last few years to improve upon 

the performance of the first-generation indexes. The second-generation commodity indexes have 

more complex strategies for selecting the particular futures contracts used to calculate the index, 

and typically select futures contracts that expire later in time than the futures contracts used in 

the first generation indexes.129

Table 4 identifies a few key commodity indexes and the commodities and weights used to 

calculate them.

 Because the second-generation index futures contracts are farther 

from maturity, they need to be replaced (“rolled”) less frequently than in the first-generation 

indexes. 

130 As the Table shows, index funds are generally weighted most heavily toward

energy commodities, particularly crude oil. In both the S&P Goldman Sachs Commodity Index 

(GSCI) and the Deutsche Bank Liquid Commodity Index (DBLCI), crude oil constitutes at least

one-third of the index. Agricultural commodities, grains in particular, are usually the second 

most heavily weighted commodity sector in indexes. The more heavily weighted an index is in 

any particular commodity sector, the more that index’s overall performance will depend upon the 

performance of that commodity sector. 

 129 See, e.g., Comparing Commodity Indices: Multiple Approaches to Return, AIA Research Report, updated June 

18, 2008. 

130 The commodity index compositions are presented as of March 2009, and are found at the following web pages, 

last visited on March 26, 2009: 

http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_gsci/2,3,4,0,0,0,0,0,0,2,1,0,0,0,0,0.html

(S&P GSCI); http://www.djindexes.com/aig/index.cfm?go=about (DJ-AIG); http://dbfunds.db.com/dbc/index.aspx

(DBLCI); http://www.jefferies.com/pdfs/RJCRB_Index_Materials.pdf (Reuters/Jefferies CRB); 

http://www.rogersrawmaterials.com/page1.html (Rogers International Index). The Rogers Index also includes the 

following commodities with percentage weights of 1 or less: rice, azuki beans, greasy wool, rubber, lumber, barley, 

canola, oats, palladium, and soybean meal.
81

Commodity Index Composition and Weights (%) (as of March 2009)

Commodity S&P GSCI

Dow 

Jones-AIG 

(DJAIG)

DBLCI

Reuters/

Jefferies 

CRB 

Rogers Int’l 

Commodity 

Index

WTI crude oil 31.98 13.8 33.57 23 21.0

Brent crude oil 12.69 14.0

Unleaded gasoline 3.39 3.7 5 3.0

Heating oil 4.82 3.6 17.00 5 1.8

GasOil 4.44 1.2

Natural Gas 7.85 11.9 6 3.0

Total Energy 65.18 33.0 50.57 39 44.0

Aluminum 2.58 7.0 10.22 6 4

Copper 2.29 7.3 6 4

Lead 0.33 2

Nickel 0.68 2.9 1 1

Zinc 0.56 3.1 2

Total Industrial 

Metals 6.43 20.3 10.22 13 13

Gold 3.49 7.9 14.73 6 3

Silver 0.33 2.9 1 2

Total Precious 

Metals 3.82 10.8 14.73 7 5

Wheat, CME 5.20 4.8 12.15 1 7.00

Wheat, KCBOT 1.23

Corn 4.93 5.7 12.33 6 4.75

Soybeans 1.84 7.6 6 3.35

Soybean oil 2.9 2.17

Total Grains 13.20 20.7 24.48 13 17.27

Cotton 1.06 2.3 5 4.20

Sugar 1.84 3.0 5 2.00

Coffee 0.90 3.0 5 2.00

Cocoa 0.45 5 1.00

Orange Juice 1 0.66

Total “Softs” 5.65 8.3 --- 21 9.86

Feeder Cattle 0.83

Live Cattle 3.36 4.3 6 2

Lean Hogs 1.79 2.4 1 1

Total Livestock 5.78 6.7 --- 7 3

 Table 4. Data sources: identified in Footnote No. 130.
82

“Sub-indexes” consist of commodities in one particular sector. For each index, there may 

be five or six sub-indexes, such as an energy sub-index, an agricultural sub-index, or an 

industrial metal sub-index. Investors seeking exposure to a particular commodity sector rather 

than exposure to a broad set of commodities may prefer to invest in a sub-index rather than a 

broad index. 

The “Roll.” The value of a commodity index depends upon the values of the futures 

contracts within the index that are within a specified amount of time away from expiration. As 

time goes forward, however, these futures contracts move closer toward expiration and 

eventually have to be replaced with futures contracts that are once again within the specified 

time from expiration. Most first-generation commodity indexes use the price of the second

month futures contract to compute the value of the index. The first month futures contract is the 

futures contract that is nearest expiration; the second month contract is the next one after that. 

After a certain amount of time, the first month futures contract will expire and the futures 

contract that had been the second-month futures contract now becomes the first-month futures 

contract. At that point, the managers of the index must replace the first month contracts with a 

new set of contracts which, at the time of their selection, serve as second month contracts. This 

replacement process, which takes place on a periodic basis, is called the “roll.”131

The roll by the index fund manager does not actually result in the purchase or sale of any 

futures contracts – it is only a computational undertaking – since the index itself has no 

underlying assets. However, as explained below, the computational roll by an index manager 

will typically result in a large number of actual futures transactions by swap dealers and others 

who have hedged their exposure to the value of the index and need to match the composition of 

the readjusted index with actual holdings of futures contracts. In this way, an index roll has a 

direct and sometimes significant impact on the futures markets by leading to a large number of 

similar trades within a short period of time.132

 131 The various indexes have established similar procedures for accomplishing the periodic roll. The indexes all 

have identified a series of dates, typically from the fourth or fifth day of a month, during which they will replace 

what have just become first-month futures contracts with a new set of later-month futures contracts. The roll is

accomplished at an equal rate over this series of trading days until 100% of the value of the first-month futures 

contracts is replaced with an equivalent value of later-month futures contracts. 

 

Standard & Poor’s describes the roll process as follows: “The simplest way to think of the process is as rolling from 

one basket of nearby futures (the first nearby basket) to a basket of futures contracts that are further from expiration 

(the second nearby basket). . . . Taking the first day of the roll as an example, just before the roll takes place at the

end of the day, the S&P GSCI consists of the first nearby basket. That portfolio, constructed the night before and 

held throughout the fifth business day, has a dollar value. For the roll, that dollar value is distributed across the first 

and second nearby baskets such that the number of contracts or the quantity of the first nearby basket is 80% of the 

total and the quantity held of the second nearby basket is 20% of the total.” Standard & Poor’s, S&P GSCI, FAQ; at 

http://www2.standardandpoors.com/spf/pdf/index/SP_GSCI_FAQ_Web.pdf. 

132 To ensure that the futures contracts they have purchased to offset their exposures to the futures prices in the 

index-related swaps they have sold, index traders will roll their index-related futures contracts during the same roll 

period that the index manager rolls the contracts used to calculate the index. Some commodity traders told the 
83

C. Three Types of Commodity Index Instruments

Investors cannot invest directly in a commodity index, since the index itself, like the S&P 

500 or the Dow Jones Industrial Average, is just a mathematically calculated value based upon 

the relative weights and prices of the commodity futures contracts within the index. Financial 

institutions have devised several types of financial instruments to enable investors to gain 

exposure to the value of a commodity index. Presently, there are three types of financial 

instruments that investors can purchase to provide a financial return based upon the value of a 

commodity index: commodity index swaps, exchange traded funds, and exchange traded notes. 

Commodity Index Swaps. The most common type of commodity index instrument is a 

financial instrument known as a “swap” whose return is based upon the performance of a 

specified commodity index. 

A commodity index swap is, in essence, a financial instrument that pays a return based on 

the value of a specified index. A “swap dealer,” such as a bank or broker-dealer, typically offers

a qualified investor the opportunity to purchase, for a fixed price, a swap whose value is linked, 

on any given date, to the value of a specified commodity index on that date.133

Commodity index swaps are not traded on regulated futures exchanges. Instead they are 

sold “over the counter,” outside of the statutory and regulatory framework that applies to futures 

exchanges. Because these swaps are traded outside of the exchanges and because current law 

prohibits CFTC regulation of swaps,

 The purchase 

price of the swap will be the value of the index on the purchase date. If the value of the 

commodity index increases, the value of the swap to the purchaser will increase by a 

corresponding amount. On the other hand, if the value of the commodity index falls, the value of 

the swap will also fall. Typically, although these swaps often may be sold back to the swap 

dealer at any time, the large institutions that purchase these types of swaps hold onto them for 

long periods of time. 

134

 

Subcommittee that they reduce their trading during the time when index traders are rolling their futures contracts; 

other traders apparently try to anticipate or respond to the rolls. Because of the many possible trading responses to 

commodity index rolls, it is difficult to determine exactly how such rolls affect futures prices. Depending on the 

trading strategies adopted by the other traders in the market at the time, the impact of the roll may vary from roll to 

roll. 

the CFTC has virtually no direct data on who purchases 

them, how many are sold over what time period, or the prices charged.

133 Swap dealers are typically large diversified financial institutions. Among the leading swap dealers operating in 

the United States are Bank of America, Citibank, Goldman Sachs, HSBC Bank, and J.P.Morgan Chase. See, e.g., 

OCC’s Quarterly Report on Bank Trading and Derivatives Activities: Fourth Quarter 2008, Table 1: “Notional 

Amount of Derivative Contracts: Top 25 Commercial Banks and Trust Companies in Derivatives,” U.S. 

Comptroller of the Currency, December 31, 2008.

134 The Commodity Futures Modernization Act of 2000, enacted into law as part of the Consolidated Appropriations 

Act of 2001, P.L. 106-554, contains several provisions which prohibit CFTC regulation of any type of swap.
84

The CFTC does possess indirect data on these swaps, because the swap dealers who sell 

them typically hedge their exposure by purchasing the referenced futures contracts on a futures 

exchange. For example, if a swap dealer has sold a swap whose value is linked to an index 

consisting of 50 percent oil and 50 percent wheat, the swap dealer will owe the investor a greater 

amount if the prices of oil and wheat increase. To avoid this financial exposure, the swap dealer 

typically purchases an equivalent amount of the specified futures contracts in oil and wheat on a 

futures exchange. If the swap increases in value due to increases in the oil and wheat futures 

prices – which means the swap dealer owes the swap purchaser more money – the swap dealer’s 

financial exposure is offset by the fact that the swap dealer also owns the referenced futures 

contracts whose prices rose. The swap dealer is then said to be “short” oil and wheat in the overthe-counter swap market, but “long” oil and wheat on the futures exchange, for a net exposure of 

zero. The swap dealer, who charges a fee for selling the swap, then becomes indifferent to any 

subsequent change in the value of the commodity index. 

While the net exposure of swap dealers who sell commodity index swaps may be 

minimal as a result of this hedging, the hedging process itself has, in effect, transmitted the 

commodity index swap purchases into purchases of contracts on the futures markets. In this 

manner, even though commodity index investors typically do not purchase future contracts 

directly, their swap purchases often result in the purchase of futures contracts on an exchange by 

their swap dealers. Those purchases, in turn, can affect prices on the exchange by creating an 

additional demand for the futures contracts referenced in the commodity indexes.

Although it may be possible for swap dealers to hedge some of their commodity index 

swap exposures by entering into over-the-counter transactions that offset these exposures (i.e., 

“internal netting”), the CFTC indicates that swap dealers frequently use the futures markets for 

the purpose of obtaining these hedges or offsets. The CFTC states: “As a result of the growth of 

the swap market and the dealers who support the market, there has been an associated growth in 

the open interest of the futures markets related to the commodities for which swaps are offered, 

as these swap dealers attempt to lay off the residual risk of their swap book.”135

Exchange Traded Funds. In the past few years, banks and other financial institutions 

have devised another type of instrument, known as exchange traded funds (ETFs), to mirror the 

performance of specified commodity indexes. Unlike the purchase of a commodity index swap 

from a swap dealer, which is a bilateral transaction between the investor and the swap dealer, 

ETFs are constructed in such a way that retail investors can buy and sell ETF shares on a stock 

exchange, in the same way investors buy and sell shares of stock on a stock exchange. The ETF 

is structured so that the value of the ETF shares should reflect the value of the commodity index 

upon which they are based.

 

 135 CFTC, Staff Report on Commodity Swap Dealers and Index Traders with Commission Recommendations, at p. 

12.
85

Purchasers of ETF shares, who can monitor the shares’ value in the same manner as the 

value of stocks traded on a stock exchange, can sell their ETF shares to any other buyer through 

the stock exchange on which the shares are offered.

136 Although the mechanism by which 

investors in ETFs gain exposure to a particular commodity index is different from the purchase 

of a commodity index swap from a swap dealer, the end result is the same – the purchaser of an 

ETF gains exposure to the value of the commodity index upon which it is based.137

A key advantage of ETF shares is that they can be bought and sold as easily as individual 

stocks. ETFs provide a way for smaller investors who are not large enough to establish an 

account and purchase and sell swaps with a swap dealer to invest in commodity indexes. One 

investment analyst explains: 

 

“At the most basic level, ETFs are just what their name implies: baskets of securities that 

are traded, like individual stocks, on an exchange. ... Unlike regulated open-end mutual 

funds, ETFs can be bought and sold throughout the trading day. They can also be sold 

short and bought on margin – in brief, anything you might do with a stock, you can do 

with an ETF.”138

 136 Due to the arbitrage mechanism used to ensure that ETF values track commodity index values, the net asset value 

of the ETF may not always equal the value of the ETF trading on the exchange. Only large, authorized institutions –

usually termed “Authorized Participants” – are permitted to purchase blocks of shares directly from an ETF issuer. 

Authorized Participants that redeem blocks of shares from the ETF must obtain the actual underlying assets – either 

futures contracts or, in some cases, securities – and deposit them with the ETF. Authorized Participants then offer 

their shares to retail investors through a stock exchange. Unlike the Authorized Participants, retail investors cannot 

obtain or sell the underlying assets, but can only buy or sell their shares in the fund through a broker in the 

secondary market on a stock exchange. 

The Prospectus for a Deutsche Bank commodity ETF describes how this process works: 

“The Shares of the Fund trade on the Amex like any other equity security.

“Baskets of Shares may be created or redeemed only by Authorized Participants. It is expected that 

Baskets will be created when there is sufficient demand for Shares that the market price per Share is at a 

premium to the net asset value per Share. Authorized Participants will then sell such Shares, which are 

listed on the Amex, to the public at prices that are expected to reflect, among other factors, the trading price 

of the Shares on the Amex and the supply of and demand for Shares at the time of sale and are expected to 

reflect, among other factors, the trading prices of the Shares on the Amex and the supply of and demand for 

Shares at the time of sale and are expected to fall between net asset value and the trading price of the 

Shares on the Amex at the time of sale. Similarly, it is expected that Baskets will be redeemed when the 

market price per Share is at a discount to the net asset value per Share. Retail investors seeking to purchase 

or sell Shares on any day are expected to effect such transactions in the secondary market, on the Amex, at 

the market price per Share, rather than in connection with the creation or redemption of Baskets.”

PowerShares DB Commodity Index Tracking Fund, Prospectus dated May 1, 2008, at p. 1. 

137 For a summary of the advantages and disadvantages of ETFs, see Christopher J. Traubsen, Exchange-Traded 

Funds: What You Should Know, Morningstar Commentary, at 

http://news.morningstar.com/articlenet/article.aspx?id=3503&_QSBPA=Y&dType=etf. 

138 Christopher J. Traubsen, Exchange-Traded Funds: What You Should Know, Morningstar Commentary, at 

http://news.morningstar.com/articlenet/article.aspx?id=3503&_QSBPA=Y&dType=etf. 
86

To provide value to their shares, commodity-based ETFs hold the various futures

contracts whose values are used to compute the index value. These ETFs typically hold a basket 

of futures contracts of commodities in proportion to the weighting of the commodities- in the 

calculation of the index. As investments in the fund increase, the ETF typically will obtain 

additional commodity futures contracts to support the investments; as investments in the fund 

decrease, the number of commodity futures contracts held in the ETF typically decrease.139

The first ETF based on a commodity index was offered in 2006.

 

140 Since then many 

types of commodity ETFs have been created and marketed. “‘Whatever opinion you have about 

anything, there’s an E.T.F. for it,’ said Michael Metz, chief investment strategist at Oppenheimer 

& Company. ‘Everything is subject to gambling and speculation.’”141 Several commodity ETFs 

track the broadly used commodity indexes, others track the sub-indexes, and some are even 

based upon the value of futures contracts for a single commodity. Single-commodity ETFs risk

much more volatility than an ETF based on a broad basket of commodities.142

Exchange Traded Notes. A third commodity-based instrument involves exchange

traded notes (ETNs). Commodity-based ETNs are designed and sold by banks and other 

financial institutions to permit retail investors to purchase shares of a debt security whose price is 

linked to that of a commodity index. Upon maturation of the note, the issuer of the ETN 

promises to pay the holder of each share of the note the value of a specified commodity index. 

 

Retail investors can buy and sell shares in ETN notes on secondary markets, in the same 

manner as stocks traded on a stock exchange. Most commodity ETNs are traded on the NYSE 

Alternext exchange (formerly the American Stock Exchange). 

ETNs offer certain advantages over ETFs. ETN share values exactly track the value of 

the underlying commodity index, and there may be tax advantages to these instruments 

compared to swaps or ETF shares.

143

 139 An Authorized Participant that wishes to create a basket of shares for sale to retail investors must purchase the 

appropriate number of commodity futures contracts and deposit them with the ETF in return for the additional 

basket of shares. In theory, the purchase of these futures contracts will cause the price of the commodity index to 

rise, while the sale of additional shares will cause the value of the shares on the exchange to fall, until they are once 

again in equilibrium. This arbitrage process theoretically works in a similar manner when investors want to sell 

their shares of the ETF on the exchange. 

 On the other hand, there also are disadvantages. Most 

140 John Spence, Commodities ETF breaks new ground, Use of derivatives signals major shift for industry, 

MarketWatch, February 6, 2006.

141 J. Alex Tarquino, Many Roads to Commodities, Through E.T.F.’s, New York Times, October 7, 2007. 

142 “Unless you think that we’re going back to the 16th-century spice trade, you should not be speculating on 

individual commodities.” J. Alex Tarquino, A New Way to Play in Commodities, New York Times, July 13, 2008 

(remarks of Gary Schatsky).

143 See, e.g., Seeking Alpha, The ETN Market Heats Up With Goldman Launch; More On the Way, August 6, 2007, 

at http://seekingalpha.com/article/43585-the-etn-market-heats-up-with-goldman-launch-more-on-the-way. 
87

prominently, ETNs expose investors to the credit risk of the ETN issuer. If the issuer of the note 

goes bankrupt, then the ETN shares held by institutional and retail investors could lose all their 

value.

144

The issuer of an ETN typically uses proceeds from the sale of shares to investors to make 

actual purchases of the futures contracts whose values are used to compute the index value to 

which the note is linked. As with exchange traded funds, the ETN issuer typically constructs a 

basket of futures contracts to reflect the weighting of the commodities in the index. The issuer 

then relies on this commodity basket to hedge its exposure to the ETN shareholders for the value 

of the index. ETN issuers who purchase futures contracts, like swap dealers, create additional 

demand for the futures contracts in the relevant index and so may affect futures prices. 

 

ETNs have gained in popularity over the past few years, but still hold a relatively small 

share of the market as compared to ETFs. One financial analyst reports: “As of 2008, there 

were close to 100 ETNs available to investors. Assets under management were more than $6 

billion, compared to $600 billion for ETFs.”145

Table 6 lists the largest commodity-based ETFs and ETNs, based on total assets. Each of

these funds had at least $100 million in assets as of April 2009. Although the largest commodity 

ETFs have substantial assets, the aggregate amount of investments in commodity-based ETFs 

and ETNs represents a small fraction of the total investments in index-related instruments, which 

continue to be made primarily through commodity index swaps. 

 144 Following the bankruptcy of Lehman Brothers in September 2008, for example, the NYSE Alternext exchange 

removed all of the ETNs issued by Lehman Brothers from listing on the exchange. NYSE Euronext News Release, 

October 21, 2008, at http://www.nyse.com/press/1223288675336.html. 

145 These figures represent the total value of investments in equity-based and commodity-based ETFs and ETNs. 

Larry MacDonald, ETN Credit Risk May Outweigh Benefits For Some, Investopedia.com, at 

http://investopedia.com/printable.asp?a=/articles/bonds/08/credit-risk-exchange-traded-note.asp. 
88

Largest Commodity ETFs and ETNs (as of April 30, 2009)

Name Symbol Incep. 

Date

Assets

(millions)

Returns (%)

2007 2008 Total 

United States Oil USO 4/10/06 2,929.40 46.82 -56.31 -27.33

DB Commodity Index DBC 2/3/06 1,924.60 31.50 -31.73 -5.28

PowerShares DB 

Agriculture DBA 1/5/07 1,748.80 N/A -19.24 -1.22

United States Natural Gas UNG 4/18/07 1,140.50 N/A -36.08 -43.78

iPath DJ-AIG Commodity DJP 6/6/06 929.00 14.90 -37.42 -15.21

iShares GSCI Commodity 

Id GSG 7/10/06 782.80 31.62 -45.75 -23.75

iPath GS CrOil TR Idx ETN OIL 8/15/06 664.10 47.53 -58.56 -33.73

PowerShares DB Oil Fund DBO 12/06/07 194.90 N/A -44.06 -11.00

ELEMENTS Rogers Agric 

ETN RJA 10/17/07 193.80 N/A -31.66 -25.53

ELEMENTS Rogers TR 

ETN RJI 10/17/07 175.80 N/A -42.43 -33.97

United States 12 Month Oil 

Fd USL 12/06/07 162.00 N/A -44.68 -39.82

Table 6. Prepared by U.S. Senate Permanent Subcommittee on Investigations, April 2009

Data Source: Indexuniverse.com, Data, at 

http://www.indexuniverse.com/sections/data.html?task=showResults.

D. Types of Commodity Index Returns 

In general, financial instruments linked to a commodity index can offer an investor up to 

three possible sources of return: the spot return, the roll return, and the collateral return.146 

Commodity index swaps, ETFs, and ETNs typically offer investors either a spot return plus a roll 

return (termed the “Excess Return”), or all three returns – the spot return plus the roll return plus 

the collateral return (termed the “Total Return”).147

Spot Return. The spot return is the most straightforward. This return is derived from 

changes in the spot market prices of the commodities included in an index. 

 

 146 See, e.g., Claude R. Erb and Campbell R. Harvey, The Tactical and Strategic Value of Commodity Futures, 

January 12, 2006. 

147 See, e.g., Standard & Poor’s, S&P GSCI, Highlights and Definitions, May 2007.
89

Roll Return. The roll return is derived from the periodic sale of futures contracts 

nearing expiration and the simultaneous purchase of futures contracts bearing more distant 

expiration dates (the roll). The return is the difference between the price of the futures contract 

being sold and the price of the futures contract being purchased. When the price of the futures 

contract being sold is less than the price of the futures contract being purchased (i.e., when the 

futures market is a carry market or in contango), the roll return will be negative. When the price 

of the futures contract being sold is greater than the price of the futures contract being purchased 

(an inverse or backwardated market), the roll return will be positive. 

Collateral Return. The collateral return is the amount of interest earned on the amount 

of any collateral required for the purchase of a commodity index swap, ETF, or ETN. With 

respect to commodity index swaps, swap dealers usually require investors to fully collateralize 

their purchase. The investor purchasing a swap typically must deposit the full purchase price of 

the underlying commodity futures with the swap dealer. 

The swap dealer then invests this collateral, which 

essentially functions as a margin deposit. Swap dealers 

typically invest the collateral funds in low-risk Treasury 

bills or bonds, which earn interest. When the swap is 

terminated, the swap dealer pays the amount of interest 

earned to the investor as part of the return payment on the 

swap. The interest payment arising from the investment 

of the collateral is termed the “collateral yield” or 

“collateral return.”148

Some ETNs and ETFs also provide a collateral 

return, since they may also require the purchasers of their 

shares to provide a deposit equal to the price of the 

commodity futures contracts included in the index and 

reflected in their shares.

As discussed below, over the past several decades the spot returns from commodity 

indexes have been relatively small. Because a “Spot Return” index will pay the investor a return 

solely based upon the change in the spot price of the commodity, there is not much interest in 

investing in an index that pays only a spot return. All of the major commodity index instruments 

today provide either Excess Returns (spot return plus roll return) or Total Returns (spot return, 

plus roll return, plus collateral return). 

 148 See, e.g., Standard & Poor’s, Investing with the S&P GSCI Commodity Indices, June 21, 2007 (powerpoint 

presentation). 

Commodity Return Terms

Spot return: The gain (loss) in the 

price level.

Roll return: The gain (loss) from the 

periodic selling of near-term futures 

and buying of longer-term futures. 

Collateral return: The interest 

earned on the collateral deposited 

into the margin account.

Excess return: Spot return + Roll 

return 

Total return: Spot return + Roll 

return + Collateral return
90

E. Commodity Index Rationale and Marketing

“More importantly, we believe commodities offer an inherent or natural return 

that is not conditioned on skill.”

--Ibbotson Associates, 2006.149

“Bottom line, forward looking expected returns for commodity futures (as well as 

for stocks, bonds, hedge funds, anything) are just bets.”

--Claude Erb and Campell Harvey, 2006. 150 

1. The Marketing of Commodity Index Instruments

Beginning about 10 years ago, a number of influential articles in financial journals 

asserted that there were significant benefits to investing in commodity indexes. A number of 

financial institutions also began to aggressively market these types of instruments. These articles 

and marketing presentations claimed commodity index instruments would help diversify a 

traditional portfolio of stocks and bonds, and that commodities offered protection against 

unexpected increases in the rate of inflation, a benefit that is not typically provided by stocks and 

bonds.151

In 2000, Robert J. Greer, one of the early proponents of investing in commodity indexes, 

wrote: “In addition to providing exposure to unexpected changes in inflation, commodity 

indexes may provide exposure to long-term growth in world demand that may also result in an 

increasing demand and prices for certain commodity products.”

 Additional arguments were that the price of commodities would rise as the global 

economy expanded and the demand for commodities increased. 

152

In 2004, Professors Gary Gorton of the University of Pennsylvania and K. Geert 

Rouwenhorst of the Yale School of Management published what would become an oft-cited 

analysis showing how an investment in a broadly diversified commodity index would have 

 Greer also identified the 

negative correlation between commodity index returns and the returns from stocks and bonds as 

a key benefit of adding a diversified commodity index to a diversified portfolio. 

 149 Ibbotson Associates (commissioned by PIMCO), Strategic Asset Allocation and Commodities, March 27, 2006, 

at p. 4. 

150 Claude R. Erb and Campbell R. Harvey, The Tactical and Strategic Value of Commodity Futures, January 12, 

2006, at p. 46.

151 See, e.g., Greer, The Nature of Commodity Index Returns, Journal of Alternative Investments, Summer 2000, at 

pp. 45-53; Ibbotson Associates (Commissioned by PIMCO), Strategic Asset Allocation and Commodities, March 27, 

2006; Vanguard, Understanding Alternative Investments: The Role of Commodities in a Portfolio, Vanguard 

Investment Counseling and Research, August 2007; Goldman Sachs, The Case for Commodities as an Asset Class

(PowerPoint presentation), June 2004. 

152 Greer, at p. 45. 
91

brought positive returns over the 45-year period from 1959 to 2004. Gorton and Rouwenhorst 

found:

“Fully-collateralized commodity futures have historically offered the same return 

[for the same level of risk] as equities. While the risk premium on commodity 

futures is essentially the same as equities, commodity futures returns are 

negatively correlated with equity returns and bond returns. ... In addition, 

commodity futures are positively correlated with inflation, unexpected inflation, 

and changes in expected inflation.”153

Gorton and Rouwenhorst pointed out that the returns from an investment in a 

basket of commodity futures would not result from an increase in the spot prices of the 

commodities, but rather from the structure of the futures market and the benefits of 

diversification.154 Discussing the benefits of diversification provided by adding 

commodity index instruments to a portfolio of stocks and bonds, Gorton and 

Rouwenhorst wrote: “It seems that the diversification benefits of Commodity Futures 

work well when they are needed most. Consistent with a negative correlation, 

Commodity Futures earn above average returns when stocks earn below average 

returns.”155

Gorton and Rouwenhorst analyzed how a number of individual commodities 

included in the Goldman Sachs Commodity Index (GSCI) performed between 1959 and 

2004.

 

156

 153 Gary Gorton and K. Geert Rouwenhorst, Facts and Fantasies About Commodity Futures, Yale International 

Center for Finance, Yale ICF Working Paper No. 04-20, February 28, 2005, at p. 1.

 Figure 21 presents this data, in order of descending return. Wheat and corn 

provided the lowest returns of all the commodities studied. 

154 The authors contended that because the futures market reflected expectations about future spot prices, “expected 

movements in the spot price are not a source of return to an investor in futures. . . . Unexpected deviations from the 

expected future spot price are by definition unpredictable, and should average out to zero over time for an investor 

in futures, unless the investor has an ability to time the market.” Id., at p. 3. The returns from an investment in 

futures, they stated, comes from an inherent “risk premium” that exists in the futures market that hedgers must pay 

to speculators in order for speculators to assume price risks from the hedgers. They cite Keynes’s theory of “normal 

backwardation,” despite the acknowledged “lack of success” in finding empirical evidence for any such inherent risk 

premium in the futures market. Id., at p. 4. 

155 Id., at p. 14. 

156 For commodities that were not traded during the entire period, data was used for as long as it was available. 
92

Commodity Returns: 1959-2004

(Gorton & Rouwenhorst, 2005)

Corn

Gold

Lead

Silver

Cotton

Zinc

Cocoa

Soybeans

Feeder Cattle

Orange Juice

Sugar

Live Cattle

Natural Gas

Coffee 

Lean Hogs

Copper

Nickel

Heating oil

Unleaded gasoline

Aluminum

Soybean oil

Wheat

Crude oil

0 5 10 15 20 25 30

Annualized Return (%)

Figure 21. Gorton & Rouwenhorst’s calculations of annualized monthly arithmetic commodity 

returns for commodities in the GSCI. Data source: Facts and Fantasies About Commodity 

Futures, Appendix 3. 

Although commodity indexes had been in existence for a number of years, prior to the 

early 2000s, there was a relatively small amount of speculation tied to these indexes.157

During the mid-2000s, a number of financial institutions – many of whom had created 

indexes or sold products related to those indexes – made strong recommendations for investors to 

purchase commodity index instruments. For example, Goldman Sachs, creator of the GSCI, 

stated: “GS recommends a permanent strategic holding in commodities as a ‘separate asset 

class’ to hedge macroeconomic risk, decrease expected portfolio risk and increase expected 

portfolio returns.”

 In the 

early 2000s, however, after the collapse of the internet bubble in the stock market and as the 

price of oil and other energy commodities began a steep rise, investors began to look to 

commodities as an alternative investment. The Gorton and Rouwenhorst paper was influential in 

establishing commodity indexes as an additional way for hedge funds, pension funds, and other 

institutional investors to diversify their portfolios and benefit from the rising prices of oil and 

other commodities.

158

 157 Goldman Sachs, The Case for Commodities as an Asset Class, at p. 2.

 Goldman Sachs listed the following benefits of investing in GSCI:

158 Id., at p. 10.
93

• “Commodities are significantly negatively correlated with both Bonds and 

Equities. . . .

• The GSCI historically has had high equity-like returns (12.24% per annum 

since 1970 as of May 31, 2004).

• Commodities perform best when other assets perform worst. . . . 

• The GSCI provides a hedge against rising inflation. . . .”159

Alternative Investment Analytics, a consultant to Prudential Bache Commodities which 

constructed and publishes the Bache Commodity Index (BCI), made similar claims for 

purchasing commodity indexes: 

• “Certain real assets, such as the BCI commodity index, may serve as a hedge 

against inflation risk. 

• Exposure to commodities adds meaningful risk reduction and return 

enhancement. For the real asset portfolios considered, the BCI typically 

demanded a 10-25% allocation.

• Commodities exposure via a passive futures based index has the additional 

virtue that is perhaps the most liquid of real assets, with the possible exception 

of TIPS [Treasury Inflation-Protected Securities].”160

In 2006, a study commissioned by PIMCO on the performance of commodity indexes

stated: “Our historical analysis supports the claims that commodities have low correlations to 

traditional stocks and bonds, produce high returns, hedge against inflation, and provide 

diversification through superior returns when they are needed most.”161

“More importantly, we believe commodities offer an inherent or natural return 

that is not conditioned on skill. Coupling this with the fact that commodities are 

the basic ingredients that build society, we believe commodities are a unique asset 

class and should be treated as such.”

 The PIMCO study was 

extremely enthusiastic about these types of investments, going so far as to suggest it required 

absolutely no skill to benefit from commodity indexes: 

162

As a result of these articles, presentations, and soaring commodity prices, the total value 

of commodity index funds grew exponentially. One market analyst estimated that the total value 

of investments in commodity index funds “jumped from $15 billion in 2003 to $56 billion in 

 159 Id., at p. 10.

160 Alternative Investment Analytics, Real Assets in Institutional Portfolios: The Role of Commodities, Current 

Update: December 10, 2007, at p. 11. 

161 PIMCO study, at p. ii. 

162 Id., p. 4. 
94

2004 and on to $80 billion” in 2006.163 As of mid-2008, the CFTC has estimated that the total 

value of commodity index investments had reached $200 billion. 

2. Critical Analyses of Index Instruments

Not all market analysts were so enthusiastic. In 2006, a number of articles appeared that 

took issue with the assertion that buying and holding commodity index instruments provided 

superior returns and benefits. These articles indicated that purchases of commodity index 

instruments were, in essence, speculative bets on the structure of the commodities futures 

markets rather than a risk-free technique for portfolio diversification. 

The issues raised in these analyses, along with declines in the performance of many 

commodity indexes in 2005 and 2006, led a number of financial institutions to devise new 

indexes. Whereas earlier, or first-generation, commodity indexes typically relied on the second 

month futures contract to calculate the index, these later indexes generally began to use longer 

dated futures contracts. 

Since 2006, these second-generation commodity indexes have become increasingly 

popular. Although there is no publicly available data on the relative amounts held in instruments 

linked to second-generation and first-generation indexes, persons interviewed by the 

Subcommittee estimated that virtually all new commodity index investments are now placed in 

second-generation index instruments, and that, in the aggregate, investments in second 

generation indexes now represent more than half of all commodity index investments. 

The shift into second-generation indexes is significant for the futures markets for several 

reasons. First, it means that instead of hedging their swap exposures with purchases of second 

month futures contracts, many swap dealers now need to hedge their commodity index swap 

sales with purchases of futures contracts whose expiration dates are more distant in time. 

Second, commodity index rolls now require sales and purchases of futures contracts that are 

farther apart in time, as opposed to just between the first and second month contracts used in 

most first-generation indexes. These changes mean that the effect of commodity index trading 

on the futures markets is not limited to the first two futures contracts, but now extends months 

longer to futures contracts that are much farther from expiration. 

One of the first major analyses challenging the rosy view of the performance of 

commodity indexes was published in January 2006, by Claude Erb and Campbell Harvey. Erb 

and Harvey analyzed the returns from the commodities used to support the 2004 Gorton and 

 163 Philip Verleger, Commodity Investors: A Stabilizing Force?, The Petroleum Economics Monthly, March, 2006. 

This and other estimates of a similar magnitude reflect both the growth in actual amounts invested in commodity 

indexes and the appreciation in value of those investments due to increasing commodity prices. 
95

Rouwenhorst analysis.

164 Erb and Harvey found that an investment in any of these commodity 

futures did not provide a return greater than the rate of inflation. They wrote: “[T]he average 

return of the average commodity futures was not statistically different from zero.”165 Erb and 

Harvey concluded that although the large returns cited by Gorton and Rouwenhorst were real, 

they did not result from any significant appreciation in the price of the commodities within the 

index, but rather the returns resulted from the periodic rebalancing of the commodity futures 

within the index and from the fact that the performance of these individual commodity futures 

contracts were uncorrelated with each other.166

The Erb and Harvey analysis found that, from 1982 to 2004, agricultural commodities 

and precious metals were the worst performing commodity sectors, while energy was the best 

performing sector. Wheat, corn, gold, and silver all had negative returns.

 

167 The returns 

computed by Erb and Harvey are shown in Figure 22. 

 164 Claude R. Erb and Campbell R. Harvey, The Tactical and Strategic Value of Commodity Futures, January 12, 

2006. Erb and Harvey’s paper referenced and expanded upon previous research into the nature of commodity index 

and commodity futures returns. See, e.g., Hilary Till, Two Types of Systematic Returns Available in the Commodity 

Futures Markets, Commodities Now, September 2000, and references cited therein. 

165 Id., at p. 4. 

166 Having uncorrelated commodity futures provides a so-called “diversification return” that does not boost the 

return of an individual commodity, but rather the portfolio as a whole. “Campbell (2000) calls portfolio 

diversification the one ‘free lunch’ in finance because it allows an investor to reduce a portfolio’s standard deviation 

of return without reducing the portfolio’s arithmetic return.” Id., at p. 36. 

167 Erb and Harvey represented returns in terms of the excess returns, i.e., the returns over the risk-free rate of return. 
96

Commodity Returns: 1982-2004

(Erb and Harvey, 2006)

Silver

Gold

Wheat

Sugar

Lean Hogs

Soybeans

Heating oil

Copper

S&P 500

Lehman Bond Index

Live Cattle

GSCI

Cotton

Corn

foreign stocks

Coffee

-10 -5 0 5 10

Annualized Excess Return (%) 

Figure 22. Annualized excess returns (geometric mean) for selected commodities in the 

GSCI and various benchmarks. Data source: Erb and Harvey, at p. 15. 

After examining why these commodities performed differently over the time period 

studied, Erb and Harvey found that one of the key factors determining the performance of a 

commodity within the index was the structure of the market – specifically, whether the futures 

contracts further from expiration were priced higher than the futures prices nearer expiration (a 

carry market or contango) or lower than the futures prices nearer expiration (an inverse market or 

backwardation). As previously explained, the roll return from an index-related investment will 

be negative in a carry or contango market and will be positive in an inverse or backwardated 

market. 

Figure 23 shows how both the roll return and spot return contributed to the performance 

of the commodities studied by Erb and Harvey. The data shows that the roll return was the 

primary determinant of returns, or lack of returns, for all of the commodities studied. For grains 

in particular – wheat and corn – the small positive spot returns were swamped by large negative 

roll returns. In other words, despite gains in the price of these commodities, investments in these 

commodities produced significant losses due to the need to regularly sell the expiring first month 

futures contracts and purchase more expensive second month futures contracts. This data 

demonstrates the significance of the roll return and structure of the commodity futures market for 

long-term investments in commodity futures contracts or index-related instruments. 
97

Spot and Roll Returns: 1982-2004

(Erb and Harvey, 2006)

Silver

Heating oil

Live Cattle

Wheat

Corn

Lean Hogs

Lean Hogs

Copper

Heating oil

Live Cattle

Cotton

Soybeans

-10

-8

-6

-4

-2

0

2

4

6

8 Excess Return

(Spot return + Roll

return)

Spot Return

Annualized 

Return (%)

Figure 23. Spot and roll returns for selected commodities. Returns reflect annualized

returns (geometric mean). Data source: Erb and Harvey, p. 15. 

Erb and Harvey cautioned that commodity prices in the past could not be relied upon to 

predict future price trends. “In reality, investors do not know what the average term structure of 

prices will look like in the future. As a result, knowing that roll returns have been an important 

driver of past returns provides no insight as to the future level of roll returns.”168 This view 

stands in direct contrast to other analyses, such as the PIMCO study, that contend commodity 

indexes offer “an inherent or natural return that is not conditioned on skill.” “Bottom line,” Erb 

and Harvey wrote, “forward looking expected returns for commodity futures (as well as for 

stocks, bonds, hedge funds, anything) are just bets. The commodity futures bet has one really 

high confidence element, the diversification return, and two very uncertain elements, spot and 

roll returns.”169

Independently, another study released in early 2006, by economists Barry Feldman and 

Hilary Till, arrived at a similar conclusion. Feldman and Till examined how an instrument 

linked to a commodity index based on wheat, corn, and soybeans futures contracts would have 

 168 Erb and Harvey, p. 25.

169 Id., at p. 46.
98

fared over a much longer period of time, from 1950 to 2004.170 Figure 24 presents this data on 

the commodity index returns in each five-year window within this 54-year period. The majority 

of returns for these commodities during the five-year intervals within this period were 

negative.171 Only during one five-year period from 1970-74, a time when many agriculture 

commodity prices spiked higher due to a confluence of extraordinary geopolitical and market 

conditions, did all three commodities provide large positive returns.172 Like Erb and Harvey, 

Feldman and Till found that, for most of the 54 years, the negative roll returns overwhelmed the 

positive appreciation in wheat and corn prices. 

 170 Barry Feldman and Hilary Till, Separating the Wheat from the Chaff: Backwardation as the Long-Term Driver 

of Commodity Futures Performance; Evidence from Soy, Corn and Wheat Futures from 1950 to 2004, EDHEC Risk 

and Asset Management Research Centre, March 2006. 

171 For the entire period, the annualized excess return for corn was -4.35% and for wheat was -2.91%, compared to a 

positive annualized return for the S&P 500 of 6.80%. Soybeans managed to show an overall return of 3.41%, 

largely due to the returns for soybeans provided from just two of these five-year periods, 1950-54 and 1970-74. Id., 

at p. 11. 

172 A number of factors led to the rapid and general increase in agricultural commodity prices in the early 1970s. 

Adverse weather conditions reduced the yields in major grain-producing countries, including the United States, 

Australia, Canada, and the Soviet Union. In 1972, the Soviet Union turned to the United States and other world 

markets to make up for a significant decline in their domestic wheat production. Increased demand for grain by the 

Soviets and other communist countries resulted in a 29% increase in global exports of grain between 1971 and 1972. 

The United States abandoned the gold standard in 1971 and the subsequent depreciation of the value of the U.S. 

dollar also boosted the demand for exports. Demand for soybean meal as a source of high-protein feedstock soared 

after the failure of the Peruvian anchovy catch, and soybean prices skyrocketed in 1973 and 1974. The stocks of 

surplus grain in the United States and other grain-producing countries had fallen due to the phase-out of various 

subsidies in the late 1960s. After this period, prices did not return to their previous levels. See May Peters, Suchada 

Langley, Paul Westcott, Agricultural Commodity Price Spikes in the 1970s and 1990s, Valuable Lessons for Today, 

USDA Economic Research Service, Amber Waves, March 2009. 
99

Returns for Corn, Wheat, and Soybeans: 1950-2004

(Feldman and Till, 2006) 

-30

-20

-10

0

10

20

30

40

1950-

54

1955-

59

1960-

64

1965-

69

1970-

74

1975-

79

1980-

84

1985-

89

1990-

94

1995-

99

2000-

04

Soybeans

Corn

Wheat

Excess Returns 

(Annualized)

 %

Figure 24. Excess returns (spot + roll) for wheat, corn, and soybeans over five-year 

periods from 1950-2004. Data source: Feldman and Till (2006), at pp. 33-34.

The negative roll returns, Feldman and Till wrote, were primarily due to the structure of the 

agriculture futures markets over the 54-year period – specifically, that successive futures 

contracts tend to increase in price (contango) in order to provide a financial incentive to store the 

commodity over time. Wheat and corn, Feldman and Till found, “are consistently in contango,” 

and therefore provided negative returns over the period.173 

 173 With respect to the length of time required for the roll return to predominate, Till found the roll yield explained

25% of the variation in futures returns over one-year time horizons, 40% of the variation over two-year time 

horizons, 67% of the variation over a five-year time horizon, and 73% of the variation over an eight-year horizon. 

Id., at p. 15. See also, Barry Feldman and Hilary Till, Backwardation and Commodity Futures Performance: 

Evidence from Evolving Agricultural Markets, Journal of Alternative Investment, Winter 2000; Hilary Till, Trading 

strategies, commodity risk, May 2007. 
100

Backwardation and Returns

Brent crude oil

Gasoline

Gasoil WTI crude oil

Heating oil Copper

Live cattle

Soy meal

Platinum

Lean hogs

Soybean oil Sugar

Soybeans Cotton

Gold

Wheat

Cocoa

Corn

Silver

Coffee

Natural gas

-10

-5

0

5

10

15

20

25

-20 -15 -10 -5 0 5 10 15

Amount of Backwardation (%)

Returns (%)

Backwardation

Contango

returns increase as 

backwardation increases

returns decrease as 

contango increases

Figure 25. The degree of backwardation is the most important factor determining returns 

over long time periods. Source: Morgan Stanley, 2005. 

In a related study released in April 2006, Till extended these findings to all commodities. 

“Over very long timeframes a number of authors have shown how the term structure of a 

commodity futures curve has been the dominant driver of returns in futures investing. In other 

words, trends in the spot price of a commodity generally have not been a meaningful driver of 

returns over long periods of time.”174 These results are shown in Figure 25, which reflects data 

from Till’s paper.175

 174 Hilary Till, Structural Sources of Return and Risk in Commodity Futures Investments, EDHEC Risk and Asset 

Management Research Centre, April 2006, at p. 7 (emphasis in original). 

 A recent commentary by Standard & Poor’s sums up this body of research 

175 The data used in Figure 25 is from a presentation by Nash and Strayer of Morgan Stanley, which was also 

reproduced in Till’s paper. Morgan Stanley, IQPC, Investing in Commodities, May 2005, at p. 2, 4. Morgan Stanley 

analyzed the performance of these commodities over two different time periods, a 10-year period from 1994 to 

2004, and a 21-year period from 1984 to 2004. The results were similar, finding that spot price changes over both

time frames had “very little effect” on the overall performance of the commodities in the index. The Morgan 

Stanley analysis also concluded that the extent to which prices fell over time (backwardation) in the futures market 

was the main factor that determined the amount of returns: “The persistence of backwardation is a driver for 

commodity returns.” For the period from April 1984 to September 2004, they found the correlation between 

backwardation and returns was 0.94 (R2

=0.88), demonstrating a strong statistical relationship. 
101

succinctly: “In commodity indexing, it is important to remember two key things, contango is 

bad and backwardation is good.” 176

The importance of the structure of the futures market on commodity index returns 

became apparent to many in late 2006. In 2004, the structure of the futures market for crude oil

– the most heavily weighted commodity in most indexes – changed. The price of longer-term 

futures contracts rose from below the price of shorter-term futures contracts (backwardation) to 

where they were now above the price of the shorter-term futures contracts (contango). By 2006, 

the price of the second month futures contract was consistently more than $1 per barrel greater 

than the price of the first month futures contract, which was an unprecedented degree of 

contango.177 (Figure 26). 

Crude Oil Prices:

Contango and Backwardation

-4

-2

0

2

4

6

8

10

Jan-85 Jan-90 Jan-95 Jan-00 Jan-05

contango backwardation

Difference in price 

between 

second and first month futures contracts 

$/barrel

Figure 26. A high degree of contango has characterized the crude oil futures market since 2004. 

Data source: Energy Information Administration. 

This change in the structure of the oil futures market had a devastating effect on the 

returns of the broad-based commodity indexes during 2006. The return on the DJ-AIG energy 

sub-index, for example, fell from a positive 42% in 2005, to a negative 41% in 2006, and helped

 176 Standard & Poor’s, Commodity Perspective, S&P GSCI, February 2009, at p. 2. 

177 At the same time prices were rising, inventories were full. The Subcommittee released a 2006 Report, The Role 

of Market Speculation in Rising Oil and Gas Prices: A Need to Put the Cop Back on the Beat, which concluded that 

the anomalous situation of high prices despite high inventories was the result of the large influx of index-related 

investments into the futures markets, which increased the price of more distant contracts relative to the nearer ones. 

“The large influx of speculative investment into oil futures has led to a situation where we have high crude oil prices 

despite high levels of oil in inventory.” Id., at p. 3. 
102

drag down the overall performance of the broad-based DJ-AIG commodity index from a positive 

21% in 2005, to a paltry 2% in 2006, despite overall rising oil prices.178

 The large losses caused by increasing oil futures prices led some analysts to openly 

ridicule commodity index investments. For example, in a 2006 posting on his “Efficient 

Frontier” website, analyst William J. Bernstein observed that the huge popularity of commodity 

index investments as protection against inflation had, in effect, undermined the ability of the 

market to provide that protection.

 

179 Bernstein argued that the commodity markets were no 

longer dominated by hedgers, but rather by speculators. He contended that, in such a market, it 

was unrealistic to expect to earn a premium from long-term futures when everyone was trying to 

do the same: “Nothing makes a premium disappear faster than tout le monde chasing after it.”180 

Bernstein left his readers with the following advice: “The next time someone tries to sell you a 

commodities fund based on the Goldman Sachs Commodities Index, smile and say, ‘Sorry, but 

I’m from Earth, and you’re from planet I Love Lucy. Let’s revisit this discussion in an alternate 

universe.’”181

To counteract the losses from the monthly roll of contracts that result from a futures 

market that is in contango, various financial institutions developed second-generation 

commodity indexes and strategies to minimize the potential losses from the roll. Generally, 

these second-generation indexes and strategies replaced the second month futures contracts used 

to compute the value of the index with more distant futures contracts so that they would have to 

roll them less frequently. Some index providers also constructed a roll methodology that 

selected the futures contract to be included based upon a mathematical calculation as to which 

futures contract would provide the best roll return.

Deutsche Bank was one of the first institutions to offer a second-generation commodity 

index.182

 178 The natural gas, livestock, and metals sub-indexes also had negative returns in 2006. Dow Jones-AIG 

Commodity Indexes, Periodic table of returns, at 

 It explained that the negative roll return from the oil market was the primary reason for 

the new index:

http://www.djindexes.com/mdsidx/downloads/aig/AIG_Comm_Per_table.pdf. 

179 William J. Bernstein, On Stuff, Efficient Frontier, September 2006, at 

http://www.efficientfrontier.com/ef/0adhoc/stuff.htm. 

180 Id. 

181 Bernstein criticized Gorton and Rouwenhorst for relying on a model of the market in which hedgers outnumbered 

speculators. According to Bernstein, this model may have reflected the composition of the market several decades 

ago, but no longer accurately depicted the modern commodities markets, in which the largest traders were hedge 

funds, institutional investors, and swap dealers. Id.

182 Deutsche Bank, DBLCI-OY: Technology To Tackle Term Structure Dynamics, June 2, 2006; DB Commodity 

Index Tracking Fund Announces Plans to Fight Contango, Business Wire, May 24, 2006; Deutsche Bank, DBIQ 

Index Guide, DBLCI Optimum Yield Commodity Indices, March 6, 2008. 
103

“We have noted for some time that the engine room of performance in a 

commodity index has traditionally derived from the positive roll yield generated 

in the energy sector due to the tendency of forward curves in this part of the 

commodity complex to be downward sloping. However, the appearance of 

contango in the crude oil term structure over the past two years has meant the 

benefits of rolling down the curve and a positive roll yield have disappeared and 

have been replaced by a rolling up the curve and picking up a negative roll 

yield.”183

Deutsche Bank announced that the new index was designed to maximize roll return: “Rather 

than select the new future based on a pre-defined schedule . . . the index rolls to that future 

which generates the maximum implied roll yield from the list of tradable futures which expire in 

the next thirteen months.” 

Other financial firms, including Goldman Sachs, Morningstar, Prudential Bache, and 

UBS-Bloomberg, also developed second-generation commodity indexes designed to avoid 

potentially negative roll returns. Although they differ in specific roll and contract selection 

methodologies, they all select longer-dated futures contracts for inclusion within the index, and 

they all roll less frequently than the traditional indexes.184

The increasing amount of speculative investments in second-generation index 

instruments, which some traders estimate now constitutes more than half of all commodity index 

investments, has significant implications for the futures markets. Unlike first-generation indexes 

 

 183 DBLCI-OY: Technology To Tackle Term Structure Dynamics.

184 The Goldman Sachs Enhanced Commodity strategy, for example, rolls into more distant futures contracts for 

crude oil when oil futures prices climb more quickly (move into a steeper contango). For other commodities, such 

as natural gas, Chicago wheat, and corn, the strategy claims to target futures contracts for only a few specified 

months to take advantage of historical and structural futures curves for those commodities. Goldman, Sachs & Co., 

Prospectus Supplement dated July 27, 2007, GS Connect S&P GSCI Enhanced Commodity Total Return Strategy 

Index ETN. The Bache Commodity Index (BCI) also holds futures contracts that are of longer maturity than in the 

traditional indexes. Alternative Investment Analytics, The Bache Commodity Index; A Factor-Based Approach to 

Commodity Investment, AIA Research Report, revised August 2008. The Morningstar Long/Short Commodity 

Index employs a “momentum based” strategy to select commodity futures based on the recent performance of the

commodity, including its futures curve (i.e., the degree of market contango or backwardation). Paul D. Kaplan, 

Beyond Beta – Passive Alternatives to Active Commodities Strategies, Morningstar, 2007. The UBS Bloomberg 

Constant Maturity Commodity Index (CMCI) allows investors to select the particular commodity sectors and 

specific maturities of the futures contracts they wish to hold – such as contracts with expiration dates 3 months, 6 

months, and between 1 and 3 years into the future. It also promises continuous rolling of these contracts on a daily 

basis to maintain contracts of these maturities within the portfolio. UBS Bloomberg CMCI Commodity 

Investments, Presentation of Index, at http://www.ubs.com/4/investch/cmci/ubs-cmci-i-en.html.

From the limited performance data of these second-generation index funds that is publicly available, it appears that, 

like their first generation counterparts, their returns are driven primarily by the energy and metals sectors. At best, 

agricultural commodities contribute only small additional returns. For grains like wheat and corn, where storage is 

readily available and increasing futures prices (contango) are persistent, the net spot and roll returns will most likely 

be negative, even with more complex roll strategies. As long as futures prices are increasing (in contango), the roll 

return will likely be negative, no matter which futures contracts are selected and no matter which roll strategy is 

employed. 
104

which generally track the price of second month futures contracts for a commodity, secondgeneration indexes track more distant futures contracts. Traditionally, there has been a 

significantly lesser amount of trading in longer-dated contracts than in second month contracts. 

The impact of speculative investments in second-generation index instruments on the prices of 

these longer-dated futures contracts is likely to be at least as significant as the impact of firstgeneration index investments on the prices of second month futures contracts.185

F. Exemptions from Speculative Position Limits for Commodity Index Trading 

 This impact 

can be seen in the analysis in Section V, which shows that spreads between longer-dated futures 

contracts for Chicago wheat have increased. 

The ability of index traders to purchase futures contracts for agricultural commodities has 

been facilitated by the CFTC’s decision not to apply the standard position limits on how many 

futures contracts that a single trader may hold for agricultural commodities to swap dealers, ETF 

managers, and ETN issuers.186 If each swap dealer, ETF manager, and ETN issuer had been 

restricted to holding no more than the standard limit of 6,500 wheat futures contracts at any 

given time under the CFTC’s existing wheat position limit, for example, it is likely that, together, 

they would have purchased and held fewer wheat contracts (open interest) on the futures 

exchanges than they actually did.187

 185 The CFTC Supplemental Commitment of Index Traders Report provides only the total amount of open interest 

across all futures contracts for a particular commodity from index trading; it does not provide data on which 

particular future contracts are held. Such a breakdown would provide valuable data to assist in the evaluation of the 

impact of index trading on the futures markets. 

 

186 The leading commodity indexes reference futures contracts in the agricultural, energy, and metals sectors. 

Agricultural position limits are established by the CTFC and enforced by the regulated commodity exchanges. In 

contrast, position limits for non-agricultural commodities such as energy and metals are established by the 

exchanges themselves under guidance issued by the CFTC. The exchanges may also be required to establish 

accountability levels which do not restrict the number of contracts that a trader may hold, but trigger additional 

review of contracts that exceed the specified levels. For more information on accountability levels, see the 

Subcommittee’s Report, Excessive Speculation in the Natural Gas Market (2007), at pp. 51-52. Because the 

exchanges establish and apply non-agricultural position limits, swap dealers, ETF managers, and ETN issuers do not 

need to apply to the CFTC for exemptions related to those commodities. 

187 The information available to the Subcommittee indicates the maximum number of wheat futures contracts that 

these dealers and funds may hold; it does not indicate how many futures contracts they actually do hold. If each 

swap dealer were restricted to holding no more than 6,500 wheat futures contracts at any given time, these swap 

dealers would have had to find another way to offset their financial exposure to the commodity index swaps they 

sold, or to assume the outright price risks from those swaps. Due to the high volatility in the commodity markets, it 

is unlikely that swap dealers would have been willing to assume the outright price risks. In addition, since the overthe-counter market (OTC) for swaps in agricultural commodities is less extensive than the OTC market for energy 

commodities, it would have been difficult for swap dealers to find the requisite offsets in the OTC market. The most 

likely scenario is that, absent exemption from limits restricting the number of contracts they could hold, swap 

dealers would have been unlikely to offer the volume of swaps that were offered over the past few years. On the 

other hand, it is possible that the OTC market for agricultural swaps is larger and has more liquidity than current 

data suggests, since available data is limited. Traders have told the Subcommittee that the OTC market for 

agricultural swaps has recently begun expanding. 
105

As explained earlier, the fundamental purpose of position limits is to prevent excessive 

speculation from causing “sudden or unreasonable fluctuations or unwarranted changes” in the 

prices of commodities traded on futures exchanges. The Commodity Exchange Act requires the 

CFTC to impose such position limits to prevent excessive speculation, but also states that the 

position limits are not to be applied to activities determined by the CFTC to constitute “bona fide 

hedging transactions or positions.” For many years, the CFTC interpreted the term “bona fide 

hedging” to require that the transactions sought to be hedged were in the cash market for the 

commodity. In 1986, the Congress encouraged the CFTC to expand the exemption to allow 

other types of risk-management transactions, so long as the expansion was consistent with the 

CFTC’s basic mission to prevent excessive speculation from causing price distortions on the 

futures exchanges. 

The key issue for the CFTC then became whether, and if so how, to extend the hedge 

exemption, which had traditionally been applied to commercial firms hedging to physical 

holdings of a commodity, to traders such as swap dealers who were using the futures market to 

hedge their exposure to financial instruments rather than actual physical commodities. 

Exemptions Granted to Date. According to data provided by the CFTC to the 

Subcommittee, since 2005, the CFTC has issued hedge exemptions to four swap dealers 

for their holdings of wheat futures contracts on the CME. Those exemptions permit the 

swap dealers to hold up to 10,000, 17,500, 26,000, and 53,000 wheat futures contracts, 

respectively, to hedge their exposures to wheat swaps tied to commodity indexes.188 In 

addition, in 2006, the CFTC staff issued two “no-action” letters permitting two ETF 

managers to hold up to 11,000 wheat futures contracts each in a single month and, in the 

case of one of the ETFs, to hold a total of 13,000 wheat futures contracts in all months 

combined.189

CFTC data indicates that, from 2006 to mid-2008, the total number of outstanding 

contracts (long open interest) attributable to commodity index traders was about 200,000 

 Together, these no-action letters and the hedge exemptions granted by the 

CFTC permit six index traders to hold a total of up to almost 130,000 wheat futures 

contracts in any single month and in all months combined. Absent the hedge exemptions 

and no-action relief, these six index traders would have been limited to a total of 39,000 

wheat futures contracts at a time, or less than one-third of the contracts that they are now 

permitted to hold. 

 188 See Exhibits 1-4. In Exhibit 4, which provides the hedge exemption for up to 17,500 contracts, the CFTC states 

that the granting of the request for the exemption reflects an increase from a previously granted hedge exemption. 

Exhibit 5 contains an exemption for an index trader on the Kansas City Board of Trade. Each of the exemptions and 

no-action letters described in this portion of the Report allowed purchases of wheat futures contracts on the Chicago 

Mercantile Exchange; in some instances, the CFTC also authorized additional, though much smaller, purchases of 

wheat futures contracts on the Kansas City Board of Trade. 

189 See Exhibits 6 and 7. 
106

contracts. That means that the six traders using the hedge exemptions and no-action letters 

issued by the CFTC may have held as much as 60% of the long open interest in Chicago wheat 

futures contracts attributable to index traders.190

Hedge Exemption. As explained earlier, the hedge exemption is tied by statute to “bona 

fide hedging transactions or positions.” It was designed to permit producers, merchants, and end 

users of commodities to hedge their legitimate anticipated business needs by purchasing futures 

contracts on commodity exchanges. 

 

Longstanding CFTC regulations define bona fide hedges as transactions that “normally 

represent a substitute for transactions to be made or position to be taken at a later time in a 

physical marketing channel, and where they are economically appropriate to the reduction of 

risks in the conduct and management of a commercial enterprise.” 

In 1986, Congress encouraged the CFTC to consider expanding the hedge exemption to 

include firms that were using the futures market to manage risks arising from a portfolio of 

financial investments. The next year, in 1987, the CFTC issued a statement that expanded its

definition of bona fide hedge transactions as requested. The CFTC stated that “various users and 

potential users of financial futures” had expressed concern that the link to transactions in the 

physical commodity markets is “overly restrictive and precludes the classification as hedging of 

numerous strategies that are otherwise risk reducing.”191 The CFTC then explained that the 

definition should not be construed to apply only to firms using futures contracts to reduce their 

exposure to risks in the cash market. It stated that the Commission’s original intent in 

promulgating the definition of a bona fide hedge was “to provide a general definition ‘to describe 

the broad scope of risk-shifting transactions which may be possible in the diverse types of 

futures contracts now under regulation.’”192 The CFTC concluded that to qualify as a bona fide 

hedge, a transaction in the futures market did not need to be a temporary substitute for a later 

transaction in the cash market, but also included “all balance sheet and other trading strategies 

that are risk reducing and otherwise consistent with this interpretation.”193

 190 Additional research is needed to determine who holds the remaining 70,000 futures contracts linked to 

commodity indexes, how many of those contracts are attributable to each such trader, and what role, if any, is being 

played by CFTC position limits, exemptions, and no-action letters. 

191 CFTC, Clarification of Certain Aspects of the Hedging Definition, 52 Fed. Reg. 27195 (July 20, 1987). During 

the consideration of the Futures Trading Act of 1986, both the House and Senate Agriculture Committees had 

directed the CFTC to review the definition of bona fide hedge to ensure that it reflected the new and evolving use of 

financial futures. CFTC, Risk Management Exemptions From Speculative Position Limits Approved Under 

Commission Regulation 1.61, 52 Fed. Reg. 34633 (September 14, 1987). For additional background on this issue, 

see also CFTC Staff Report on Commodity Swap Dealers and Index Traders with Commission Recommendations, 

at pp. 13-15.

192 Id.

193 Id. 
107

Several months later, the CFTC issued a new “interpretation” of its definition of bona 

fide hedge transactions to permit exchanges to grant hedge exemptions for various risk 

management transactions. The CFTC stated that “the exemption of certain risk-management 

positions from exchange speculative limits would be consistent with the objectives” of the hedge 

exemption. The CFTC explained that it adopted this broader view of the hedge exemption so 

that “any futures or option positions involved in such risk reducing strategies currently would be 

eligible for exemption from exchange speculative limits pursuant to exchange rules.”194

The CFTC specified that such exemptions be granted on a case-by-case basis, subject to a 

demonstrated request and showing by the applicant of the need for the exemption. The CFTC

also required that applicants for such “risk management exemptions” be “typically engaged in 

buying, selling or holding cash market instruments.” Additionally, the CFTC required the 

exchanges to monitor the exemptions it granted to ensure that any positions held under the 

exemption did not result in any large futures or options position that could disrupt the relevant 

futures market. 

 

In 1991, the CFTC granted the first exemption from its speculative position limits to a 

swap dealer seeking to hedge its exposure to a commodity index swap which it had sold to a 

pension fund.195

“The swap transaction allowed the pension fund to add commodities exposure to 

its portfolio indirectly, through the OTC trade with the swap dealer – something it 

could have done directly, but only in a limited fashion. 

 The CFTC later described the swap and resulting hedge exemption as follows: 

“The pension fund would have been limited in its ability to take on this 

commodities exposure directly, by putting on the long futures position itself, 

because the pension fund – having no offsetting price risk incidental to 

commercial cash or spot operations – would not have qualified for a hedge 

exemption with respect to the position.”196

Since setting this precedent, the CFTC has granted three additional hedge exemptions to 

swap dealers seeking to offset their exposures to individual commodities or commodity indexes. 

The CFTC has stated that these hedge exemptions “were all subject to specific limitations to 

protect the marketplace from potential ill effects.”197

 194 CFTC, Risk Management Exemptions From Speculative Position Limits Approved Under Commission Regulation 

1.61, 52 Fed. Reg. 34633 (September 14, 1987). 

 Those limitations included that: (1) the 

futures positions must offset specific price risks; (2) the dollar value of the futures positions must 

195 CFTC Staff Report on Commodity Swap Dealers, at p. 14. In this instance, the commodities constituting the 

index included wheat, corn, and soybeans. 

196 Id., at p. 15. 

197 Id.
108

be no greater than the dollar value of the underlying risk; and (3) futures positions could not be 

held into the month of contract expiration. 

“No-Action” Letter Exemptions. Although the CFTC has granted several hedge 

exemptions to swap dealers, it has determined that it is not appropriate to grant such exemptions 

to exchange traded funds (ETFs) for the commodity futures held by the ETFs. As described 

previously, the manager of an ETF does not hold futures to offset price risks, but rather holds 

futures contracts to ensure that the value of the fund matches the value of the shares in the fund 

that are traded on a stock exchange. Strictly speaking, therefore, the ETF manager is not holding 

these futures to offset a price risk or for risk management purposes.

Although the CFTC determined that the hedge exemption was unavailable to ETF 

managers, on two occasions the CFTC staff nevertheless determined it was appropriate to 

provide relief to ETFs from the position limits for agricultural commodities. In 2006, the CFTC 

staff issued a letter stating that it would not enforce the standard position limits with respect to 

Deutsche Bank’s operation of a commodity-related ETF. Later that year it provided similar 

relief to another firm, publicly identified by the CFTC only as “X,” managing what appears to be 

another ETF.198

In a “No-Action” letter dated May 5, 2006, the CFTC staff granted Deutsche Bank’s 

request that the CFTC refrain from taking enforcement action against the bank for violating the 

speculative position limits on wheat and corn futures, provided the bank held no more than

11,000 wheat contracts and 17,500 corn contracts in any one month.

 

199

Several months later, the CFTC granted similar relief to “X.” It described X’s investment 

strategy, designated by the letter “P,” to be “a long-only, fully collateralized trading strategy.” 

Despite requiring Deutsche Bank to provide an index and investor fund that was “highly 

transparent,” the CFTC staff allowed X to operate without similar transparency, noting only X’s 

assertion that “X’s clients are provided with at least the level of disclosure and transparency 

described in your letter.” Despite the lack of transparency to other market participants, the 

 In explaining why it 

granted the bank’s request, the CFTC noted five factors: “The futures trading activity passively 

tracks a widely recognized commodity index”; the trading was leveraged; the fund itself did not 

have price exposure (the price exposure was passed onto the shareholders); the index and the 

fund were transparent; and the positions would not be carried into the spot month. 

 198 See Exhibit 6, Letter from Richard A. Shilts, Director, Division of Market Oversight, to Mr. Michael Sackheim, 

Esq., Sidley Austin LLP, May 5, 2006 (CFTC letter No. 06-09), No-Action, Division of Market Oversight. See 

Exhibit 7, Letter from Richard A. Shilts, Director, Division of Market Oversight, to [redacted], September 6, 2006 

(CFTC letter No. 06-19), No-Action, Division of Market Oversight. The CFTC did not state why it granted 

confidentiality to “X.” 

199 CFTC No-Action Letter No. 06-09. 
109

CFTC staff allowed X to exceed the speculative position limits by an even greater amount than 

for Deutsche Bank’s transparent strategy. 

Table 7 compares the levels of No-Action relief granted by the CFTC staff with the 

regulatory position limits applicable to other market participants. 

No-Action Relief Granted from Speculative Position Limits

WHEAT

CFTC 

Speculative 

Position Limit

Limit for 

Deutsche Bank 

ETF

Limit on X for 

P Strategy

Spot Month 600 0 0

Single Month 3,000 11,000 11,000

All Months 6,500 11,000 13,000

CORN

CFTC 

Speculative 

Position Limit

Limit for 

Deutsche Bank 

ETF

Limit on X for 

P Strategy

Spot Month 600 0 0

Single Month 5,500 17,500 17,500

All Months 9,000 17,500 27,000

Table 7. Data source: CFTC.

Proposed Risk Management Exemption. In November 2007, the CFTC proposed to 

amend its regulations to create a new type of exemption from the standard position limits. 

Called a “risk management exemption,” it would permit ETF managers to apply for permission 

to exceed established speculative position limits, rather than have to continue to rely upon NoAction letters.200 The CFTC noted that the last substantive changes to its speculation position 

limits had been made in 1991, and “the intervening 16 years have seen significant changes in 

trading patterns and practices in derivatives markets.”201

The CFTC cited the emergence of commodity index trading, in particular, as a reason for 

creating the new exemption. In its proposal, the CFTC stated: “To the extent that a type of 

 

 200 CFTC, Notice of proposed rulemaking, Risk Management Exemption From Federal Speculative Position Limits, 

72 Fed. Reg. 66097 (November 27, 2007).

201 Id.
110

trading activity can be identified that is unlikely to cause sudden or unreasonable fluctuations or 

unwarranted changes in prices, it is a good candidate to qualify for an exemption from position 

limits.” The CFTC stated that commodity index trading had “characteristics that recommend it 

on that score,” including that index trading was passively managed, unleveraged, and diversified 

across many commodities.202

The CFTC notice reiterated the CFTC staff’s previous determination that ETF managers 

could not qualify for the hedge exemption as currently drafted, but also affirmed its belief that 

ETF managers should be able to quality for exemptions from the speculative position limits: 

 

“In the index fund positions described in the no-action letters, the price exposure 

results from a promise or obligation to track an index, rather than from holding an 

OTC swap position whose value is directly linked to the price of the index. The 

[CFTC staff] believed that this difference was significant enough that the index 

fund positions would not qualify for a hedge exemption. Nevertheless, because 

the index fund positions represented a legitimate and potentially useful investment 

strategy the Division granted the index funds no-action relief, subject to certain 

conditions, described below, that were intended to protect the futures markets 

from potential ill effects.” 

The proposed risk management exemption would have allowed an exemption from 

speculative position limits for: (1) “intermediaries, such as index funds, who pass price risks on 

to their customers; and (2) pension funds and other institutional investors seeking to diversify 

risks in portfolios by including an allocation to commodity exposure.”203

The proposed exemption was not finalized. In April 2008, largely in response to public 

outcry over rising prices for oil, natural gas, and other basic commodities, the CFTC suspended 

this rulemaking. CFTC Acting Chairman Walt Lukken announced that in light of “current 

market conditions and the uncertainty surrounding additional speculative money in these 

markets,” the Commission would be “very cautious” about proceeding with the rulemaking and 

requested additional comments.

 

204

 202 The CFTC did not provide any empirical evidence or factual basis for this assertion. It is unclear why the CFTC 

believed passive investments could not cause unreasonable fluctuations or unwarranted changes in price, or why the 

fact of diversification across commodities lessened the impact upon any single commodity. 

 The Acting Chairman stated: “I believe that before acting, 

203 72 Fed. Reg. at p. 66099. The proposed rule would have imposed a number of conditions that an applicant had to 

satisfy to be granted a risk management exemption: (1) the positions had to be established and liquidated in an 

orderly manner; (2) the positions had to be part of a broadly diversified portfolio of either long-only or short-only 

futures based upon either (a) a fiduciary duty to match or track the results of a broadly diversified index that 

includes such commodities, or (b) a portfolio diversification plan that has exposure to a broadly diversified index 

that includes such commodity markets; (3) the exemption had to be passively managed; (4) the futures trading must 

be unleveraged; and (5) the positions could not be carried into the spot month. Id., at p. 66100. 

204 See Exhibit 8, Opening Statement of Acting Chairman Walt Lukken, Agricultural Markets Roundtable, 

Commodity Futures Trading Commission Headquarters, April 22, 2008.
111

this agency must be certain that additional speculative pressures will not exacerbate the 

anomalies we are experiencing in these markets.” 

A few months later, the CFTC staff recommended that the CFTC consider a more limited 

risk management exemption than the one outlined in the suspended rulemaking. In its Report on 

Commodity Swap Dealers and Index Traders, issued in September 2008, the CFTC staff 

recommended that the Commission:

“develop an advance notice of proposed rulemaking that would address whether 

to eliminate the bona fide hedge exemption for swap dealers and replace it with a 

limited risk management exemption that is conditioned upon, among other things: 

(1) an obligation to report to the CFTC and applicable self regulatory

organizations when certain noncommercial swap clients reach certain position 

levels in related exchange traded contracts, and/or (2) a certification that none of a 

swap dealer’s noncommercial swap clients exceed specified position limits in 

related exchange-traded contracts.”205

In response to the staff recommendation, on March 24, 2009, the CFTC issued a “concept 

release” seeking public comment on whether to create a new “risk management” exemption to 

existing commodity position limits, and, if so, what terms and conditions should apply.

 

206

The CFTC proposal invites public comment on the issue of how commodity index 

trading affects the futures markets and whether – and if so, to what extent – the CFTC should 

 The 

concept release traced the history of the CFTC’s application of the bona fide hedge exemption to 

swap dealers and others for index fund investments, as well as the staff’s recommendation in the 

September 2008 Report to address this issue. It described the proposed “conditional limited risk 

management exemption” as “essentially look[ing] through the swap dealer to its counterparty 

traders.” The CFTC stated that creating this new exemption would have “the potential to bring 

greater transparency and accountability to the marketplace and to guard against possible 

manipulation.” It requested comment on a number of specific questions, including whether the 

CFTC should continue to allow swap dealers to qualify for exemption under the current 

definition of a bona fide hedge; whether the CFTC should develop a new “limited risk 

management exemption” for swap dealers; which transactions could qualify for the new 

exemption; what conditions should apply to the exemption; whether there should be an overall 

limit to the size of the exemption; and how to ensure that the exemption was not being used to 

circumvent position limits by individual traders. 

 205 The CFTC staff explained that these conditions were designed to ensure that noncommercial counterparties are 

not purposefully evading the oversight and limits of the CFTC and exchanges, and that manipulation is not 

occurring outside of regulatory view. CFTC Staff Report on Commodity Swap Dealers, at p. 34. If implemented, 

the recommended certification condition for a swap dealer’s clients would represent a key new limitation. 

206 CFTC, Concept Release on Whether To Eliminate the Bona Fide Hedge Exemption for Certain Swap Dealers 

and Create a New Limited Risk Management Exemption From Speculative Position Limits, 74 Fed. Reg. 12282 

(March 24, 2009). 
112

continue to grant exemptions from position limits for index traders. As the next section shows, 

the large presence of commodity index traders in the Chicago wheat futures market has increased 

the difference between futures and cash prices (basis) and impeded price convergence at contract 

expiration. Under these circumstances, the CFTC should not grant any type of exemption from 

position limits to commodity index traders in the wheat market, and should instead phase out the 

exemptions already provided. 
113

“A futures market is not a scholarly seminar in which learned men debate what is, and 

arrive at, an equilibrium price, it is a game in which businessmen compete, with money at 

hazard, to establish a market price that works.” 

--Professor Thomas Hieronymus207

V. IMPACT OF INDEX TRADING ON THE WHEAT MARKET

Over the past several years, the traditional relationship between the prices of soft red 

winter wheat in the Chicago futures market and the price of wheat in the cash market has broken 

down. Increasingly, the price of wheat futures on the Chicago exchange has been significantly 

higher than the price of wheat in the cash market, resulting in an unprecedented large difference 

(basis) between the two. In addition, the two prices have failed to converge as the nearest futures 

contract reaches expiration. The increasing gap between the futures and cash prices (basis), 

together with the failure of convergence, have seriously impaired the ability of farmers, grain 

elevators, grain merchants, grain processors, and others in the agriculture industry to use the 

Chicago wheat futures market to manage and reduce the price risks arising from their operations 

in the wheat market. 

The Subcommittee investigation finds there is substantial and persuasive evidence that 

the large presence of commodity index traders in the Chicago wheat futures market is a major 

reason for the breakdown in the relationship between the Chicago futures market and the cash 

prices for wheat. This evidence indicates that the large number of futures contracts purchased 

and held (long open interest) by index traders has created a significant additional demand for 

wheat futures contracts on the Chicago exchange that is unrelated to the supply of and demand 

for wheat in the cash market. As a result of this significant additional demand – which has 

increased the demand for wheat futures contracts by between 30 and 100% during the course of 

the past three years – wheat futures prices have increased relative to wheat cash prices. The 

increase in futures prices relative to the cash prices has created a substantial incentive for grain 

elevators to place more wheat in storage, hold it, and sell it at the higher prices in the futures 

market, rather than sell the wheat immediately in the cash market. Because it has been so 

profitable to store the grain in this manner, grain elevators and other traders no longer have a 

sufficient financial incentive to engage in the type of arbitrage transactions that normally occur 

when a futures contract expires, in which buyers and sellers play the futures and cash markets 

against each other until the prices in the two markets converge. The result is an abnormal, large, 

and persistent difference between wheat futures and cash prices and a frequent failure of 

convergence at contract expiration. 

 207 Hieronymus, at p. 327.
114

This section of the Report presents evidence on the extent of the breakdown in the 

relationship between the Chicago wheat futures and cash prices, and the contributing role of the 

large amount of commodity index trading on the Chicago exchange.

A. Pricing Breakdown in the Wheat Futures Market 

The traditional relationship between the Chicago wheat futures market and the cash 

market for wheat has broken down in three distinct ways. First, since 2006, market data shows 

that the price of wheat in the Chicago futures market frequently has been significantly higher 

than the price of wheat in the cash market. Second, during this same period, the market data 

shows that the wheat futures and cash prices have often failed to converge at the expiration of the 

Chicago wheat futures contracts. Third, during most of 2008, the market data shows that wheat 

futures prices were not just higher than the cash price, but were at a level unrelated to the 

fundamentals of supply and demand in the cash market at the time. This set of pricing problems 

indicates that the underlying problem in the Chicago wheat futures market is not merely a lack of

convergence at contract expiration, as is often stated, but a problem of consistently elevated 

futures prices relative to the cash market. 

Increasing Futures and Cash Price Gap – Daily Basis. Market data obtained and 

analyzed by the Subcommittee shows that, since 2006, the difference between Chicago wheat 

futures prices and cash prices has steadily increased. Figure 26 presents data showing the daily 

difference between the price of the Chicago and Kansas City wheat futures contracts and the 

average cash price for each type of wheat.

208 As explained earlier, the three U.S. exchanges that 

trade wheat futures contracts are in Chicago, Kansas City, and Minneapolis; the Chicago 

exchange has significantly more trading volume in wheat and a substantially greater proportion 

of index trading in wheat contracts than the other two exchanges.209

 208 The Subcommittee calculated the daily basis by using the daily average cash price for each type of wheat 

provided by the MGEX daily cash index, and then subtracting this cash price from the futures price as shown on the 

relevant exchange for the first-month futures contract price on the same day for the same type of wheat. Using a 

daily basis computed from the MGEX cash index is useful, because it provides the average price calculated from 

multiple locations and provides data on the behavior of the basis that is comparable to the basis data from individual 

markets or delivery locations for the wheat. The “average” basis derived from the MGEX cash index is directly 

related to the basis at the delivery locations – typically the basis at any particular location will differ from the basis 

at the contract delivery location by a constant value, namely the cost of transporting the commodity from the 

particular location to the contract delivery location. The average basis, therefore, should differ from the basis at the 

delivery location only by the average cost of transportation to the delivery location. A change in the basis at the 

delivery locations over time should be reflected in a corresponding change in the average basis over that same 

period of time. Traders interviewed by the Subcommittee stated that when hedging they preferred to use the basis at 

the delivery locations rather than a basis computed from the MGEX cash index basis, because the MGEX cash index 

was based upon bids rather than actual reported transaction prices and because they were more familiar with the 

delivery location basis. The Subcommittee’s analysis of the relationship between the daily basis calculated in this 

manner from the MGEX index and the daily basis calculated from USDA data at specific delivery points indicates 

that the MGEX data is as reliable as the USDA data for the purposes of these calculations and this analysis. 

209 As shown in the prior section, as much as 50% of the outstanding wheat contracts (long open interest) on the 

Chicago exchange is held by index traders and up to 30% is held by index traders on the Kansas City Exchange. 
115

Figure 26 indicates that, prior to 2005, the average daily basis in the Chicago and Kansas 

City wheat futures markets behaved similarly. From 2000 to 2005, the average daily difference 

between the futures price for soft red winter wheat traded on the Chicago exchange and the 

average cash price for that type of wheat was about 25 cents per bushel. Over that same time 

period, the average daily difference between the futures price for hard red winter wheat traded on 

the Kansas City exchange and the cash price for that type of wheat was about 26 cents per 

bushel. In 2006, the basis in the Kansas City futures market remained about the same, but the 

basis in the Chicago futures market began to climb. From 2007 through 2008, the average daily 

basis for wheat traded on the Chicago exchange jumped to $1.10 per bushel; on the Kansas City 

exchange during this period the average daily basis rose to nearly half that amount, about 51 

cents per bushel. During 2008, on the Chicago exchange, the average daily basis reached a 

maximum of about $2.25 per bushel, whereas on the Kansas City exchange the maximum basis 

reached about 90 cents per bushel. The average daily basis increased on both exchanges, but the 

increase in Chicago was more dramatic and sustained.

210

 

According to CFTC data, there is no index trading on the Minneapolis exchange. The following charts do not 

include basis data from the Minneapolis exchange, however, because Minneapolis wheat prices experienced unusual 

extremes over the last two years, resulting in unusual and extreme swings in the basis. Prior to late 2007, the 

average basis on expiration for the Minneapolis wheat contract was relatively stable. Starting in late 2007, however, 

the average basis on expiration started to increase substantially, reaching an extraordinarily high level of around 

$2.50 in March and May of 2008. These high basis levels were not due to a general lack of price convergence in 

the Minneapolis wheat market. Rather, they reflected the dramatic volatility in Minneapolis wheat prices in late 

2007 due to record low levels of wheat in storage and high global demand. See, e.g., Anthony Faiola, The New 

Economics of Hunger, Washington Post, April 27, 2008; Joshua Boak, Short wheat stocks yield price storm, 

Chicago Tribune, February 28, 2008 (“‘We have never seen anything like this before,’ [KCBOT Chairman Jeff] 

Voge said. ‘Prices are going up more in one day than they have during entire years in the past.’”); Lauren Etter, 

Markets on Tear; Wheat, Oil, Euro – Grain Trading Explodes in the Minneapolis Pits Speculators Flood In, Wall 

Street Journal, February 27, 2008 (“Minneapolis has become ground-zero for global wheat following Agriculture 

Dept.’s January statement that winter-wheat plantings were less than expected”); David Streitfeld, In Price and 

Supply, Wheat is the Unstable Staple, New York Times, February 13, 2008 (“Prices have been gyrating in recent 

days as traders tried to figure out what to make of the situation. On Tuesday, prices for a sought-after variety, spring 

wheat, jumped to $16.73 a bushel on the Minneapolis Grain Exchange, the latest of several records.”). Once the 

grain shortage was alleviated in early 2008, the average basis for hard spring wheat fell back to levels well within 

historical norms. The extreme price volatility in the Minneapolis wheat market from late 2007 to early 2008, with 

the resulting basis changes, renders the Minneapolis basis data an unreliable benchmark for analyzing the 

Minneapolis wheat market, which has virtually no index traders, and for understanding how that data compares to 

the basis data from Chicago and Kansas City, both of which have substantial index trading.

210 The Subcommittee investigation does not attribute the increasing daily basis depicted in Figure 26 solely to index 

trading. Other factors also contributed to the increase. During this period, for example, rising oil, gasoline, and 

diesel fuel prices increased the cost of transporting wheat by rail, truck, or barge, and could have contributed to the 

increase in the basis in both markets. Increases in the cost of transportation alone, however, cannot account for the 

much higher increase in the daily basis for Chicago wheat as compared to Kansas City wheat. 
116

Figure 26. Daily basis, computed from MGEX cash index prices for HRW and SRW. Data 

source: MGEX, KCBOT, CME. 

Increasing Basis at Contract Expiration. In addition to the unusually high daily 

difference between the futures and cash prices for wheat on the Chicago exchange, market data 

shows that, since 2006, there has also been an increasing failure of the wheat futures and cash 

prices to converge at contract expiration. Figure 27 presents data showing that the difference 

between the price of the expiring Chicago soft red winter wheat futures contract and the average 

cash price for soft red winter wheat rose from an average of about 21 cents during the five-year 

period 2000-2005, to about 56 cents over a two-year period from 2006 to 2007, to $1.53 in 

2008.

211 In comparison, over the same time periods, the average basis at contract expiration for 

the Kansas City hard red winter wheat futures contract rose from an average of 26 cents from 

2000 to 2005, to about 37 cents from 2006 to 2007, to about 50 cents in 2008, a much narrower 

increase in the basis.

212

 211 The Subcommittee compiled the basis data in Figure 27, again using the MGEX daily cash index to determine the 

average daily cash price for wheat. The data in Figure 27 is consistent with the basis data at the delivery locations 

for the Chicago and Kansas City contracts. 

 This data shows that, over the past few years, the Chicago wheat market 

has experienced a dramatic and sustained lack of price convergence. 

212 The average basis at contract expiration for the Kansas City wheat contract generally remained below 36 cents 

throughout this period. However, in three months – September 2007, July 2008, and September 2008 – the basis 

increased to over 70 cents. 

-50

0

50

100

150

200

250

Chicago and Kansas City Wheat Futures

Difference Between Futures and Average Cash Price

(Average Daily Basis)

Chicago (SRW)

Kansas City (HRW)

cents/bu.
117

Chicago and Kansas City Wheat Futures

Difference Between Futures and Cash Price (Basis) at Expiration

Chicago

0

100

200

300

Mar-00Mar-01Mar-02Mar-03Mar-04Mar-05Mar-06Mar-07Mar-08

Kansas City

0

100

200

300

Figure 27. Increasing lack of convergence between the CME SRW wheat futures 

contract and the cash price of SRW wheat. Data sources: CME, KCBOT, MGEX. 

Futures Prices Inconsistent With Cash Market Fundamentals. The daily basis data 

and contract basis expiration data analyzed by the Subcommittee provides some quantification of 

the extent of the pricing problems in the Chicago wheat market. The market data also shows 

how severely disconnected the price of Chicago wheat futures became in relation to the actual 

cash market for soft red winter wheat throughout the latter half of 2008. 

Figure 28 presents data showing that, beginning in the spring of 2008, soft red winter 

wheat prices in the cash market fell from a peak of about $12 per bushel to a low of about $3 per 

bushel by December 2008. This drop in the price was due in part to a large wheat harvest in the 

summer of 2008, planted as a result of the high wheat prices that prevailed during most of 2007. 

The resulting 2008 soft red winter wheat surplus depressed the price of this wheat in the cash 

market. Soft red winter wheat was so plentiful that it began to be used for animal feed. That is 

part of the reason why the soft red winter wheat cash price fell all the way down to the price of 

corn, which is also used at times for animal feed. In the Chicago futures market, however, it was 
118

a different story. The soft red winter wheat futures price declined during 2008, but remained 

substantially above the price in the cash market, often by as much as $1.50 to $2 per bushel, an 

unprecedented price difference. In fact, during this period the soft red winter wheat futures price 

remained close to the price of futures contracts for higher-quality hard red winter wheat. In 

short, for much of 2008, at the same time soft red winter wheat was selling in the cash market for 

the price of lower-quality corn, it was selling for a much higher price on the Chicago futures 

exchange, very close to the price of higher-quality, higher-protein wheat. This pricing data 

shows that, during 2008, Chicago wheat futures prices were plainly inconsistent with wheat cash 

prices.

In sum, the market data analyzed by the Subcommittee shows that, over the last few 

years, the difference in price between Chicago wheat futures contracts and the cash price of 

wheat (basis) has increased significantly, that the two prices have frequently failed to converge at 

contract expiration by a large amount, and that in 2008, the Chicago futures price for soft red 

winter wheat became severely disconnected from the fundamentals of supply and demand in the 

cash market. 
119

 

Figure 28. During 2008, SRW was selling in the cash market for the same price as a 

lower-quality commodity, while in the futures market it was selling for the same price as a 

higher-quality commodity. Data source: CME, KCBOT, MGEX. 

0

2

4

6

8

10

12

14

Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08

Wheat and Corn Cash Prices

2008

Chicago wheat (SRW)

Kansas City wheat (HRW)

Corn

$/bushel

0

2

4

6

8

10

12

14

Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08

Wheat and Corn Futures Prices

2008

Chicago wheat (SRW)

Kansas City wheat (HRW)

Corn

$/bushel
120

B. The Role of Index Trading in Wheat Pricing Problems

The Subcommittee investigation found significant and persuasive evidence that the large 

number of wheat futures contracts (long open interest) held by commodity index traders is a 

primary reason for the pricing problems in the wheat market just described, including the 

increasing daily difference between wheat futures prices and cash prices (basis), the increasing 

lack of price convergence at contract expiration, and the disconnect between wheat futures prices 

and cash market fundamentals in Chicago during 2008. This evidence consists of the following: 

• Index trading and pricing trends in the wheat market; 

• Subcommittee interviews with market participants;

• Testimony presented by market participants to the CFTC; 

• Financial and academic analyses; and

• Commodity market theory on how futures prices are established. 

Each of these factors is discussed below.

1. Index Trading and Pricing Trends in the Wheat Market 

a. Volume of Index Trading in the Wheat Market

The percentage of outstanding wheat contracts (long open interest) held by index traders 

in the Chicago wheat futures market is significantly greater than the percentage held by index 

traders in any other agricultural commodity market.213 As shown in the prior section, since 

2006, commodity index traders have held between 35 and 50% of the outstanding wheat 

contracts purchased (long open interest) on the Chicago exchange, and between about 20 and 

30% of the outstanding wheat contracts purchased (long open interest) on the Kansas City 

exchange.214

These percentages alone, however, do not present a full measure of the presence or 

influence of index-related instruments in these markets. In several respects, expressing the size 

of index trading as a simple percentage of the total long open interest held by index traders 

 

 213 Index traders also participate in the futures markets for corn, soybeans, soybean oil, cotton, lean hogs, live cattle, 

feeder cattle, cocoa, sugar, and coffee. Aside from wheat, the other commodity markets in which index traders hold 

a substantial share of the long open interest are the futures markets for two livestock commodities, lean hogs and 

live cattle. Lean hog futures contracts are financially settled, meaning that the price of the expiring futures contract 

is set at the price of the commodity in the cash market at contract expiration. By definition, therefore, lean hog 

futures and cash prices will be equal at settlement, so there is no problem with convergence. Live cattle, unlike 

grain, cannot be placed in storage from one contract expiration to another. That constraint means there is always an 

active cash market for live cattle at contract expiration that helps to force convergence. 

214 See Figures 19 and 20.
121

understates their presence. First, except for the period just prior to the periodic roll of the nearterm contracts into longer-term contracts, all of the open interest due to index traders is held in 

futures contracts other than the first month contract nearest expiration. The share of long open 

interest held by index traders in the months other than the first month is certainly larger than the 

share of long open interest held by these index traders in all of the months.215

Second, a significant share of the long and short open interest is held by spread traders. 

Spread traders do not go either long or short; they hold equal positions in two different contracts, 

buying one and selling the other. Index traders, on the other hand, are purely directional traders. 

They buy contracts and hold onto them for long periods of time. Comparing the level of index 

traders to the total number of directional traders provides a better indication of the relative 

contribution of index traders to the direction of the market than if non-directional spread traders 

are included in the comparison. Roughly speaking, it indicates how much of the “push” upwards 

in the market is due to index traders. Figure 29 indicates that index traders constitute a much 

larger share of the directional traders than of all traders. 

Figure 29. The net long open interest due to index instruments represents up to 60% of 

the long open interest (excluding spread positions) in the Chicago wheat futures market. 

Data source: CFTC.

 215 The CFTC commitment of traders data does not break out any trader positions by contract months. Based on the 

Subcommittee’s review of publicly available open interest data from the Chicago exchange, the open interest in the 

first month represents, on average in recent years, an estimated 10-20% of the total open interest at the time the roll 

of commodity index funds is completed under the S&P GSCI roll methodology. Assuming index traders represent 

35-50% of the total long open interest at the time the standard roll is completed, it follows that at the time the 

standard roll is completed index traders could represent anywhere from about 38% (35%/0.9) to about 62% 

(50%/0.8) of the open interest in the second and following months. 

0%

20%

40%

60%

80%

Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09

Index Traders Net Long Positions 

Share of Long Open Interest Excluding Spread Positions

Wheat CBOT Wheat KCBOT

Corn CBOT Soybeans CBOT

% of Long Open 

Interest
122

Third, another measure of the extent of index trading in the futures market is to examine 

the long open interest held by index traders compared to the short open interest held by traders 

classified by the CFTC as “commercial” traders. The data indicates that the long open interest 

held by index traders in the Chicago wheat market is relatively high compared to the short open 

interest held by these commercial traders. In some instances, the data indicates that there have 

been more index traders who want to buy futures contracts than there are short commercial 

traders willing to sell them. In these instances, when the demand exceeds the supply, index 

traders looking to buy must bid up the price in order to attract additional sellers. 

Over the past few years, the relative balance between index traders and short commercial 

traders in the Chicago futures market has been very different from the balance in the other 

markets in which index traders are present, including the Kansas City wheat market and the 

Chicago corn and soybean markets as well. In these other markets the open interest due to short 

commercial traders has generally significantly exceeded the open interest from long index 

traders. (See Figure 30). In contrast, in the Chicago wheat market during the period in which 

data is available, the number of long index traders generally has been roughly equal to the 

number of short commercial traders. On several occasions, the latest being an extended period in 

2008, the open interest due to index traders exceeded that of short commercial traders. 

For example, on July 1, 2008, index traders held 212,012 contracts for the future delivery 

of Chicago wheat. On the same date, short commercial traders had 165,044 contracts 

outstanding for the future delivery of Chicago wheat. Since each contract represents 5,000 

bushels of wheat, as of July 1, 2008, index traders had bought 1,060,060,000 bushels of wheat 

for futures delivery, while commercial sellers had supplied only 825,220,000 million bushels to 

meet that demand. In short, on that date, demand for soft red winter wheat futures from index 

traders exceeded the supply provided by commercial sellers by roughly 20%. When demand 

substantially exceeds supply, the price of wheat futures must rise to attract more sellers.216 

 216 One noted futures market scholar described how additional purchases of futures contracts by speculators increase 

the price of futures contracts as follows: “Assume there is an exogenous increase in net speculative purchases of 

futures. This tends to drive up the futures price relative to the spot price, and by increasing the return to short 

hedgers induces a larger amount. Similarly, an exogenous increase in speculative sales of futures lowers the futures 

price which increases the return to and therefore the amount of long hedging.” Lester G. Telser, The Supply of 

Speculative Services in Wheat, Corn, and Soybeans, Food Research Institute Studies, Supplement to Vol. VII, 1967, 

at p. 163 (available in farmdoc archives). 
123

Chicago Wheat Futures and Options

Index and Non-Index Traders

0

50

100

150

200

250

300

350

Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09

# of contracts 

(thousands)

Commercial 

short

Index long

Kansas City Wheat Futures and Options

Index and Non-Index Traders

0

20

40

60

80

100

120

140

Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09

# of contracts 

(thousands)

Commercial 

short

Corn Futures and Options

Index and Non-Index Traders

0

400

800

1200

Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09

# of contracts 

(thousands)

Commercial 

short

Soybeans Futures and Options

Index and Non-Index Traders

0

100

200

300

400

500

Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09

# of contracts 

(thousands)

Commercial 

short

Figure 30. Relative share of index trading in grain futures markets. Data source: CFTC.

0

50

100

150

200

250

300

350

400

450

Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09

Non-Commercial Long, No Index

Commercial Long, No Index

Non-Commercial Spread Positions, No Index

Non-Commercial Short, No Index

Commercial Short

Index Long

Index Short

xx

x

Legend
124

The result is that the Chicago wheat futures price rose higher than the price in the cash 

market and did so, not in response to normal supply and demand factors related to the 

commercial delivery of wheat in the cash market, but in response to the additional demand 

generated by index traders seeking to offset their sales of commodity index instruments. Overall, 

from 2006-2008, index traders increased the demand for wheat futures contracts by a significant 

amount – from between 33% to 100%.217

The demand for futures contracts from index trading directly affects futures prices only, 

since index traders do not operate in the cash market, and they have no interest in taking delivery 

or making use of a wheat crop. They are not buying futures contracts to hedge any actual 

purchases of wheat in the cash market. Instead, index traders are buying futures contracts to 

offset the index instruments they have sold to third parties. They purchase futures contracts to 

offset this financial exposure, regardless of the price of those contracts or the underlying 

fundamentals of supply and demand in the cash market. The demand for wheat futures created 

by index traders is unrelated to the demand for wheat in the cash market and unrelated to the type 

of price changes in the cash market that typically affect decisions by market participants to buy 

or sell. In light of all of these factors, it is not surprising that, in recent years as index trading 

grew significantly, the price of Chicago wheat futures have become increasingly disconnected 

from the price of wheat in the cash market. 

 

b. Impact of Index Trading on Short-Term Futures Price Spreads

The impact of index trading on the Chicago wheat market can be seen by observing the 

change in price relationships between various futures contracts on the Chicago exchange as 

compared to the corresponding contracts on the Kansas City and Minneapolis exchanges. In 

particular, a number of Chicago wheat price spreads (the difference in price between two 

different futures contracts) increased significantly over the same time period that the number of 

wheat contracts held by index traders on the Chicago exchange rose significantly as well. In 

contrast, the same price spreads on the Kansas City and Minneapolis exchanges did not increase 

by a similar amount during the same time period. Supply and demand fundamentals in the cash 

market alone cannot account for the greater price spreads in the Chicago market. The most 

significant factor differentiating the Chicago wheat futures market from the other wheat futures 

markets is the large number of wheat contracts purchased and held by index traders.

Figure 31 shows the difference in price – the price spread – between the first and second 

month futures wheat contracts on both the Chicago and Kansas City exchanges between 2000 

and 2008. The data shows futures prices for soft red winter wheat traded on the Chicago 

exchange and for hard red winter wheat traded on the Kansas City exchange. The difference in 

prices between a second month futures contract and a first month futures contract is called the 

“2-1” spread. The data shows that, before 2004, the 2-1 spread for Chicago wheat futures 

 217 During this period index traders constituted between about 25 and 50% of the total long open interest. This 

means that these index traders increased the long open interest by 33% (25/75) to 100% (50/50). 
125

contracts generally tracked the 2-1 spread for Kansas City wheat; the price difference in both 

markets was generally less than 6 cents, meaning the second month prices were generally higher 

than the first month prices. Beginning in the fall of 2004, however, the 2-1 spread for Chicago 

wheat futures increased significantly relative to the spread for Kansas City wheat futures, 

frequently exceeding 7 cents, while the Kansas City spread typically was well below that 

amount. The greater price spread on the Chicago exchange as compared to the Kansas City 

exchange has generally persisted since 2004, with only a few limited exceptions.

Figure 31. Beginning in 2004, the 2-1 spread for Chicago wheat grew much larger than 

for Kansas City wheat. Data source: CME, KCBOT.

The increase in the spreads and the generally higher futures prices in the Chicago wheat 

futures market compared to the Kansas City wheat futures market cannot be fully explained 

using traditional considerations of supply and demand in the cash markets for soft red winter and 

hard red winter wheat. The soft red wheat crop, harvested in the summer of 2005 and marketed 

from 2005 to 2006, was smaller than average, at 309 million bushels. On the other hand, the 

hard red winter wheat crop marketed from 2005 to 2006, was larger than average, at 930 million 

bushels. The smaller than average soft winter wheat crop should have resulted in a smaller 2-1 

spread, since a reduction in supply normally results in higher near-term prices relative to the 

longer-term price. Instead, the 2-1 price spread increased. Professor Irwin and his colleagues 

have concluded that wheat futures prices from mid-2006 until mid-2007 were not supported by 

the supply and demand conditions in the cash market. They wrote: “Futures prices of SRW 

wheat were higher than could be supported by fundamentals of supply and demand, and 

-20

-15

-10

-5

0

5

10

15

Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

Chicago and Kansas City Wheat Futures 

Difference in Price Between 2nd and 1st Month Contracts

Chicago

Kansas City

cents/

month
126

therefore, higher than could be supported by the cash market.”218

The divergence of the Chicago wheat futures market from the fundamentals of supply 

and demand in the cash market can also be observed by comparing the spreads between futures 

and cash prices in the various wheat markets. Figure 32 displays the difference in price between 

the cash price of soft red winter wheat and the cash price of hard red winter wheat, and the 

difference in price between the first month futures contracts for soft red winter wheat on the 

Chicago exchange and the first month futures contract for hard red winter wheat on the Kansas 

City exchange. 

 The large increase in the 2-1 

spread in the Chicago wheat futures market from 2005-2007 indicates the strong influence of an 

additional factor, unrelated to supply and demand, such as index trading, in the Chicago futures 

market. 

Figure 32. In 2006, the price of Chicago wheat futures became artificially elevated relative to the 

cash market. Data source: CME, KCBOT, MGEX. 

 218 Professor Irwin and his colleagues state that soft red winter wheat futures prices during this period were driven 

higher “by the overall increase in wheat prices and the preference of many market participants to trade in the more 

liquid Chicago market rather than at other exchanges.” Irwin et al. (May 2007), at p. 14. It is unclear how greater 

liquidity – meaning a greater trading volume and open interest – in the Chicago market would lead to an increase in 

the price of wheat. Generally, greater liquidity should lead to prices that are more aligned with market 

fundamentals. Moreover, most of the additional liquidity that entered the Chicago wheat futures market during the 

period in which the convergence problem dramatically worsened resulted from index trading. If the source of the 

pricing problems in the Chicago market is due to additional liquidity in that market, and index traders have been the 

greatest source of additional liquidity during the period in which those problems worsened, it is then logical to 

conclude that the increase in index trading is the source of these pricing problems. 

Difference in Price Between HRW and SRW:

Cash and Futures Markets

-50

0

50

100

150

200

Jan-00Jan-01Jan-02Jan-03Jan-04Jan-05Jan-06

Jan-07

Jan-08

Difference Between HRW and SRW Cash Prices

Difference Between HRW and SRW Futures Prices

cents/bu.

Cash price 

difference

Futures price 

difference
127

Figure 32 shows that prior to 2006, the difference between the price of the first month 

futures contract for wheat on the Chicago exchange and the first month contract for wheat on the 

Kansas City exchange generally followed the difference in price between the cash prices for the 

two types of wheat. Beginning in the spring of 2006, the difference in price between these two 

types of wheat in the Chicago and Kansas City futures markets became significantly less than the 

difference in price between these two types of wheat in the cash market. This pricing disparity 

indicates that, beginning in 2006, the Chicago wheat futures price was increasingly elevated with 

respect to the price of wheat in the cash market. As the price of soft red winter wheat on the 

Chicago exchange increased relative to the price of soft red winter wheat in the cash market, the 

difference in price between Chicago wheat futures and Kansas City wheat futures became much 

less than the difference in price between the two types of wheat in the cash market. 219

The most straightforward explanation for the disconnect between the price of soft red 

winter wheat in the cash and futures markets is the increasing presence of price-insensitive 

commodity index traders buying and holding Chicago wheat futures contracts. Index traders buy 

and hold futures contracts without regard to the fundamentals of supply and demand in the cash 

market. Since 2006, index traders have constituted between 35 and 50% of the total outstanding 

long open interest in the Chicago wheat market. It is to be expected that if nearly half of the 

holders of long open interest are pursuing a trading strategy for the buying and holding of wheat 

futures that is insensitive to the fundamentals of supply and demand in the cash market, then the 

wheat futures market will become increasingly reflective of that price-insensitive strategy and 

less reflective of the fundamentals of supply and demand in the cash market.

 

220

Because the purchaser of an intermonth spread such as the 2-1 spread depicted in Figure

31 is, in effect, helping to pay for the cost of storing the commodity over the length of the spread, 

it is useful to express a spread as the percentage of the total carrying costs for the commodity 

 In effect, the 

large presence of commodity index traders, who do not buy or sell in relation to the 

fundamentals in the cash market, have created an additional supply-demand dynamic in the 

Chicago wheat futures market that is not related to the supply-demand dynamic in the cash 

market. The result are prices which not only fail to converge at contract expiration, but are the 

product of a fundamental disconnect between the futures and cash markets for wheat. 

 219 The extent to which the gap between the intermarket (i.e., between two different wheat markets) cash and futures 

price spreads increased since 2005 can be seen in Figure 26. The difference between the intermarket cash and 

futures price spreads equals the difference in intermarket basis: (HRW cash – SRW cash) – (HRW futures – SRW 

futures) = (HRW cash – HRW futures) – (SRW cash – SRW futures) = HRW basis – SRW basis. Thus, the extent 

to which the two lines in Figure 32 begin to diverge in 2006 is shown in Figure 26, which displays the average or 

“index” basis for the Chicago SRW and Kansas City HRW wheat markets. 

220 If a market is constituted half and half between price-sensitive traders and price-insensitive traders who only buy 

and hold, it is difficult to imagine how the half of the market that is price-sensitive, which both buys and sells 

according to the various traders’ perceptions and expectations regarding supply and demand, can have a greater 

upward effect on price than the other half that only buys and holds. 
128

over that time period (expressed as percentage of “full carry”). Figure 33 presents the same data 

as in Figure 31, but expressed in terms of percentage of full carry rather than cents per month. 

In March 2006, the 2-1 price spread in the Chicago wheat futures market reached full 

carry and, afterwards, regularly exceeded full carry. About 18 months later, after the 2007-2008 

winter wheat crop was harvested amid high demand in the cash market, near term wheat prices 

increased and the Chicago market receded from full carry status. During 2008, both the Chicago 

and Kansas City futures exchanges returned to a full carry status for extended periods of time. In

contrast, the Minneapolis market for hard red spring wheat only briefly reached full carry in the 

fall of 2008, following the harvest of the relatively plentiful 2008/09 crop. (Figure 34). 

Figure 33. The 2-1 spread for Chicago and Kansas City wheat futures expressed as a 

percentage of full carry. Interest rates based upon 3-month Treasury bills. Storage costs 

are considered to be 0.165 cents per day (approx. 5 cents/month). Displayed values 

represent 5-day moving averages. Data source: CME, KCBOT, US Treasury Dept.

-200%

-100%

0%

100%

200%

Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

Chicago and Kansas City Wheat Futures

Price Difference Between 2nd and 1st Futures Contract

Expressed as % of Full Carrying Cost

Kansas City (HRW)

Chicago (SRW)
129

Figure 34. The 2-1 spread for Minneapolis wheat expressed as a percentage of full 

carry. Interest rates based upon 3-month Treasury bills. Displayed values represent 5-

day moving averages. Data source: CFTC, US Treasury Dept.

The extent to which the 2-1 spreads in the three wheat markets has been able to provide 

or exceed full carry is fully consistent with the evidence that, assuming all other market 

conditions are equal, the substantial presence of index traders tend to increase the 2-1 spread in 

that market. The Chicago wheat market, with a high level of index traders, exhibits a substantial 

increase in the 2-1 spreads to levels consistently at and above full carry. The Kansas City wheat 

market, with a moderate level of index traders, exhibits a more moderate but nonetheless visible 

increase in the 2-1 spreads to a level at or above full carry. The Minneapolis wheat market, with 

no index traders, continues to exhibit virtually no tendency to exceed full carry for any extended 

period of time.

c. Impact of Index Trading on Longer-Term Price Spreads

During the same time period from 2000 to 2008, the data shows the same pattern for 

price spreads between more distant wheat futures contracts on the three exchanges. Again, the 

data shows an increase in the wheat price spreads on the Chicago exchange compared to the 

comparable price spreads on the Kansas City and Minneapolis exchanges. Figure 35 shows the 

price spread between the third and second month futures contracts for both the Chicago and 

Kansas City wheat futures contracts. This price spread is called the “3-2” spread. The data for 

the 3-2 spread presents a very similar picture as the data on the 2-1 spread in Figure 31 with 

respect to second and first month wheat futures contracts. 

-200%

-100%

0%

100%

200%

Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

Minneapolis Wheat Futures

Daily Spread Between 2nd and 1st Futures Contract

Expressed as Percentage of Full Carrying Cost
130

Figure 35. Beginning in 2004, the difference in price between the third-month and the 

second-month futures contracts grew much larger in the Chicago wheat futures market 

than in the Kansas City wheat futures market. Data source: CME, KCBOT.

Figure 36. Beginning in 2004, 12-month price spread for Chicago wheat futures grew 

much larger than the same spread for Kansas City and Minneapolis wheat futures. Data 

source: CME, KCBOT, CFTC.

-20

-15

-10

-5

0

5

10

15

Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

Chicago and Kansas City Wheat Futures 

Difference in Price Between 3rd and 2nd month Contracts 

Chicago

Kansas City

cents/

month

-200

-150

-100

-50

0

50

100

Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

Chicago, Kansas City, and Minneapolis Wheat Contracts

12-month Price Spreads

Chicago

Kansas City

Minneaspolis

cents
131

The pattern appears yet again when examining very long-term price spreads between 

wheat futures contracts that are 12 months apart. Again, the price spreads grew significantly 

larger in the Chicago futures market than in the Kansas City and Minneapolis futures markets. 

Figure 36 shows the 12-month price spreads in the three wheat futures markets. The data shows 

that, prior to mid-2004, these long-term price spreads behaved similarly in all three wheat 

markets. Beginning in September 2004, the long-term price spreads in the Chicago wheat 

market again began to diverge from those in the Kansas City and Minneapolis markets. 

Additionally, both the long-term spreads and the shorter-term spreads in the Chicago market 

reached historically high levels in late 2006. 

The next Figure, Figure 37, presents data in three charts from five different intermonth 

price spreads for wheat futures contracts in each of the wheat futures markets to show the 

contribution of each monthly spread to the overall increase in the price spreads in the Chicago 

market compared to the other two markets.

221 The vertical white lines on the data indicate the 

expiration dates for the futures contracts. 

 221 Full-page versions of these charts are included in the Appendix. 

Chicago Wheat Futures Contracts

Intermonth Spreads

-200

-150

-100

-50

0

50

100

Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

6-5 Spread

5-4 Spread

4-3 Spread

3-2 Spread

2-1 Spread

cents
132

Figure 37. Price spreads in the three wheat futures markets. Data source: CME, 

KCBOT, CFTC. 

Kansas City Wheat Futures Contracts

Intermonth Spreads

-200

-150

-100

-50

0

50

100

Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

6-5 Spread

5-4 Spread

4-3 Spread

3-2 Spread

2-1 Spread

cents

Minneapolis Wheat Futures Contracts

Intermonth Spreads

-200

-150

-100

-50

0

50

100

Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

6-5 Spread

5-4 Spread

4-3 Spread

3-2 Spread

2-1 Spread

cents
133

The three charts in Figure 37 indicate that, since 2004, there has been a major structural 

change in the Chicago futures market compared to the other two futures markets. The data 

shows a significant increase in Chicago wheat price spreads between a number of successive 

futures contracts, increasing both the short-term and long-term spreads in the Chicago futures 

market. These increased price spreads produce thick price bands (i.e., large price spreads) on the 

Chicago data that are not present in the Kansas City or Minneapolis data. The data shows that 

these substantial increases in price spreads in the Chicago market have occurred over several 

years and with respect to different size wheat crops; they cannot be explained solely by the 

fundamentals of supply and demand in the cash market. Rather, they are consistent with the 

presence of a significant number of index traders who are continuously bidding up both nearterm and longer-term futures prices on the Chicago exchange. 

The next three charts, in Figure 38, present the same intermonth price spread data as the 

prior three charts in Figure 37, but adds data showing the daily basis (difference between the 

price of the first month futures contract on the exchange and the average cash price using the 

MGEX cash index) in each market. This additional data shows how increases in the price 

spreads in the Chicago wheat futures contracts relate to the lack of convergence at the expiration 

of those contracts. 

Chicago Wheat Contracts

Basis and Spreads

-3

-2

-1

0

1

2

3

4

Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08

1st Month Basis 2-1 Spread 3-2 Spread

4-3 Spread 5-4 Spread 6-5 Spread

$/bu.
134

Figure 38. Price spreads and daily average basis in the three wheat futures markets. 

Data source: CME, KCBOT, CFTC, MGEX.

Kansas City Wheat Contracts

Basis and Spreads

-3

-2

-1

0

1

2

3

4

Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08

1st Month Basis 2-1 Spread 3-2 Spread

4-3 Spread 5-4 Spread 6-5 Spread

$/bu.

Minneapolis Wheat Contracts

Basis and Spreads

-3

-2

-1

0

1

2

3

4

Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08

1st Month Basis 2-1 Spread 3-2 Spread

4-3 Spread 5-4 Spread 6-5 Spread

$/bu.
135

An examination of these three charts reveals how the increase in longer-term price 

spreads has contributed to the increasing basis and the lack of convergence in the Chicago wheat 

market, magnifying the pricing problems.

Figure 39 presents the same basis and spread information as in the first chart in Figure 38

for the Chicago exchange, but focuses solely on the period from January 2005 to December 

2007, so that the data can be seen in more detail.

222 

Figure 39. Price spreads and daily average basis in the Chicago wheat futures market, 

March 2005-September 2006. Data source: CME, MGEX.

Figure 39 illustrates how even when the basis is decreasing between contract expiration 

dates, the basis can nevertheless increase from one contract to another over multiple contracts. 

Figure 39 also displays how the basis is related to the intermonth spreads. Specifically, the new 

basis after a contract expires equals the “old” basis (i.e., the basis just prior to contract 

expiration) plus the “old” price spread between the first and second months (i.e., the spread just 

prior to contract expiration). 

 222 A full-page reproduction of Figure 39 is found in the Appendix. 

Chicago Wheat Contracts

Basis and Spreads

March 2005 - September 2006

-0.20

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06

6-5 Spread

5-4 Spread

4-3 Spread

3-2 Spread

2-1 Spread

1st Month Basis
136

New Basis = Old Basis + 2-1 spread

 At the same time, the “new” 2-1 spread at the expiration of a contract will be equal to the 

“old” 3-2 spread. When the first month futures contract expires, the value of this “new” 2-1 

spread will then become the “new” basis. In this manner, even distant intermonth spreads may 

eventually influence the spread between the cash and the first month futures contract. 

Indeed, Figure 39 shows how the increase in the basis resulting from the addition of the 

2-1 spread to the old basis can be greater than the decrease in the basis during the period in 

which the previous first month futures contract moved towards expiration. When intermonth 

spreads are large, as they were in the summer of 2006 and again in the summer of 2008 for the 

Chicago wheat contract, and there is a weak cash market, the basis exhibits a tendency to 

increasingly diverge rather than converge. Not only do the large intermonth spreads provide a 

full carry, thereby inhibiting arbitrage transactions in the cash market at the terminal elevators, 

but they continue to increase the basis at the expiration of each contract. 

It also becomes apparent from Figures 38 and 39 that it is a strong demand for wheat in 

the cash market that best promotes and eventually causes convergence. This data pattern is fully 

consistent with the conclusion that the large number of futures contracts held by index traders in 

the Chicago futures market are a major factor causing the lack of convergence. When demand 

for wheat in the cash market is strong, the cash price moves closer to the first month futures price 

and the intermonth spreads are reduced as well. When demand in the cash market is weak, the 

cash and futures prices do not converge and intermonth spreads expand. Thus, it can be seen 

from Figure 38 that when the spreads collapsed in both the Kansas City or Chicago due to strong 

demand in the cash market, there was much better convergence. 

These pricing patterns are consistent with classical models on how futures markets work. 

According to these models, the intermonth spreads in the grain markets are strongly influenced 

by the level of speculative purchases of futures contracts from hedgers who are selling futures 

contracts. Because it costs money to store grain, the price of grain in the future is typically 

higher than the price of grain today. Speculators purchasing grain for more distant delivery 

therefore must pay a higher price for those futures contracts than the prevailing cash price of 

grain. In effect, the speculators buying from the hedgers are paying for part or all of the costs of 

storing the grain until it is delivered. When the demand for grain is strong, such as in times of a 

grain shortage, immediate purchases of grain on the cash market can push up cash prices and 

significantly reduce the spread between the nearer and farther futures contracts. The intermonth 

price spreads therefore reflect the balance between the immediate demand for grain by merchants 

and processors and the more distant demand for grain by speculators and others. 

In the Chicago wheat market, the substantial purchases of wheat futures by index traders

have created a significant demand for futures contracts and increased the futures prices in more 

distant months. These higher prices have increased the price spreads between the more distant 
137

months and the nearer months, particularly between the second and first months. The monthly 

roll of futures contracts tied to commodity indexes has also contributed to the increase in these 

price spreads. On occasion these price spreads have increased above full carry.223

At other times, during periods in which there is a strong demand for wheat in the cash 

market, the cash price of wheat has risen relative to the futures price. The cash price increase 

directly reduces the basis. In addition, the strong demand in the cash market has reduced the 

intermonth spreads, thereby allowing the basis to continue falling across several contracts. Thus, 

convergence is promoted during times of strong demand in the cash market and inhibited during 

times of weak demand in the cash market.

 These index 

traders have therefore provided a significant financial incentive for firms to store grain. As a 

result, the difference between the futures price and the cash price for Chicago wheat has on a 

number of occasions risen to record levels, thereby preventing convergence at contract 

expiration.

224

 2. Subcommittee Interviews with Market Participants

 The influence of index trading on price 

convergence, therefore, has depended in part upon the relative demand for Chicago wheat in the 

cash market. Ever since index-based traders have become a large presence in the Chicago wheat 

futures market, when demand in the cash market for wheat has been normal or weak, there has 

been poor convergence, but when demand in the cash market for wheat has been strong, 

convergence has returned. This trend can be expected to continue as long as index traders 

constitute a significant share of the Chicago wheat futures market. 

At the same time that the Subcommittee was compiling and analyzing market data from 

the three exchanges that offer wheat futures contracts, the Subcommittee contacted a wide 

variety of individuals and firms with expertise in the wheat and grain markets to obtain their 

views on the severity and nature of the pricing problems, the cause of those problems, and the 

role of index trading. The Subcommittee interviewed market participants encompassing the 

entire spectrum of the wheat industry, from farms to grain elevators to grain merchants to grain 

processors. The Subcommittee spoke to persons who bought and sold wheat futures contracts on 

the exchanges and who bought and sold actual wheat in the cash markets. In addition, the 

 223 A number of traders interviewed by the Subcommittee stated that a lack of confidence in price convergence for

Chicago wheat contracts has itself contributed to the lack of convergence. In a properly functioning market, traders 

will engage in arbitrage transactions when they believe one market is overpriced relative to the other, and the pricing

difference will eventually disappear. If traders believe that one market is overpriced relative to the other, but that 

the price differences will not disappear over time, they will not engage in arbitrage transactions because they do not 

have confidence that the transactions will, in fact, produce the expected result. Arbitrage only works when a 

sufficient number of traders believe it will work. The lack of confidence by many traders that Chicago futures and 

cash prices will converge, while impossible to quantify, should be considered as another factor contributing to the 

lack of price convergence.

224 In more technical terminology, convergence is promoted when the demand for accessibility is strong relative to 

the supply of storage, and impeded when the demand for accessibility is weak relative to the supply of storage. 
138

Subcommittee interviewed a number of grain market analysts, all of whom had many years of 

experience in the grain industry and expertise in the Chicago, Kansas City, and Minneapolis 

markets. 

Virtually all of the grain traders and many of the market analysts provided the 

Subcommittee with the same explanation for the large, persistent difference in Chicago wheat 

futures and cash prices (basis), and for the failure of those prices to converge as the futures 

contracts near expiration. These grain traders and analysts stated that the most significant factor 

contributing to the increasing basis and the lack of price convergence was the large presence of 

commodity index traders in the Chicago wheat futures market. Many traders stated that index 

traders had created an additional demand for futures contracts that was not related to or matched 

by any corresponding demand in the cash market, and that the futures prices had responded to 

this added demand by rising to a higher level than the prices in the cash market. 

In previous investigations conducted by the Subcommittee into the operation of the 

commodity markets, there usually has been a range of views on the causes of particular price 

movements. Typically, different traders with different market perspectives have had differing 

views on the behavior of the market. In contrast, during this investigation, there has been a 

striking unanimity of perspective. Virtually all of the traders and analysts contacted by the 

Subcommittee stated that the large presence of commodity index traders in the Chicago market 

was the primary factor contributing to the pricing problems in the wheat market.

Many traders and analysts explained that the higher futures prices made it more profitable 

for grain elevator operators to purchase grain in the cash market, place it into storage, and then 

hedge those grain purchases with the sale of relatively high-priced futures contracts than to 

engage in arbitrage transactions (buying wheat in the cash market, selling futures contracts, and 

then delivering the wheat) at contract expiration. When price spreads are near or above full 

carry, a grain elevator can recover more than the full cost of storing the grain. Elevator operators 

and other grain market participants told the Subcommittee that, in recent years, because the 

futures and cash price difference has been so great, this approach – often termed “cash and 

carry” – was more profitable than any other type of prudent investment strategy.225

Storage data for wheat, when compared to contract price differences, illustrates the point. 

Figure 40 combines two sets of data for the period, 2001 to 2008: the daily price spreads 

between the second and first month wheat futures contracts expressed as a percentage of full 

carry on the Chicago exchange during these eight years, and the amount of wheat stored in the 

 

 225 Because only approved warehouses can make delivery under the futures contract, only these approved 

warehouses can directly engage in the type of arbitrage transactions that will help force convergence (i.e., buy wheat 

in the cash market, sell a futures contract, and deliver the wheat under the futures contract). For approved 

warehouses, it can be particularly profitable to engage in cash and carry transactions rather than arbitrage 

transactions because the cost of storage is so low. 
139

grain warehouses at the Chicago wheat futures contract delivery locations.226 As Figure 40 

illustrates, the amount of grain in storage at these elevators generally increased over time after 

futures prices rose and provided a greater financial incentive to store grain, and generally 

decreased when futures prices fell and provided less of a financial incentive to store grain. 

Figure 40. The amount of grain in storage at the terminal elevators for delivery of the 

Chicago wheat futures contract depends upon the incentive to store grain provided in the 

futures market, represented here by the percentage of full carry provided by the 

difference in price between the second- and first-month futures contracts. Values for the 

2-1 spread reflect the 20-day moving average of the daily difference between the secondand first-month futures contracts on the CME. Full carry is computed from the 3-month 

Treasury bill and a daily storage fee of 0.165 cents (4.95 cents per month). Data source: 

CME. 

Because most traders interviewed by the Subcommittee considered the large presence of 

index traders in the Chicago wheat market as a major underlying cause of the pricing problems in 

that market, these traders and market analysts were skeptical that the changes in the Chicago 

wheat futures contract recently adopted by the Chicago exchange and approved by the CFTC –

providing additional delivery locations, higher storage fees, and revised quality specifications –

would be sufficient to cure the pricing problems. These traders and analysts believed that as 

long as the high price spreads persisted, more storage facilities at the new delivery locations 

would most likely result in more grain being placed into storage at the new delivery warehouses 

rather than a sufficient number of cash transactions at contract expiration to force convergence. 

 226 For a description of the term “full carry,” see Section III.

-100%

-50%

0%

50%

100%

150%

200%

0

5

10

15

20

25

30

35

40

45

Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

Chicago Wheat Futures Contracts:

Stocks of Wheat at Delivery Elevators

and 2-1 Spread as % of full carry

bushels

(millions)

% of 

full carry

Stocks of wheat

in warehouses approved for 

delivery

Spread between first and second 

futures contracts

(as % of full carry)
140

They also viewed the likely result of the increased storage fees to be an increase in the price 

spreads to reflect the higher costs of storage.

The traders and analysts contacted by the Subcommittee did have a range of views on 

what should be done to remedy the pricing problems in the Chicago wheat market. Most traders 

and analysts supported revoking the exemptions and other waivers that have enabled commodity 

index traders to hold many more contracts than the standard position limit of 6,500 wheat 

contracts at a time. They thought that limiting the purchases by index traders would help relieve 

the demand for futures contracts that is increasing the price of wheat futures contracts relative to 

the cash market. Some were concerned that imposing restrictions on index traders who use the 

regulated exchanges might cause them to offset their financial exposures in the less transparent 

and unregulated over-the-counter market, and therefore would result in a loss of liquidity and 

transparency. Still others said that regulatory action was unnecessary, because commodity index 

trading would diminish over time as it became apparent that index instruments were highly 

speculative investments that would not necessarily generate superior returns or less risk. 

3. Testimony Presented to the CFTC 

In addition to the data analysis and interviews conducted by the Subcommittee, public 

testimony presented to the Commodity Futures Trading Commission (CFTC) by a number of 

grain market participants and analysts have identified the large amount of index trading in the 

Chicago wheat market as a major underlying cause of the market’s pricing problems. 

On April 22, 2008, the CFTC sponsored a public “Agricultural Forum” to discuss the 

pricing problems affecting the Chicago wheat futures market. The CFTC invited a wide range of 

commodity market participants to attend. A significant number of the grain market participants 

in this Forum pointed to the large presence of index traders in the Chicago wheat market as a 

major factor underlying the large and persistent increase in futures prices compared to cash 

prices and the lack of price convergence at contract expiration.

National Grain and Feed Association. The National Grain and Feed Association, for 

example, wrote to the CFTC:

“[The] previously reliable relationship between cash and futures has deteriorated 

to a point where many commercial grain hedgers are questioning the effectiveness 

of hedging using exchange-traded futures. 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; 2) demand for storage created by biofuels growth; and 3) the 

futures market running ahead of cash values due to passively managed, long-only 

investment capital.”227

 227 Statement of the National Grain and Feed Association to the Commodity Futures Trading Commission, April 22, 

2008. (Exhibit 8).

 
141

The National Grain and Feed Association stated that although many factors typically affect price 

levels and basis, “we believe that one new factor – the entry of large amounts of long-only, 

passively managed investment capital into agricultural futures markets – is causing a disruption 

in markets.”228

American Bakers Association. The American Bakers Association (ABA), whose 

members produce approximately 85% of all baked goods consumed in the United States, also 

identified the index traders in the wheat market as the primary cause of the disruption in the 

market: “Overall, we believe that the root cause of the current dilemma is a lack of regulation 

upon the largest single participant in the futures markets – the long only commodity index.” The 

ABA wrote to the CFTC:

“[T]he commodity exchanges have moved away from their original intent – to 

allow producers to sell their product in a transparent, regulated manner to physical 

users of the commodity. ABA is concerned that traditional market participants 

are being pushed out of the market – in favor of more non-traditional, new market 

participants that are essentially using the commodities market as a financial 

instrument.”229

National Corn Growers Association. The National Corn Growers Association (NCGA) 

also participated in the 2008 CFTC forum. The corn market has also experienced an increase in 

basis and a number of recent occasions when there has been a lack of convergence, although not 

as frequent or severe as in the wheat markets.230

“It is NCGA’s opinion that the large funds are having an overwhelming influence 

on the futures markets and are ‘non-commercial traders.’ Frequently, we see 

dramatic shifts in the futures market that have no substantiated fundamental 

drivers. While we do not want to drive the index and hedge funds from the 

market, they should be treated for what they are, ‘speculators.’ I realize this flies 

in the face of some CFTC decisions, but I believe to truly be classified as a hedge, 

an entity must have a cash commodity position. NCGA realizes 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 

 The NCGA also believes that the significant 

presence of commodity index traders in the grain markets has contributed to the problems of 

increasing basis and lack of convergence in these markets:

 228 Id. 

229 Letter from American Bakers Association to The Honorable Walt Lukken, Commodity Futures Trading 

Commission, May 7, 2008. (Exhibit 9). 

230 Since 2005, index traders have held between 20 and 30% of the total long open interest in the corn futures 

market.
142

selling a market basket of futures prices, not a market basket of physical 

commodities.”231

American Cotton Shippers Association. The American Cotton Shippers Association 

(ACSA) provided a similar diagnosis of a number of pricing problems in the cotton futures 

market.232

“We simply cannot function in a market with unrestrained volatility unrelated to 

supply-demand conditions or weather events. The ICE Number 2 Contract is no 

longer a rational market for price discovery and hedging – its use to the 

commercial trade has been minimized. It is now an investment vehicle for huge 

speculative funds that have created havoc in the market unimpeded by 

fundamentals or regulation. It is a market overrun by cash precluding convergence 

of cash and futures prices, hedging, and forward contracting – a market lacking an 

economic purpose – a market not contemplated by the Congress when it 

authorized futures trading of agricultural commodities.”

 The ACSA stated:

233

American Farm Bureau Federation. The American Farm Bureau Federation, 

“the national’s largest general farm organization and the representative of millions of 

farmers and ranchers in every state in the nation,” expressed the same views regarding 

the cause of the recent lack of convergence in the grain markets:

“Trading activity by funds is certainly one of the contributing factors generating 

high futures prices for commodities. Ordinarily, this would appear to be positive 

for agriculture. But if the futures markets do not converge with cash markets, 

there is little information on what real price levels should be either for producers 

or consumers of the commodity in question. With convergence, even if futures 

market prices fall precipitously in the delivery month, there are still economic 

signals being sent that producers can respond to. Without convergence, these 

trades become just so much froth.

“In mid-March [2008], index funds represented approximately 42 percent of the 

open interest in Chicago wheat, meaning that roughly two out of every five 

outstanding contracts were held by funds with limited need to trade on supply and 

demand fundamentals – they simply buy and hold. The result was a disconnect of 

the cash price (traditionally based on futures as a means of price discovery) from 

the high of the futures market. Forward contracting virtually ceased.”234

 231 Statement of Garry Niemeyer, National Corn Growers Association, Commodity Futures Trading Commission 

Agricultural Markets Roundtable, April 22, 2008. (Exhibit 10). 

 

232 Since 2005, index traders have held between 25 and 40% of the total long open interest in the cotton futures 

market. 

233 Comments of American Cotton Shippers Association to Commodity Futures Trading Commission on Speculative 

Disruption In Cotton Futures Contract, April 22, 2008. (Exhibit 11).

234 Statement of the American Farm Bureau Federation to the Commodity Futures Trading Commission, Public 

Meeting to Discuss Recent Events Affecting The Agriculture Commodity Markets, April 22, 2008. (Exhibit 12). 
143

Bunge North America. In its comments to the CFTC on its 2006 proposal to 

create what is now the Commitment of Index Traders Report, Bunge North America, Inc. 

(“Bunge”), one of the largest grain processors and marketers globally, provided the 

CFTC with several observations about the effect of index trading in the Chicago wheat 

futures market. Bunge described the issue for the CFTC as follows:

“The growth in commodity funds and the corresponding growth in financial 

hedge positions has created in some physical commodity futures markets an 

investment class that is large and non-responsive to economic conditions in the 

underlying cash market. This phenomenon perhaps is most readily apparent in 

trading in the nearby December futures for soft red wheat at the Chicago Board of 

Trade, where traditional basis relationships have eroded and the price discovery 

and risk management utility of the wheat futures contract is in question. . . . 

“The most noteworthy market from a negative consequences perspective is in the 

CBOT soft red wheat futures market. It is increasingly the view among 

traditional commercial market participants that the index fund position are not 

necessarily market liquidity providers, but are rather takers of liquidity, as they 

generally do not trade on cash market fundamentals.” 235

4. Recent Market Analyses

 

Several recent articles by market analysts, investment advisors, and academic scholars

have also examined the impact of the increasing presence of index trading in a number of 

commodity markets on futures and cash prices for those commodities. 

Vanguard Investment Counseling & Research. A 2007 paper prepared by Vanguard 

Investment Counseling & Research reported that the swell of money into commodity index

instruments had diminished the returns for index traders holding commodity futures tied to those 

indexes.236

“Another recent influence on term structure in the commodities markets is money 

flowing into long-only commodity index-linked products. These passive 

investments are consistently rolling out of expiring nearby contracts into the 

 The Vanguard analysis contended that the increasing number of index-linked trades 

in the commodity futures markets had actually changed the structure of those markets:

 235 Letter from Thomas J. Erickson, Vice President Government & Industry Affairs, Bunge North America, Inc., to 

CFTC, Re: Comprehensive Review of the Commitment of Traders Reporting Program (71 F.R. 119 (June 21, 

2006)). (Exhibit 13).

Although all of these commenters identified commodity index traders as a major disruptive force in the grain 

market, they provided a variety of suggestions as to the best way to address this problem. Some recommended that 

the CFTC not grant any additional exemptions from position limits. Others recommended that the CFTC not only 

stop granting new exemptions, but also impose stricter position limits on all index traders. Some recommended 

increasing the margin requirements for index traders. Some recommended additional transparency and study. 

236 Vanguard, Understanding Alternative Investments: The Role of Commodities in a Portfolio, Vanguard 

Investment Counseling & Research, August 2007. 
144

second-month contract. The resulting strong demand for second-month contracts 

pushes up prices. If strong enough, such demand could influence the term 

structure, as longer-term contract prices increase relative to short-term (nearby) 

contract prices.”237

Vanguard also advised that it expected returns from commodity indexes to be 

lower in the future:

“A large contributor to differences in commodity futures returns is the return 

derived from rolling futures contracts before they expire. This roll return is 

positive when futures markets are backwardated and negative when markets are in 

contango. Many markets (such as those for energy contracts) have been 

consistently backwardated in the past. However, probably in part because of 

large-only investor inflows, these markets were in contango beginning in 2004. 

Consequently, over the next few years, we do not expect average returns from a 

long-only passive commodity investment to be as high as they have been in the 

past. . . . We caution against making an allocation [to commodities] on the basis 

of an extrapolation of historical commodity returns.”238

Mellon Capital Management. A 2008 paper issued by Mellon Capital Management 

(MCM) presented a similar analysis.239 MCM also found that the increasing amount of 

commodity index trading likely had shifted the structure of the futures markets. Noting that the 

total amount of index trading in futures markets had ballooned from “less than $10 billion in 

2001 to well over $200 billion in 2008,” MCM observed that these investors “are almost entirely 

long and will tend to bid up the price of futures, potentially contributing to contango.”240

 237 Id., at p. 13. Vanguard reported that returns from commodity indexes over the period, 1970 to 2006, had largely 

been driven by the rise in energy prices, and that the indexes most heavily weighted towards energy had therefore 

performed better. “Since the introduction of energy futures contracts in 1983, total returns have been driven not by a 

general rise in commodity prices but by the strong performance of the energy sector.” Id., at p. 4. Vanguard warned 

not to expect a continuation of these returns, because the structure of the energy markets had been shifting away 

from backwardation and into contango, which most likely would result in a negative return. “Unfortunately, there is 

evidence that the roll return is declining or even disappearing in markets where it traditionally has been strongest 

(such as energy futures markets).” Id., at pp. 11-12. See also, PSI, The Role of Market Speculation in Rising Oil 

and Gas Prices, June 2006, at pp. 13-14.

 MCM 

presented data (this data is displayed in slightly different format in Figure 41) showing the 

increase in contango over the past 10 years in a number of commodities that are included in 

index funds. 

238 Id., at p. 13. (emphasis in original).

239 Maria Riddle, The Role of Commodities in a Modern, Diversified Portfolio, Mellon Capital Management, 

November 2008. 

240 Id. 
145

Figure 41. The market structure for many commodities included in index funds has 

changed significantly over the past 10 years. Data source: MCM.

MCM concluded that the resulting increase in futures prices was not likely to produce 

attractive returns: “Given the historical track record of commodities as a volatile ‘path to 

nowhere,’ there is little reason to expect a return in excess of cash over the long term. The 

increasing prevalence of contango markets (upward sloping forward price curves) reinforces this 

view for today’s futures investor.”241

The Petroleum Economics Monthly. In the March 2009 edition of The Petroleum 

Economics Monthly, Philip Verleger, a noted oil economist, found the increase of investments in

commodity index instruments had a significant effect on price spreads in the crude oil futures 

market.

 

242

 241 Id., at p. 5. MCM also stated: “Nothing in the long-term history of commodity prices – up to and including 

recent experience – suggests that, as a group, they will produce equity-like returns going forward.” Id., at p. 8. 

With respect to spot returns, MCM noted that commodity spot prices, in real terms, “are pretty close to where they 

were in 1900.” For corn, crude oil, copper, silver, and cattle, MCM found that “as recently as 1999, the cumulative 

inflation-adjusted returns for all five commodities were negative when measured over the previous century.” Id., at 

p. 2. MCM nonetheless concluded that it could be worthwhile for an investor to purchase commodity indexes to 

diversify a portfolio and provide a hedge against inflation. 

 His explanation of the effects of purchases of large amounts of futures contracts by 

242 Philip K. Verleger, Jr., The Great Glut: The Influence of Passive Investors, The Petroleum Economics Monthly, 

Volume XXVI, No. 3, March 2009. Mr. Verleger also found there was no correlation between the weekly flow of 

20

40

60

80

100

Copper Sugar Crude Oil Live Cattle Lean Hogs Wheat Coffee Heating Oil Corn

Commodity Market Structure: 

Increase in Contango, 1998 - 2008

July 1988 through June 1998

July 1998 through June 2008

Chart reflects percentage of time (months) 

each commodity market is in contango 

% of time in 

contango
146

index traders and other speculators on the price spreads in the crude oil futures market matches

the explanations provided to the Subcommittee by grain traders and grain market analysts on the 

effect of commodity index trading on the price spreads in the wheat futures market. 

“[T]here is very, very convincing evidence that firms in the oil industry respond 

to financial incentives to hold inventories. Inventories increase when markets are 

in contango. Inventories are liquidated when markets are in backwardation. The 

rate of acquisition or liquidation depends on the magnitude of the contango or 

backwardation. The degree of contango or backwardation is measured by the 

returns to storage.

“These findings describe the market’s current dynamic. The market cycle starts 

with investment in futures by speculators, peakies, and those seeking to diversify 

portfolios. Buying by these individuals tends to lift forward prices, reducing 

backwardation or increasing contango.”243

Mr. Verleger warned that when passive investments become large enough – such as when 

they constitute one-half of the open interest in a market, as he believes they did in the crude oil 

market at the time of his analysis – the size of these positions can “overwhelm the market” or 

“invite a squeeze.”244

 

money into or out of energy and agricultural futures contracts due to commodity index traders and the weekly 

changes in the spot price of those commodities. 

 He recommended that the CFTC and the exchanges enforce position limits 

to prevent this type of disruption to the markets resulting from index traders. “We suggest that 

243 Id., at p. 25. Mr. Verleger uses the term “peakies” to refer to persons who believe that the global annual 

production of crude oil has peaked or will soon reach a peak. In testimony before the Congress in 2006, former 

Chairman of the Federal Reserve Alan Greenspan offered a similar analysis regarding the effects of increasing 

investments from hedge funds and other institutional investors on commodity prices: 

“[I]ncreasing numbers of hedge funds and other institutional investors began bidding for oil [and] 

accumulated it in substantial net long positions in crude oil futures, largely in the over-the-counter market. 

These net long futures contracts, in effect, constituted a bet that oil prices would rise. . . . With the demand 

from the investment community, oil prices have moved up sooner than they would have otherwise. In 

addition, there has been a large increase in oil inventories.”

Statement of Alan Greenspan, Oil Depends Upon Economic Risks, Hearing before the Senate Committee on Foreign 

Relations, June 7, 2006. See also Staff Report of the Senate Permanent Subcommittee on Investigations, The Role 

of Market Speculation in Rising Oil and Gas Prices: A Need to Put the Cop Back on the Beat, June 27, 2006, at pp. 

7, 13 (“[T]he large purchases of crude oil futures by speculators have, in effect, created an additional demand for oil, 

driving up the price of oil for futures delivery in the same manner that additional demand for contracts for the 

delivery of a physical barrel today drives up the price for oil on the spot market. . . . [T]he influx of speculative 

dollars appears to have altered the historical relationship between price and inventory, leading the current oil market 

to be characterized by both large inventories and high prices.”)

244 Philip K. Verleger, Jr., Passive Investors Are “Roiling” Markets, The Petroleum Economics Monthly, Volume 

XXVI, No. 2, February 2009, at p. 25. Mr. Verleger also found that purchases of futures contracts by commodity 

index traders can be beneficial if they result in an increase in the amount of oil in storage and do not distort the 

market. “Price volatility tends to decline as inventories rise. Higher stock levels also tend to moderate upward 

pressure on prices. Thus the increase in inventories almost certainly augers a period of lower prices, quite possibly 

much lower prices.” Philip K. Verleger, Jr., Giving Credit Where Credit is Due: The Stabilizing Influence of 

Passive Investors, Notes at the Margin, Volume XIII, No. 16, April 20, 2009, at p. 1.
147

regulators and the exchanges might need to intervene in trading activity, perhaps by enforcing 

rigid position limits in some contracts. Failure to do so could make one or more contracts 

irrelevant to the world market.”245

Institute for Agriculture and Trade Policy. In 2008, the Institute for Agriculture and 

Trade Policy (IATP), a farm-oriented research organization based in Minneapolis, issued a paper 

which examined the role of index trading in the runup of agricultural commodity prices from 

2006 and 2008.246

“As prices have become more volatile and convergence less predictable since 2006, the 

futures market has lost its price discovery and risk management functions for many 

market participants. According to the FAO [Food and Agriculture Organization of the 

United Nations], as of March 2008, volatility in wheat prices reached 60 percent beyond 

what could be explained by supply and demand factors.”

 The Institute described the problem in part as follows:

247

In addition to the problems that higher futures prices, price volatility, and poor price convergence 

cause for farmers and agricultural businesses, IATP noted that these pricing problems have 

global implications: “The Agribusiness Accountability Initiative (AAI) stated that ‘massive 

 245 Id., at p. 14. Mr. Verleger has discussed the impact of commodity index trading upon the commodity markets in 

several of his weekly and monthly newsletters going back to January 2005. Although he has typically found a 

variety of other factors primarily responsible for the behavior of crude oil spot prices during this period, Mr. 

Verleger has also consistently found that index traders have increased the price of crude oil futures contracts. See, 

e.g., Philip K. Verleger, Jr., The Influence of Index Traders on Oil Prices, The Petroleum Economics Monthly, 

Volume XXV, No. 3, March 2008, at p. 24 (“The results . . . suggest that buying by index funds has promoted 

additional forward sales by noncommercial and commercial market participants. Although we cannot produce the 

results of statistical causality tests to confirm this view, our hypothesis is that buying by index fund traders has lifted 

forward prices. The rise in forward prices has then been seen as an increasingly good opportunity for commercial 

traders to hedge by selling forward.”); Philip K. Verleger, Jr., Commodity Investors: Trying to Squeeze a Barrel into 

A Pint Jar, The Petroleum Economics Monthly, Volume XXIII, No. 10, October 2006, at p. 15 (“The evidence 

presented below suggest that much, if not all, of futures purchases by commodity investors has been offset by 

inventory accumulation. . . . What happens if investors seeking to put money into commodities cannot find 

counterparties? The obvious answer is the forward price will be bid up until the investors give up or a counterparty 

sells. We suggest the forward price curves for gasoline and heating oil have been distorted by this process. 

Furthermore, this bidding has influenced forward ‘cracks’ (the difference between the future price of products and 

the future price of light sweet crude).”); Philip K. Verleger, Jr., Commodity Investors: A Stabilizing Force, The 

Petroleum Economics Monthly, Volume XXIII, No. 3, March 2006, at p. 14 (“In summary, the introduction of 

investors in physical commodities has altered the economics for holding crude oil. It is now profitable to build and 

hold crude oil inventories.”); Philip K. Verleger, Jr., Are Oil Markets Entering Yet Another “New Era”?, The 

Petroleum Economics Monthly, Volume XXII, No. 7, July 2005, at p. 1 (“The current new era is marked by the 

entry of long-term investors, who have pushed forward crude prices to record levels.”); Philip K. Verleger, Jr., 

Inflating the Commodity Bubble: Impact of Pension Fund Investment on Oil Prices, The Petroleum Economics 

Monthly, Volume XXII, No. 1, January 2005. 

246 Institute for Agriculture and Trade Policy, Commodities Market Speculation: The Risk to Food Security and 

Agriculture, November 2008, available at www.iatp.org.

247 Id., at p. 5.
148

commodity market speculation ... has pushed the prices of wheat, maize, rice and other basic 

foods out of the reach of hundreds of millions of people around the world.’”248

IATP called commodity index funds “the elephant in the room” due to the “huge amount 

of money invested through them and the price volatility that results from index fund ‘bets.’”249

“Perhaps the most crucial loophole is the one that exempts financial speculators from the 

speculation position limits of commercial hedgers, provided that the speculator ‘swap’ 

the futures contract through a middleman ... which would then itself seek to sell the 

contract it had just bought to spread its risk. . . . The [commodity index] funds are 

legally bound by their prospectus to trade to maintain this fund composition balance, 

regardless of the supply and demand fundamentals in agricultural markets. . . . The 

underlying fundamental for these funds is not the supply and demand of physical 

commodities ... but the prospectus formula and profit target. . . . While it is generally 

agreed that some speculative capital is necessary for the effective operation of 

commodities futures and options markets, it does not follow that the amount of capital 

must be unbounded for futures and options trading to carry out its price discovery and 

risk management functions.”

 

IATP explained how these funds have a major impact on futures markets:

250

Among other steps to rein in excessive speculation in the commodity markets, IATP 

recommended establishing position limits on U.S. exchanges and banning foreign commodity 

exchanges from operating in the United States unless they also establish and enforce position 

limits for “financial speculation.”251

University of Illinois Analyses. In a series of papers published over the past two years, 

Professor Scott Irwin and colleagues at the University of Illinois thoroughly documented and 

analyzed the recent convergence problems in the wheat, corn, and soybean markets, but did not 

find that index trading played a major role.

252

 248 Id., at p. 3.

 

249 Id., at p. 7.

250 Id., at pp. 7-8.

251 Id., at p. 11.

252 Scott H. Irwin, Philip Garcia, Darrel L. Good, and Eugene L. Kunda, Poor Convergence Performance of CBOT 

Corn, Soybean and Wheat Futures Contracts: Causes and Solutions, Marketing and Research Report 2009-02, 

Department of Agricultural and Consumer Economics, University of Illinois at Urbana-Champaign, March 2009; 

Scott H. Irwin, Dwight R. Sanders, and Robert P. Merrin, Devil or Angel? The Role of Speculation in the Recent 

Commodity Price Boom (and Bust), February 2009; Dwight R. Sanders, Scott H. Irwin, and Robert P. Merrin, The 

Adequacy of Speculation in Agricultural Futures Markets: Too Much of a Good Thing?, Marketing and Research 

Report 2008-02, Department of Agricultural and Consumer Economics, University of Illinois at Urbana-Champaign, 

June 2008; Scott H. Irwin, Philip Garcia, and Darrel L. Good, The Performance of Chicago Board of Trade Corn, 

Soybean, and Wheat Futures Contracts After Recent Changes in Speculative Limits, July 2007. In addition to 

extensively documenting the nature and extent of the recent convergence problems in the grain markets, these papers 
149

In a 2007 paper, Professors Irwin, Garcia and Good found that the several instances in 

which the corn and soybean markets experienced a lack of price convergence represented “[a] 

picture . . . of weakness, but not failure.”253 They believed these price convergence failures 

resulted from “a unique situation” involving extraordinarily high barge rates along the Illinois 

River, futures prices that failed to reflect fundamental values in the cash market, and “a large 

carry in the futures market that influenced delivery and load-out decisions.”254

With respect to poor price convergence in the wheat market, the professors found that the 

performance of the Chicago wheat futures contract was so “dismal” that it constituted “failure to 

accomplish one of the fundamental tasks of a futures market.”

 A large carry, 

they noted, provides merchants with an incentive to store the commodity for later delivery, when 

futures prices are higher. They explain that, as more of the commodity is stored and less is 

marketed, there are fewer transactions to force price convergence. 

255 “This prolonged period of 

weak basis,” they elaborated, “suggests that the contract is not providing a hedging mechanism, 

may not be providing proper price signals to wheat producers and consumers, and may be 

reducing the effectiveness of crop revenue insurance products based on CBOT wheat futures 

prices.”256 They identified the following factors as responsible for the lack of price convergence:

(1) soft red winter wheat futures prices that “exceeded fundamental value” in reference to the 

cash market; (2) a large carry; and (3) insufficient deliveries. As with corn and soybeans, the 

large carry served to encourage storage rather than deliveries, resulting in fewer transactions to 

force price convergence.257

 

have helped focus much of the analysis and discussion on this issue. Professor Irwin has made presentations to the 

CFTC on his findings on several occasions. Many of the people interviewed by the Subcommittee staff during this 

investigation were familiar with these papers.

 

253Irwin, Garcia and Good (2007), at p. 17. 

254 The referenced increase in the carry (i.e., spread between the second and first month futures contracts) in the corn 

and soybean markets occurred from late 2005 through August 2006. Id., at pp. 10-17. There was a similar increase 

in the carry in the Chicago wheat market during this period. 

255 Id., at pp. 10, 17.

256 Id., at p. 17.

257 Professors Irwin, Garcia, and Good also believed that the decline of Chicago as a center of commerce in wheat, 

particularly soft winter wheat, and the use of the Chicago wheat contract as a global benchmark for wheat prices, 

were partially responsible for the convergence failures. They recommended changing the terms of the Chicago 

wheat futures contract to encourage and facilitate deliveries of wheat, but also more research “to investigate the need 

for and development of a new contract that more precisely reflects world supply and demand conditions for wheat.” 

Id., at p. 18. As they note, however, Chicago has not been a major center of wheat commerce for nearly a century. 

In 1926, a Federal Trade Commission (FTC) Report on the Grain Trade noted “the tendency toward a loss by 

Chicago of its primacy as a market for the physical handling of grain, especially as regards wheat, while maintaining 

its dominant position in futures. An increasing quantity of grain that never goes to Chicago is hedged in Chicago 

futures.” FTC, Report on the Grain Trade, Vol. VII, Effects of Futures Trading, at p. 286 (1926). The FTC Report 

recommended additional delivery points for the contract: “Outside deliveries might be considered a further logical 

step in making the national market for future trading, so far as practicable, also national in some sense as regards the 
150

In this paper, Professors Irwin, Garcia, and Good identified increased speculation as one 

of the key factors responsible for the larger carry in these markets during this period: “The 

larger carry in the corn and soybeans markets in the past year likely resulted from large crop 

inventories, increased commercial long hedging in deferred contracts by exporters and ethanol 

producers, and the large increase in speculative interest in owning corn and soybean futures.”258

In a 2009 paper, Professors Irwin, Garcia, Good, and Eugene Kunda found that, from late 

2005 to 2009, the wheat, corn, and soybean markets were plagued by “extended periods” in 

which there was a lack of price convergence, although corn and soybeans had not performed as 

poorly as wheat. “Performance has been consistently weakest in wheat, with futures prices at 

times exceeding delivery location cash prices by $1/bu., a level of disconnect between cash and 

futures not previously experienced in grain markets.”

 

The paper identified index traders as one of the factors underlying this increase in speculation in 

the grain markets. Although it identified “a particular concern” that “the huge inflow of 

commodities investment has raised prices, at least temporarily, to higher levels that can be 

justified by economic fundamentals,” it did not evaluate or address this specific concern in more 

detail. 

259 Again, the 2009 paper identified the 

large carry in these markets as the root cause of the convergence problem. “In sum,” the paper 

stated, “[this] analysis pinpoints an unusually large carry in nearby spreads as the main factor 

driving poor convergence performance of corn, soybean, and wheat futures contracts in recent 

years. The large carry led to a historically large wedge between futures and cash prices and 

substantial declines in hedging effectiveness.”260

 

facilities offered for delivery on its futures.” Id. A 1953 analysis by Professor Holbrook Working of the 

effectiveness of hedging techniques in the wheat futures market also referenced the longstanding decline of the cash 

wheat market in Chicago. Professor Working stated that he used price quotations from the Kansas City markets 

rather than Chicago “because changes in the major wheat-producing areas and in the normal lines of movement of 

the commodity have left Chicago with a vestigal spot wheat market that no longer affords a good source of spot 

price quotations.” Holbrook Working, Futures Trading and Hedging (1953), reprinted in Selected Writings of 

Holbrook Working, (1977), at p. 145. In 1961, Stanford University Professor Roger Gray commented, “It is 

somewhat misleading to speak of our three major wheat futures markets. Chicago is the major futures market, 

carrying about three-fourths of all the open contracts on all United States wheat futures markets in the postwar 

period. Kansas City and Minneapolis have divided nearly all of the remainder in a ratio of about two to one in favor 

of Kansas City. . . . Yet Chicago is a cash wheat market of only secondary importance . . . .” Roger W. Gray, The 

Relationship Among Three Futures Markets, Food Research Institute Studies, Vol. II, No. 1 (February 1961), at p. 

22 (available at farmdoc archives). The issue, therefore, is not whether Chicago has declined as a location for the 

wheat trade – it clearly has – but what additional factor has arisen within the past few years that, together with 

weaknesses in the contract, now threatens the very existence of the Chicago wheat contract as a useful hedging 

instrument. 

 

258 Id., at p. 13 (emphasis added). 

259 Irwin, Garcia, Good, and Kunda (2009), at p. 1.

260 Id., at p. 5. Professor Irwin and his colleagues found that all contracts performed poorly whenever the price 

spread between the second and first futures contracts (i.e., the carry) exceeded 80% of full carry. They explained 

how a large carry impairs convergence:
151

Although Professors Irwin and his colleagues again identified the increased carry in the 

grain markets since 2006 as a major underlying cause of the convergence problems in these 

markets, they again did not identify the root cause for this increase.261

 

“Large carry markets contribute to lack of convergence by ‘uncoupling’ cash and futures markets 

when futures prices are above cash prices. The delivery instrument for corn and soybeans is a 

shipping certificate, while the delivery instrument for wheat was a warehouse receipt until recently 

when it was changed to a shipping certificate (starting with the July 2008 contract). Those longs 

who receive certificates or receipts from shorts in the delivery process are not required to cancel 

those instruments for shipment. The instruments can be held indefinitely with the holder paying 

‘storage’ costs at the official rates specified by the CBOT in contract rules. The taker in delivery 

(the long) may choose to hold the delivery instrument rather than load out if the spread between 

the price of the expiring and next-to-expire futures contracts exceeds the cost of owning the 

delivery instrument. Therefore, as the magnitude of the nearby spread exceeds the full cost of 

carry for market participants with access to low-cost capital, those participants can (and do) stand 

for delivery but do not cancel delivery certificates or receipts for load out.

 Rather, they partially 

“The lack of load out, then, means that deliveries do not result in cash commodity purchases by 

the taker that would contribute towards higher cash prices and better convergence. Alternatively, 

a smaller carry in the market and the absence of an ‘abnormal’ return to certificate ownership 

would motivate participants with long positions to liquidate prior to delivery, putting downward 

pressure on nearby futures and contributing to better convergence.” 

Id., at p. 2. 

261 Professor Irwin and his colleagues rejected index trading as a possible cause for the increase in the price spreads

and resulting carry in the market, because they did not find lasting increases in the price differences between the first 

and second month futures contracts during the five-day roll periods for the S&P GSCI commodity index. For a 

number of reasons, however, the increase in the second to first month price spreads resulting from increased index

trading would not necessarily be manifested during this small window of time. 

First, there is no reason to expect that the increase in the spread between the second and first month contracts 

resulting from index traders would occur only during the five days when the S&P GSCI is rolling futures contracts 

from the first to the second months. All of the traders in these markets are well aware of when the various funds roll 

their contracts, and some may avoid trading during any period in which they believed they would have to compete 

with index traders for the purchase or sale of specific futures contracts. Thus, to a certain extent the increase in 

trading by index traders during this period may be directly offset by decreased trading by non-index traders during 

this period. The net increase in demand for futures contracts resulting from index traders, therefore, could be spread 

out over a much larger time frame than this five-day window. 

Second, since 2006, the roll window for the S&P GSCI has represented a decreasing proportion of the total time 

period in which index-related futures contracts are rolled. Since 2006, most new investments in commodity indexes 

have been placed into the second-generation indexes. The second-generation commodity indexes rely on futures 

contracts that are more distant than those in the first-generation funds, and roll less frequently in order to avoid or 

reduce the losses from rolling contracts in contango markets. 

Third, as discussed previously, other intermonth spreads – including the spread between the third and second month 

contracts – have also increased over the past few years. Once a futures contract reaches expiration, what had been 

the spread between the third and second month futures contracts then becomes the spread between the second and 

first month contracts. Hence, much of the increase in the spread between the second and first months since 2006 is 

directly related to the prior increase in the spread between the third and second month contracts rather than the 

rolling of contracts. Hence, much of the increase in the 2-1 spreads has already occurred by the time the S&P GSCI 

contracts are rolled. 

Fourth, investments tied to commodity indexes directly affect the intermonth price spreads through their initial 

investments as well as through the periodic rolling of contracts. The initial purchase of a futures contract by an 

index trader, by itself, will increase the difference in price between the second month contract and the first month 
152

attributed the failures of convergence to “structural issues related to the delivery process” –

meaning the fact that Chicago is no longer a principal location for commerce in wheat – and 

recommended that the contract delivery point be moved to New Orleans to increase the number 

of cash transactions near contract expiration and encourage price convergence. 

5. Basic Futures Market Theory: Impact of Speculation on Price

Finally, basic theory about how commodity markets work supports the finding that 

commodity index trading is a primary cause of the pricing problems in the Chicago wheat 

market.

All of the traders in commodity futures markets, including speculators, commercial 

hedgers, and others, affect the price of commodity futures contracts. A bid to purchase or an 

offer to sell a particular futures contract at a particular price that is made by a speculator has the 

same effect upon the market as an identical bid or an offer from a commercial hedger. It is the 

interactions between all of the buyers and sellers which determine market prices, not theoretical 

models of what the appropriate price should be given the fundamentals of supply and demand. 

G. Wright Hoffman, one of the first economists to extensively analyze trading on the futures 

markets, observed, “Fundamental market information determines prices only through the 

opinions and actions of traders composing the market.”262

 

contract, and between more distant contracts. Because these index traders are passive, meaning they hold onto the

futures contracts for long periods of time and do not subsequently buy or sell on the basis of market supply and 

demand fundamentals, there is no subsequent selling of these contracts prior to the roll that would lower these 

spreads. Hence, by the time a roll window arrives, the spread already would have been elevated to a certain degree 

due to the buy and hold strategy pursued by these index traders. It is not possible to quantitatively determine or 

estimate the relative contribution of the initial purchase and the subsequent roll to the overall level of the price 

spread. To the extent that the subsequent roll does not actually increase the price spread, however, it may still serve 

to maintain that spread and prevent it from falling as firms seek to “sell the spread” in order to recover the costs of 

storing the commodity over the time period represented by the spread. This type of effect also would not be 

observable in any correlation between price and position. 

 Similarly, Professor Holbrook 

The 1967 USDA Economic Research Service study on speculation, margins, and prices emphasized the importance 

of examining a wide time frame rather than a discrete trading window when analyzing the effect of speculation on 

price. “If one assumes that the principal, measurable price effect of speculation is not caused by the holding of 

speculative position over time, but, instead, by the immediate market reaction to the transaction (buying or selling) 

itself, then no combination of measures which reflect merely the net change in ‘ownership’ of open contracts can 

adequately explain the real price effect of speculation.” Margins Speculation and Prices in Grains Futures Markets,

at p. 71. The USDA advised taking a broad approach: “[A]ppropriate examination of speculative activities and 

related price behavior over a wide sample of market situations would identify circumstances under which 

speculation quite likely was a measurable price-making factor.” Id., at 73.

262 G. Wright Hoffman, Future Trading Upon Organized Commodity Markets in the United States, (University of 

Pennsylvania Press, 1932), at p. 259. In 1941, the USDA published Mr. Hoffman’s study of grain prices and the 

futures markets over a 15-year period beginning in 1923, the year in which data on the positions of traders first 

became available under the Grain Futures Act of 1922. USDA, Grain Prices and the Futures Market: A 15-year 

Survey, 1923-1938, Technical Bulletin No. 747, January 1941 (G. Wright Hoffman, consulting economist). Mr. 

Hoffman’s USDA study concluded that “when the trading of market leaders results in large purchases or sales 

within comparatively brief periods of time, it is capable of causing the price to move with the trading – if purchases, 

upward; if sales, downward.” Id., at p. 49. The USDA found that when the net positions of the five largest 

speculators in the Chicago wheat futures market were “combined and considered as a group their positions as well 
153

Working writes, “[T]he price of a commodity, of which stocks are held, cannot be determined by 

an impersonal economic law; it is determined by human judgments, essentially speculative, 

regarding what those stocks can be sold for at a later time.”263 Professor Thomas Hieronymus 

has also observed, “A futures market is not a scholarly seminar in which learned men debate 

what is, and arrive at, an equilibrium price; it is a game in which businessmen compete, with 

money at hazard, to establish a market price that works.”264

The price of a futures contract reflects the supply of and demand for that contract, as 

transmitted to the market by the buyers and sellers of the contract. As in any type of market, if 

there are more buyers than sellers, then the price will rise until there is sufficient incentive for 

additional sellers to enter the market. It follows, therefore, that if in the commodity futures 

markets there are more traders, such as speculators, who desire to purchase a futures contract 

than other traders, such as hedgers, who in the normal course of business would sell those 

contracts, then the price of those futures contracts must rise to attract additional sellers. In this 

 

 

as their large trades reveal a pronounced price relationship. They suggest in even stronger terms than for earlier 

periods that the trading of these leaders caused prices to move with their trading.” Id., at p. 52 (emphasis added). 

Moreover, the USDA found that the larger the speculative trades, the more likely those trades were to affect prices. 

“[T]he larger the daily net trades by leading operators the more certain it becomes that the prices will respond 

directly to the trading.” Id., at p. 60. 

Mr. Hoffman also contributed to the 1926 report prepared by the Grain Futures Administration (the GFA was the 

predecessor agency to the Commodity Exchange Authority, which was the predecessor agency to the CFTC) at the 

request of the U.S. Senate on the causes of the price fluctuations in the wheat market in 1925. The 1926 report 

concluded, “While this investigation did not reveal any concentrated action for the deliberate purpose of 

manipulating the market, most of the wide and erratic price fluctuations that occurred in wheat futures at Chicago 

during the early part of 1925 were largely artificial and were caused primarily, either directly or indirectly, by heavy 

trading on the part of a limited number of professional speculators.” Fluctuations in Wheat Futures, Senate Doc. 

No. 135, 69th Cong., 1st Sess., June 28, 1926, at p. 1. It found that “large speculative operations” were “a constant 

hazard in the market, the force of which may move prices far out of line with the normal and, temporarily, at least, 

destroy completely the hedging value of the futures market.” The report advised that limits on the size of 

speculative positions and intraday trading were necessary “if the futures market shall best serve hedgers and others 

who have need of it in the process of moving grain from the farms of this country to the consumers of this and other 

countries.” Id., at p. 6. 

Fifty-five years after the Senate published this report, Professor Todd Petzel published a critique of the GFA’s study 

of the events of 1925, observing that the use of statistical techniques for the analysis of market data that were not yet 

developed at the time of the GFA study did not support the GFA’s conclusions. Professor Petzel’s analysis 

confirmed the correlation between the purchases by speculators and price changes, but he then stated “it is important 

that causality not be read into [the fact of correlation]. It is impossible to determine whether price increases (or 

decreases) during the day caused purchases (or sales) by speculators or the converse.” Todd E. Petzel, A New Look 

at Some Old Evidence: The Wheat Market Scandal of 1925, Food Research Institute Studies, Vol. XVIII, No. 1, 

1981, at p. 123 (available at farmdoc archives). Professor Petzel found that “without intraday trading data it is 

impossible to suggest a causal relationship.” Id., at p. 126. Professor Petzel, therefore, did not disprove the GFA’s 

finding, but rather rejected it because it could not be proved according to a high degree of statistical certainty with 

the available data. In the absence of good or sufficient data, however, non-statistical methods are often used to 

demonstrate the truth or falsity of a hypothesis. 

263 The Economic Functions of Futures, Markets, at p. 294. 

264 Hieronymus, at p. 327.
154

manner an excess of speculative purchases of futures contracts will raise the price of those 

futures contracts.265

It is also well-established that speculative activity is often a major determinant of price 

spreads. Professor Hieronymus wrote in his classic textbook: “Speculators in futures markets 

affect prices; they accumulate and liquidate inventory which puts prices above the levels that 

would otherwise prevail when they are accumulating and puts prices below levels that would 

otherwise prevail when they are liquidating.”

 

266

Professor Hieronymus describes in detail how speculators in the grain markets influence 

the intermonth price spreads in the grain futures markets and thereby affects the deliveries and 

storage of grain at terminal elevators. He first explains how a terminal elevator determines 

whether to hold or deliver grain:

 

“The elevator management must formulate a judgment of the most favorable 

spread at which it can move its hedges forward and, at a smaller spread, deliver 

grain. In making this judgment, it looks at existing supplies, supplies to come, 

demands for use and shipment, and the amount of available space. It is a complex 

judgment, and first delivery day is nearly always a time of intense interest.

“The opposite ends of these futures trades by warehousemen are taken by 

speculators; they buy the hedges. They pay premiums for the deferred deliveries. 

If they are to make money the cash price must increase by more than the amount 

of the premium. They pay, indirectly, the storage that the warehouseman receives 

 265 A variety of rationales are sometimes offered to support the contrary view that speculation does not affect futures 

prices. First, it is sometimes asserted that in an efficient market any deviations from “fundamental value” will 

quickly disappear as other market participants take advantage of the arbitrage opportunities presented by such 

deviations. This view presumes that “fundamental value” is an objective reality that all market participants can 

readily discern. As Hoffman, Working, and Hieronymus and many others have stated, “fundamental value” is not 

an objective value that exists independently from the market – it is what the market says it is. Hence, there is 

actually no reason to believe the price of a futures contract should be anything other than what the market currently 

says it is. Second, it is often asserted that “for every buyer there is a seller.” The significance of this fact is unclear; 

presumably it is intended to mean that the upward pressure placed on the market by the buyers will always be met 

by an equal and opposite downward pressure placed upon the market by the sellers, thereby implying that price 

increases cannot be attributed solely to the buyers. This argument is unpersuasive, since it leads to the logical 

conclusion that prices in any market should be static – in any market there are an equal number of buyers and 

sellers. Moreover, it is the presence of bids and offers that move prices, not the presence of buyers and sellers; for 

every bid there is not necessarily a corresponding offer and vice versa. Third, it is often asserted that, because 

speculators never take delivery, they must eventually engage in a market transaction that is the opposite of the initial 

transaction – for example, they must eventually sell each futures contract that is purchased – so that there is no net 

effect from their speculative buying and selling. This analysis ignores the fact that market conditions and prices at 

the time of the subsequent transaction will be different from the market conditions and prices at the time of the 

initial transaction, so that the subsequent transaction will not necessarily have an equal and opposite effect upon the 

market as the initial transaction. Moreover, most hedging does not result in physical delivery. In many commodity 

futures markets, only 1 or 2% of the transactions result in physical delivery. It cannot be credibly argued that 98-

99% of the transactions in a commodity futures market have no effect on price because they do not result in 

delivery. 

266 Hieronymus, at pp. 145-6.
155

indirectly. As the spreads are wide, they are paying more storage than when the

spreads are narrow.”267

 Professor Hieronymus refers to the interaction between large speculators and the 

terminal elevators as “the delivery game.”

 

268 Not only do the speculators take the opposite 

position from the hedgers in the price spreads, but their actions in bidding up the price of the 

spreads, or conversely, in selling their spread positions, directly affects the amount of the grain 

stored at the terminal elevators. “Thus, it is the speculators who make the inventory decisions. 

Inventory is accumulated when speculators are willing to pay enough more for distant contracts 

than nearby to encourage accumulation and hedging, and inventory is liquidated when 

speculators will pay little more or even less for the more distant contracts.”269

In sum, unless there is an independent increase in the supply of futures contracts by 

commercial hedgers, increased futures purchases by speculators – or index traders – will result in 

 

 267 Id., at pp. 159-60. Professor Hieronymus’s observation that speculators who are long the spread are in effect 

paying for the storage costs of the commodity by the warehouse (or other persons holding warehouse receipts) offers 

another explanation of why investors in commodity index strategies in a contango market fare so poorly. The 

monthly roll of the underlying futures in an index fund is in essence the purchase of an intermonth spread – it entails 

selling the nearby futures and purchasing the longer-term futures. The hedger on the other side of this transaction 

purchases the shorter-term futures and sells the longer-term futures. By buying the spread from the hedger, the 

index trader is essentially paying that hedger the storage cost of the commodity over the time span of the spread. 

These index traders are, in effect, paying for the cost of storage of the commodity while hoping that the price will 

appreciate by more than the storage cost of that commodity. As shown in the previous section, over the past 50 

years, that approach has been an extremely poor strategy in the wheat and corn markets.

268 Id., at p. 172.

269 Id., at p. 194. Although there is an extensive body of literature on the effect of speculation on price levels, only a 

fraction of this literature specifically addresses the effect of speculation on intermonth price spreads. One of the few 

empirical analyses of this issue was published in 1967 by the U.S.D.A. Economic Research Service, as part of a 

larger study entitled, “Margins, Speculation, and Prices in Grain Futures Markets.” USDA Economic Research 

Service, Margins, Speculation, and Prices in Grain Futures Markets (U.S. Government Printing Office, 1967) 

(available at farmdoc archives). The purpose of the study was “to define and measure speculation and its relation to 

price fluctuations, and to measure the relation of margin changes to speculation and price movements.” The USDA 

concluded that speculation played a role in price formation, but it was often impossible to quantitatively measure 

that contribution even using the best available data. “Original, objective analyses show that speculation explained 

part of short-term price ranges or changes in most [of] the market situations for which estimating procedures were 

developed. The relative importance attributable to speculation, compared with other explanatory variables, varied 

widely, as did its absolute price effect.” Id., at p. 4. The USDA study also examined how the relationship between 

hedgers and speculators can affect prices. In particular, the USDA noted that changes in the balance between the 

number of speculators and the number of hedgers can influence prices. “We noted that fluctuations in the grain 

futures markets became marked when long or short aggregate commitments in speculation or hedging became 

unbalanced, with respect to offsetting positions in the same category. Price stability often occurred when long and 

short hedging positions were well balanced and when these positions represented approximately an equal share of 

total open contracts as did holdings by speculators other than spreaders.” Id., at p. 3. The report noted that large 

purchases of futures contracts by speculators can increase the price spreads in the futures market: “[C]ertain (intracommodity) spread positions are relatively important in influencing changes in price differences between contracts. 

Changes in aggregate holdings of spreads by large speculators between contracts within different crop years (e.g., 

long old crop – short new crop) consistently were closely related to logical, corresponding shifts in price spreads.” 

Id., at p. 5. 
156

an increase in the price of futures contracts. The basic laws of supply and demand fully apply to 

the actions of speculators and index traders in the commodity futures market. As speculators or 

index traders demand additional futures contracts, the price of those futures contracts will 

increase and the commercial sellers will have an added financial incentive to place their grain 

into storage. All else equal, therefore, as the demand for futures contracts from index traders 

increases, the price of those futures contracts can be expected to increase as well. 

Whether an increase in demand from index traders will, in fact, result in an increase in 

futures prices and spreads will depend on additional factors, including the relative balance 

between the long index investor and short hedgers, and the extent of demand in the cash market. 

When there is significantly more selling (i.e., short hedging) of futures contracts than speculative 

buying, the additional purchases of futures contracts by index traders can more readily be 

absorbed by the market than when the index funds are of comparable size or larger than the short 

hedgers. When the demand for contracts for future delivery of a commodity from index traders

matches or exceeds the supply of the contracts for future delivery, the price of those contracts for 

future delivery will rise relative to the price of the commodity in the cash market.270

The extent of the demand for the commodity in the cash market also will have a 

significant influence on the price spreads, basis, and convergence. Price spreads, particularly the 

spread between the cash and futures price (the basis), will increase when demand in the cash 

market is weak, and decrease when the demand in the cash market is strong. A strong cash 

market will raise the cash price relative to the futures price and result in smaller spreads between 

futures contracts, as the near-term demand for the commodity rises relative to the longer-term 

demand. Thus, when the cash market is strong enough – as it was in the latter part of 2007 –

convergence may occur even when there is a large presence of index trading in the market. 

When the cash market is weaker than usual – as it was during the second part of 2008 – the 

demand for futures contracts from index traders will cause the spreads to widen significantly, 

and price convergence will be impeded. 

The problem with the large basis levels and lack of convergence in the Chicago wheat 

futures market is fully explained by this framework. This framework does not rely on any novel 

 270 There is no widely accepted way to quantify what an acceptable level or percentage of speculation in a particular 

market might be. The USDA Economic Research Service’s 1967 study into the effects of speculation on futures 

prices addressed this point: 

“Data limitations precluded our serious consideration of developing or adopting a single 

benchmark, a ‘speculative statistic’, which could quantify speculation and contribute consistently 

and rationally to explanations of futures price behavior of an extended period of time. Even if the 

concept that speculation could be precisely defined by a single statistic is acceptable in theory, 

such a historical series simply could not have been developed and tested.”

USDA, Margins Speculation and Prices in Grains Futures Markets, at p. 67 (available on farmdoc archives). The 

USDA study concluded that “Price behavior is probably best explained by a number of independent factors acting 

singly and jointly with one another.” Id., at p. 73.
157

concepts or theories of commodity market behavior. It simply integrates the presence of 

commodity index traders into well-accepted, basic models of how commodity markets work. 

The Commodity Exchange Act does not define the term “excessive speculation,” but 

rather states that excessive speculation that causes “sudden or unreasonable fluctuations or 

unwarranted changes in the price of such commodity is an undue and unnecessary burden on 

interstate commerce in such commodity.” The Act then directs the CFTC to establish limits on 

trading to diminish, eliminate, and prevent this burden on commerce. 

This Report finds there is significant and persuasive evidence that the large amount of 

commodity index trading due to speculative purchases of index instruments has contributed to

“unreasonable fluctuations” and “unwarranted changes” in the price of wheat futures contracts, 

since the change in the relationship between futures and cash prices in the wheat market is, in 

large part, due to this index trading rather than the fundamentals of supply and demand in the 

cash market. Additionally, this Report finds there is significant and persuasive evidence that the 

change in the relationship between the price of wheat futures contracts and the price of wheat in 

the cash market has significantly impaired the ability of farmers, grain elevators, millers, grain 

merchants, grain processors, and others in the grain industry to use the futures markets to reliably 

price wheat and manage their price risks, which has imposed significant, additional costs upon 

these participants in the grain industry. Because there is substantial and persuasive evidence that 

this level of speculation in the wheat futures market has been a major cause of these unwarranted 

changes and unreasonable fluctuations, and has imposed an undue burden on interstate 

commerce, this Report finds that the high level of index trading in the wheat futures market 

constitutes “excessive speculation” that the Congress directed the CFTC to prevent through the 

imposition of limits on trading. 
158

VI. FUTURES PRICES AND CROP INSURANCE

A final issue involves the federal crop insurance program. The evidence shows that 

artificially high futures prices can result in increased farmer and taxpayer costs through the 

federal crop insurance program and in inaccurate insurance payouts. 

Federal crop insurance is available to farmers who want to cover potential financial 

losses due to natural perils such as bad weather and crop disease. The federal crop insurance 

program uses settlement prices from certain futures contracts to determine how much money 

should be paid to a farmer who has purchased coverage and to set insurance premiums. Futures 

prices that are higher than justified by the fundamentals of supply and demand in the cash market 

increase the costs of purchasing crop insurance for farmers as well as for federal taxpayers who 

share in the cost of those insurance premiums. Futures prices are also used to set both base and 

harvest prices for certain types of crop insurance. The base price is then used to set revenue 

guarantees, and the harvest price is used in the revenue calculation. Both prices are included in 

formulas used to calculate insurance payments made to farmers. The increasing lack of 

predictability as to the difference between the futures price and the cash price for wheat (the 

basis) undermines the reliability and effectiveness of the formulas used to calculate insurance 

payouts, potentially resulting in underpayments or overpayments by the program to the 

purchasers of federal crop insurance. 

A. Background

 1. Development of the Federal Crop Insurance Program

The U.S. Department of Agriculture’s (USDA) Risk Management Agency oversees the 

current federal crop insurance program in conjunction with private insurers. The program was 

first authorized by Congress in the 1930s after the devastation to farmers and the agricultural 

community from the Great Depression and the Dust Bowl.271 Farmers faced losses due to 

inclement conditions such as drought, flooding, hail, freezes, and disease.272 The crop insurance 

program was created as a way for the government to help protect farmers from future losses. In 

1938, Congress created the Federal Crop Insurance Corporation to help manage the program.273

 271 Arthur M. Schlesinger. Jr., The Crisis of the Old Order 1919-1933 (Houghton Mifflin Company, 1957), at p. 

174-175. Net farm income in 1932 was $1.8 billion – less than one-third what it had been three years earlier. To put 

this into real terms, it took 16 bushels of wheat – more than the average yield of a whole acre – for a farmer to buy 

his children a pair of $4 shoes. 

Initially, the program was started as an experiment, and crop insurance coverage was mostly 

272 Douglas R. Hurt, The Dust Bowl: An Agricultural and Social History, (Nelson-Hall, 1981), at p. 30-31. In 1931, a 

bumper crop of wheat accompanied by drought brought economic disaster to the southern Great Plains. In the Dust 

Bowl states, the price of wheat fell from an average of $.99 per bushel in 1929 to $.34 in 1931.

273 The Federal Crop Insurance Corporation was created by Congress in legislation that was passed on February 16, 

1938 (7 U.S.C. 1501). 
159

limited to major crops in the main producing areas. The program was not heavily utilized during 

its first 50 years. During this time, participation in the program was low, while losses were high. 

In 1980, the Federal Crop Insurance Act was passed, expanding the insurance program to 

more crops and regions of the country.

274

In 1994, the crop insurance program was reformed yet again, with enactment of the Crop 

Insurance Reform Act, which effectively eliminated ad hoc disaster assistance payments.

The Act contained a number of provisions that were 

designed to encourage more farmers to participate in the crop insurance program. For example, 

Congress eliminated limitations in the Federal Crop Insurance Corporation’s ability to offer 

reinsurance to private companies. While more farmers utilized the program after the new Act 

was passed, many chose not to participate because they believed that if a disaster were to occur 

that affected their crops, the Federal Government would come through with disaster assistance as 

it had so many times before. The low participation rate in the crop insurance program led to 

Congress issuing a number of ad hoc disaster assistance bills following major disasters in the 

1980s and early 1990s. 

275

In 2000, in another bid to increase program participation, Congress authorized USDA to 

start subsidizing the premiums farmers paid to obtain crop insurance. These taxpayer subsidies 

today cover more than 60% of the premium costs. Currently, farmers pay about 41% of the 

amount needed to cover insured losses.

 

Initially, the 1994 Act made participation in the crop insurance program mandatory for farmers 

to be eligible for other USDA benefits such as payments under price support programs. This 

requirement increased program participation. In 1996, Congress repealed the mandatory 

participation requirements, but farmers who accepted other federal benefits were required to 

purchase crop insurance or waive their eligibility for any disaster benefits that might be made 

available during that crop year. 

276 According to The Center for Agricultural and Rural 

Development at Iowa State University, this large subsidy means that most farmers will get 

substantially more back from the program than they pay into it. The Center estimated that the 

premium subsidy is large enough that the average farmer can expect a rate of return of 143% for 

the premium paid.

277

Today, about 58% of U.S. grain farmers participate in the crop insurance program which

has grown to become the largest single source of financial protection to farmers.278

 274 The Federal Crop Insurance Act of 1980, P.L. 96-365.

According to 

275 The Crop Insurance Reform Act of 1994, P.L. 103-354. 

276 Babcock, Bruce A. and Hart, Chad, E. Iowa Ag Review, summer 2006, Volume 12, No. 3.

277 Id.

278 According to the 2002 USDA Agricultural Resource Management Survey, nearly 58% of farms that earned most 

of their income from grains, oilseeds, dry beans, or peas purchased crop insurance. 
160

the 2008 USDA Performance and Accountability Report, in 2008, USDA’s Risk Management 

Agency provided more than $88 billion of Federal crop insurance protection to farmers.279 The 

premiums continue to be heavily subsidized. In 2006, the crop insurance program cost taxpayers 

approximately $2.5 billion, or $3.31 for each dollar paid out.280

2. How the Program Works

USDA offers crop insurance through its Risk Management Agency (RMA). RMA

administers the crop insurance program in partnership with private insurance companies. 

Farmers purchase crop insurance from an approved private insurance company that is authorized 

to sell the policy on behalf of USDA. The farmer enters into a contract with the insurance 

company to insure the eligible acreage of a particular crop planted in a particular county. The 

farmer pays a premium for the insurance, but part of the cost of the premium is paid for with 

taxpayer dollars. Insurance is provided on a crop-by-crop and county-by-county basis. RMA 

acts as a reinsurer for a portion of all federal crop insurance policies, meaning it acts as an 

insurer for the private insurance companies that provide direct coverage to farmers. 

Under the federal crop insurance program, the private insurer agrees to indemnify the 

farmer for losses that occur during the insured crop year. The insurer has the backing of 

USDA’s RMA and receives reimbursement for a portion of the administrative costs associated 

with underwriting the policy. Additionally, USDA and the insurer share a percentage of the risk 

of loss and opportunity for gain associated with each insurance policy written. According to 

USDA, all eligible acreage must be insured to reduce the potential for adverse selection against 

the insurance provider.281

Insurance Options. USDA offers farmers a number of different insurance options for 

hundreds of crops, including wheat, corn, and soybeans. Options include policies that protect 

against loss of yield and loss of revenue. Based upon their needs, farmers can choose the policy 

option that is best for them. Crop coverage availability is determined by county, but coverage is 

broadly available for most crops in their core growing areas.

282

 279 U.S. Department of Agriculture 2008 Performance and Accountability Report (November 17, 2008) at p. 3.

Coverage availability differs by 

location and varies by policy type. For example, Crop Revenue Coverage policies for wheat are 

available in 2,354 counties across 40 states, while corn coverage is available in 2,517 counties 

across 47 states, and soybean coverage is available in 1,986 counties across 32 states. Revenue 

Assurance wheat coverage is available in 1,181 counties across 17 states, while corn coverage is 

280 Babcock, Bruce A. and Hart, Chad, E. Iowa Ag Review, summer 2006, Volume 12, No. 3.

281 Adverse selection could occur if the insured party has better knowledge of the relative risk of a particular 

situation than the insurance provider does. 

282 For a current list of crops covered, see http://www.rma.usda.gov/policies/08croplist.html.
161

available in 1,528 counties across 19 states, and soybean coverage is available in 1,388 counties 

in 19 states.283

There are two basic categories of federal crop insurance: “yield based” insurance 

determined according to a farmer’s actual production history, and “revenue based” insurance 

determined according to the farmer’s expected crop income. Each category offers a number of 

different insurance plans for farmers to choose from. 

Under yield based plans, the farmer chooses a level of yield to insure, typically from 50% 

to 75% of the farmers’ average crop yield, but up to 85% in some areas. The farmer also selects 

the percent of the predicted price he or she wants to insure, typically from 55 to 100% of the crop 

price as established annually by RMA. If the harvest is less than the insured yield, the farmer 

can collect an indemnity payment based upon the difference. Indemnity payments are calculated 

by multiplying the difference between the harvest and the yield by the insured percentage of the 

established price that was selected when crop insurance was purchased. Yield based plans do not 

use futures market prices in their calculations. 

Under revenue based plans, the farmer insures a level of crop income, based upon the

average yield multiplied by the expected price for the crop. If the revenue that the farmer earns

is lower than the level the farmer insured, an indemnity payment will be made for the difference. 

Three key plans under the revenue insurance category, Crop Revenue Coverage (CRC), Revenue 

Assurance (RA), and Group Risk Income Plan (GRIP), use futures market settlement prices to 

establish the expected crop prices as well as the harvest price that is used to determine any 

loss.284

3. Inadequate Program Oversight

RMA is responsible for protecting against waste, fraud and abuse in the crop insurance 

program. Recently, the U.S. Government Accountability Office (GAO) and others have raised 

concerns regarding the integrity and oversight of the program. In 2005, 2006, and 2007, GAO 

reports detailed millions of dollars lost to wasteful and incorrect indemnity payments that RMA 

did not identify, prevent, or correct.

285

 283 This information was provided to the Subcommittee by USDA. 

GAO found that some farmers allowed crops to fail –

either deliberately or through neglect – in order to collect insurance. 

284 Given similarities in the programs, USDA has proposed a rule that would combine the Crop Revenue Coverage 

program and the Revenue Assurance program starting in 2011. 

285 See Crop Insurance: Continuing Efforts Are Needed to Improve Integrity and Ensure Program Costs Are 

Reasonable, GAO-07-819T (May 3, 2007). See also Crop Insurance: More Needs to Be Done to Reduce Program’s 

Vulnerability to Fraud, Waste, and Abuse,GAO-06-878T, (June 15, 2006) and Crop Insurance: Actions Needed to 

Reduce Program’s Vulnerability to Fraud, Waste, and Abuse, GAO-05-528 (September 30, 2005). 
162

Additionally, GAO found that the insurance companies running the programs did not 

conduct due diligence in investigating losses and paying claims, and the payments USDA made 

to companies running the programs were found to be excessive. GAO reported that USDA data 

showed that an estimated $62 million in 2006 indemnity payments made under the crop 

insurance program were the result of waste, such as incorrect payments based on incomplete or 

missing paperwork. In 2007, this number was $63 million, and in 2008, it more than doubled to 

$165 million.286 According to GAO, USDA has taken some steps to address these concerns, but 

in 2007, GAO identified federal crop insurance as a program in need of better oversight to ensure 

program funds were spent as economically, efficiently, and effectively as possible.287

One person interviewed by the Subcommittee stated that some farmers have chosen to 

plant crops even though futures prices were unusually high relative to cash prices because, under 

the crop insurance program, the farmer could receive an indemnity payment if prices 

subsequently fell. Higher futures prices encourage farmers to plant more wheat even if these 

high futures prices are not justified by the actual conditions of supply and demand for wheat. 

The person interviewed stated that even though farmers recognized that there would be ample 

supplies of soft red winter wheat, some planted additional acres of wheat anyway, in the 

expectation they would nonetheless receive indemnity payments if prices fell as a result of the 

overplantings. Another person interviewed by the Subcommittee stated that the futures market 

had become so disconnected from the cash market that he was not aware of any farmers who 

based any of their planting decisions on the prices in the futures market. 

B. Impact of Futures Prices on Crop Insurance

Recent turmoil in the wheat market, including rising prices, increased price volatility, and 

divergent prices in the cash and futures markets, has led to uncertainty among farmers when 

making decisions about which crop insurance to buy. In addition, because revenue-based crop 

insurance relies on base and harvest prices to calculate revenue guarantees and crop revenues, 

increasing futures prices and the widening gap (basis) between cash and futures prices have led 

to higher premiums and greater uncertainty as to the eventual level of indemnity payments. 

USDA offers farmers three different revenue insurance plans: Crop Revenue Coverage 

(CRC), Revenue Assurance (RA), and Group Risk Income Plan (GRIP). All three use futures 

settlement prices to establish crop price guarantees to be paid in the event of a loss.

Futures prices are used to determine a “base price” and “harvest price” for insured crops. 

For an insured wheat crop, for example, the base price is determined by averaging daily contract 

settlement prices on the Chicago futures exchange during the one month period, August 15-

 286 U.S. Department of Agriculture 2008 Performance and Accountability Report (November 17, 2008) at p.300.

287 Crop Insurance: Continuing Efforts are Needed to Improve Program Integrity and Ensure Program Costs are 

Reasonable, GAO-07-994T (June 7, 2007).
163

September 14, for the July futures wheat contract in the following year. The July contract is

used, because it is the futures contract that will expire closest to the time when the insured wheat 

crop will be harvested. Base prices for corn and soybean crops are determined using futures 

contracts that expire closest in time to when each of those commodities is harvested, as set out in 

Table 1. Once established, the base price is used to provide revenue guarantees under a formula 

applicable to the particular type of crop insurance purchased by the farmer. 

The harvest price is also determined by using the average daily settlement price for a 

specified futures contract on the Chicago exchange. For wheat, settlement prices during the 

month of June for the July futures contract are used; corn and soybean crops use futures contracts 

in later months, as set out in Table ES-1. Once established, the harvest price is used to calculate 

a guaranteed amount of revenue from the harvest of the insured crop. The amount is calculated 

by taking the farmer’s actual production history (APH) yield multiplied by the yield coverage 

level and the harvest price. The policy’s guaranteed revenue is the larger of a specified minimum 

guarantee or the harvest guarantee calculated for a specific policyholder. The resulting 

guaranteed revenue amount is then used in determining whether and how much of an indemnity 

payment is owed to an insured farmer. 

Base and Harvest Price Calculation Information for Wheat, Corn, Soybeans

Base Price Harvest Price

Wheat

Average settlement price from 

August15-September 14 for the 

following July futures contract on 

Chicago exchange

Average settlement price in June for 

July futures contract on Chicago 

exchange

Corn

Average settlement price in 

February for December futures 

contract on Chicago exchange

For CRC coverage: average 

settlement price in October for 

December futures contract on 

Chicago exchange 

For RA and GRIP coverage: average 

settlement price in November for 

December futures contract on 

Chicago exchange 

Soybeans

Average settlement price in 

February for November futures 

contract on Chicago exchange

Average settlement price in October 

for November futures contract on 

Chicago exchange

Table 8. Prepared by Permanent Subcommittee on Investigations, May 2009

Data source: USDA
164

Farmers with certain CRC, RA, or GRIP policies can use the larger of the base or harvest 

price to calculate their guarantee. Farmers with other RA policies use only the base price to 

calculate their indemnity payment. Typically, if the harvest price is greater than the base price, 

then an indemnity payment can be made only if there is a yield loss, meaning the actual yield is 

less than the yield guarantee. If there is a yield loss, then the farmer is paid for the lost bushels 

(yield guarantee minus actual yield) at the more favorable harvest price. 

To understand how the widening gap between futures and cash prices can increase the 

cost of federal crop insurance premiums and decrease program effectiveness, the following 

examples explain how base and harvest prices affect premiums and payouts. 

1. Increased Insurance Premiums

USDA uses the prices of commodity futures contracts to calculate the premiums due 

under federal crop insurance policies. As futures prices have increased in recent years, farmers 

have faced higher premiums for crop insurance coverage. Because the Federal Government 

subsidizes these premiums, the higher amounts have also increased taxpayer costs. 

Crop insurance premium rates vary by county, crop, type, practice, and plan or insurance, 

and are based on a combination of historical yield losses for the crop and county as well as a 

variable known as the price factor or price volatility as measured by options traded on the 

Chicago exchange. The premiums for CRC, RA, and GRIP policies represent a combination of 

yield risk and price risk. USDA uses historical yield loss data to determine the “yield risk”

associated with a particular crop in a particular county – the risk that the actual yield may be 

lower than the average yield. Premium rates for revenue products are based on a combination of 

yield risk and the price risk arising from the volatility of the prices in the futures market.288 

Below are two examples of how premiums are calculated.289

Example 1: Futures Prices and CRC Premiums 

A corn farmer has an actual production history (APH) yield of 152 bushels per acre, and 

chooses to insure the crop under a CRC policy at 65% with a base price of $5.40 per bushel. The 

base price is derived from the average settlement prices during February for the following 

December futures contract traded on the Chicago exchange. The premium rate for the farmer’s 

county has been determined to be 0.069. This rate is based upon a combination of historical 

yield losses for the crop and county and the price volatility as measured by options traded on the 

Chicago exchange. Calculations below are for CRC coverage. RA coverage calculations would 

be the same, although the premium rate could vary. 

 288 The “price risk” is measured by the price of options on futures for the commodity. 

289 These examples were provided to the Subcommittee by USDA. 
165

Expected Value of Crop: APH Yield x Base Price

= 152 x $5.40= $821.80

Yield Guarantee: APH Yield x Coverage Level

= 152 x .65= 98.8

Revenue Guarantee: Yield Guarantee x Base Price

= 98.8 x $5.40= $533.52

Total Premium: Revenue Guarantee x Premium Rate

= $533.62 x 0.069= $36.50

Premium Subsidy: The Federal Government pays a portion of the farmer’s premium. That 

portion varies by coverage level and insurance plan. For 65% coverage for CRC insurance in 

2009, the Federal Government pays 59% of the total premium.

= $36.50 x .59= $21.53

Farmer Premium: Total Premium-Premium Subsidy

= $36.50- $21.53= $14.97

Example 2: Futures Prices and GRIP Premiums

A corn farmer has an actual production history (APH) yield of 159.4 bushels per acre, 

and chooses to insure the crop under a GRIP policy at 90% with a base price of $4.04 per bushel. 

As above, the base price is derived from the average settlement prices for the December futures 

corn contract traded on the Chicago exchange. The premium rate for the farmer’s county has 

been determined to be 0.111. This rate is based upon a combination of historical yield data and 

price volatility. 

Expected County Revenue (ECR): Expected County Yield (ECY) x Base Price

= 159.4 x $4.04= $643.97

GRIP Liability: 1.5 x ECR

= 1.5 x $643.07= $965.97

Yield Guarantee: ECY x Coverage Level

=159.4 x .9= 143.5

Revenue Guarantee: ECR x Coverage Level

=$643.98 x .9= $5.79.58

Total Premium: GRIP Liability x Premium Rate

=$965.97 x 0.111= $107.22

Premium Subsidy: The Federal Government pays a portion of the farmer’s premium. That 

portion varies by coverage level and insurance plan. For 90% coverage for GRIP insurance in 

2009, the Federal Government pays 44% of the total premium. 
166

=$107.22 x .44= $47.18

Farmer Premium: Total Premium-Premium Subsidy

=$107.22-$44.18= $63.04

In the case of both premium calculations, a higher futures price would have boosted the 

base price and resulted in a higher premium cost to both the Federal Government and farmer.

2. Inaccurate Insurance Payouts

Futures prices also affect insurance payouts, since the level of insurance payouts depends 

on both the levels of futures prices at the time the crop is planted and the levels of the futures 

prices at the time of harvest. Higher futures prices at the time of planting can result in a higher 

level of insurance payments, whereas higher futures prices at the time of harvest can result in 

either a higher or a lower level of insurance payments, depending on the type of insurance and 

other factors relating to the size of the harvested crop. Since the Federal Government provides 

financial support for the crop insurance program, higher insurance payouts impose additional 

costs on taxpayers. The following examples demonstrate how futures prices are incorporated 

into federal crop insurance calculations.

Crop Revenue Coverage. Crop Revenue Coverage (CRC) uses both a farmer’s average 

yield and commodity futures prices to set revenue guarantees. CRC insurance protects against 

reductions in price, yields, or a combination of both. Coverage is based upon a farmer’s average 

yield (or actual production history – “APH”) multiplied by the higher of the base price or the 

harvest price for the commodity (based on the specified futures exchange settlement prices). 

A farmer’s APH yield is based upon a minimum of four and a maximum of 10

consecutive years of crop yield data. A farmer can choose an insurance coverage level of 

between 50 and 85% of a guaranteed level of revenue. CRC will make payments whenever the 

farmer’s actual revenue is below the guarantee. There is no limit on the amount the harvest price 

can decrease from the base price; however, the harvest price may not be greater than 200% of the 

expected price. For example, the 2009 expected price for CRC for winter wheat in Missouri is 

$8.58. That means that the harvest price for wheat is limited to $17.16 or lower. 

Example 3: Futures Prices and CRC Insurance 

A wheat farmer has an APH yield of 50 bushels per acre, and chooses to insure the crop 

under a CRC policy at 75% of the APH yield with a base price of $5.93 per bushel. Assume the 

harvest price is $7.93 per bushel, and the harvested yield is 30 bushels per acre. The base price 

of $5.93 was derived from the average settlement price from August 15 to September 14 for the 

July wheat futures contract during the harvest year, as set out in Table 1. The harvest price of 

$7.93 was derived from the average daily settlement price during the month of June for the July 

wheat futures contract, as set out in Table 1. 
167

Minimum Guaranteed Revenue= APH Yield x Yield Coverage Level x Base Price

= 50 x 75% x $5.93=$222.37 per acre

Harvest Guarantee Revenue= APH Yield x Yield Coverage Level x Harvest Price

= 50 x 75% x $7.93=$297.37

The Calculated Revenue, used in determining an indemnity payment:

Calculated Revenue= Harvested Yield x Harvest Price= 30 x $7.93= $237.90

The indemnity payment is the difference between the guaranteed revenue and calculated 

revenue: Indemnity Payment= $297.37-237.90= $59.47 per acre

This example shows how CRC insurance would provide an indemnity payment due to 

low yields. Farmers with CRC coverage could also receive indemnity payments if the calculated 

revenue were lower than the revenue guarantee. In either case, however, a higher futures price 

would have boosted the base and harvest prices and resulted in larger CRC indemnity payments.

Revenue Assurance. Revenue Assurance (RA) is similar to CRC insurance in that the 

plan guarantees a minimum gross income per acre, but the yield levels used to calculate the 

guaranteed level of revenue have a narrower range than in the CRC. RA also uses futures prices 

to establish a set guaranteed level of revenue under its policies. RA policies are written in a 

manner similar to CRC, but offer farmers two options. The standard RA policy bases coverage 

on the farmer’s average yield multiplied by the base price for the commodity based on the 

specified futures exchange settlement prices for the commodity. This price does not increase 

even if the futures price rises by harvest time. The second option is the “harvest price option.” 

If the farmer elects to purchase this option, the revenue guarantee does increase if the harvest 

price is higher than the base price, just as it does under CRC. The harvest price option carries a 

higher premium than the base price option. RA will insure a farmer at a coverage level between 

65-85%. As with CRC, the harvest price may not be greater than 200% of the expected price. 

Here is an example of how the RA base price option would work.

Example 4: Futures Prices and RA Insurance 

A wheat farmer has an APH of 50 bushels per acre and chooses to insure the crop at 75% 

of the APH yield with a base price of $5.93 per bushel. Assume the harvest price is $7.93 per 

bushel and the harvested yield is 30 bushels per acre. As above, the base price of $5.93 and the 

harvest price of $7.93 are derived from the average settlement prices for the July futures wheat 

contract traded on the Chicago exchange. 

Revenue Guarantee: APH x Yield Coverage Level x Base Price

= 50 x 75% x $5.93= $222.37

Actual Harvest: Actual Yield x Harvest Price

=30 x $7.93= $237.90
168

Indemnity= Revenue Guarantee-Actual Revenue

= $222.37-237.90= $0

The revenue guarantee is used in the calculation since under the base price option, the 

revenue guarantee does not rise even though the harvest price is greater than the base price. In 

this example, higher futures prices for the July futures contract would have reduced the amount 

of indemnity, since the price of the July futures contract is used to calculate the actual revenue. 

If the July futures contract is very high relative to the actual cash price for the crop, the use of 

this formula will result in less insurance payments than warranted by the actual conditions in the 

cash market at the time of the harvest. 

Group Risk Income Protection. Group Risk Income Protection (GRIP) is an insurance 

plan based on county yields rather than individual yields. The income guarantee level is based 

upon county expected yield and average futures prices. The actual gross revenue is based upon 

the actual county yield and the average futures price at harvest. Because GRIP is a group-based 

product, guarantees and indemnity payments are determined at the county level for all farmers 

participating in the program. This approach means that if a farmer has a good crop, but the 

overall county does not, the farmer will still receive an indemnity payment and vice-versa. 

GRIP does not require any farm production history so it is an attractive plan to farmers 

who do not have production records or who have a low APH yield. Unlike the other insurance 

options, GRIP offers coverage between 70 and 90% of the county yield (at 5% increments), and 

most farmers choose to insure at the highest level. 

Under GRIP, farmers receive payments any time the actual county revenue drops below 

the trigger revenue that the farmer chooses. The trigger revenue is calculated by multiplying the 

expected crop price by the expected county yield, and multiplying the result by the elected level 

of coverage. The amount of payment the farmer receives depends upon the level of protection

selected when the farm is enrolled in the program. The maximum liability per insured acre is 

150% of the base price, multiplied by the expected county yield. If a farmer elects to increase 

the liability of the policy, the premium and potential indemnity increase proportionately. 

GRIP can also be purchased with a harvest option, which means that if the harvest futures 

price is higher than the base price, the harvest price is used to calculate the trigger price. GRIP 

has the same limits as CRC on the degree to which the harvest price can differ from the base 

price. Below is an example of how GRIP works. 

Example 5: Futures Prices and GRIP Insurance 

In 2007, a wheat farmer lives in a county with an expected county yield of 50 bushels per 

acre, and chooses to insure the crop under a GRIP policy at 90% with a base price of $4.35 per 

bushel. Assume a harvest price of $5.74 and a harvest yield of 30 bushels per acre. The base 
169

price of $4.35 and the harvest price of $5.74 are derived from the average settlement prices for 

the July wheat futures contract traded on the Chicago exchange.

Expected County Revenue (ECR): Expected County Yield (ECY) x Base Price

= 50 x $4.35= $217.50

GRIP Liability: 1.5 x ECR (Growers may elect to increase the liability of their policy up to 

150% of the expected county revenue. Most growers select this option.)

= 1.5 x $217.50= $326.25

Yield Guarantee: ECY x Coverage Level

=50 x .9= 45

Revenue Guarantee: ECR x Coverage Level

= $217.5 x .9= $195.75

Actual County Revenue (ACR): Actual County Yield x Harvest Price

Indemnity Calculation

= 30 x $5.74= $172.20

Payment Factor for GRIP: ( [Revenue Guarantee-ACR]/ Revenue Guarantee) – This is the 

percent of a GRIP policy’s liability to be paid out as an indemnity payment. The purpose of this 

payment formula is to create a “disappearing deductable” – an enhanced payout that helps to 

cover the deductible portion of the loss. 

= [$195.75-$172.20]/ $195.75= 12.03% 

Indemnity Payment: Payment Factor x Maximum GRIP Liability

=12.03% x $326.25= $39.24 per acre

3. Impact of Divergent Futures and Cash Prices 

Because key federal crop insurance plans rely on base and harvest prices to set revenue 

guarantees, and those prices reflect the relevant commodity futures contract prices, the trend in 

recent years toward large differences (basis) between futures and cash prices and the lack of 

price convergence at contract expiration signal that the program is less and less reflective of the 

actual conditions in the wheat market. 

Table ES-2 shows the base and harvest prices for the last three years for soft red winter 

wheat, and adds comparative data on prices from the cash market. This data shows an upward 

pricing trend as well as an increasing difference between the harvest and cash prices (basis). For 

example, prior to 2006, the greatest difference between the harvest price and the cash price was 

46 cents per bushel. In 2006, the difference between the harvest price and the cash price 

increased to 80 cents, which was more than 25% of the cash price. In 2008, the difference 

between the harvest price and the cash price grew to $1.21 per bushel. 
170

Base, Harvest, and Cash Prices for Soft Red Winter Wheat

2001-2009

Year

Base Price for 

SRW wheat for 

RA coverage

Harvest Price for 

SRW wheat for 

RA coverage

Average Cash 

Price for SRW 

wheat in June in 

Toledo, OH 

Difference 

Between 

Harvest Price 

and Cash Price

2001 $2.97 $2.63 $2.17 +$0.46

2002 $3.04 $3.17 $3.00 +$0.17

2003 $3.53 $3.07 $3.02 +$0.05

2004 $3.36 $3.35 $3.36 -$0.01

2005 $3.40 $3.31 $3.13 +$0.18

2006 $3.50 $3.84 $3.04 +$0.80

2007 $4.35 $5.94 $5.23 +$0.71

2008 $5.93 $8.31 $7.10 +$1.21

2009 $8.58 TBD TBD TBD

Table 9. Prepared by the Permanent Subcommittee on Investigations, June 2009

Data source: USDA, MGEX

The lack of convergence between futures and cash prices in recent years affects the 

accuracy and effectiveness of the indemnity payments farmers receive from their crop insurance 

coverage. Given that the indemnity calculation for crop insurance in some of the insurance 

programs, such as the RA program, use the settlement price of the futures market contract that is 

closest to the contract that will expire at the time of harvest, and these futures prices have risen 

relative to the cash harvest prices, the calculation of the revenue received by the farmer under 

these insurance formulas may be substantially higher than the actual revenue received by the 

farmer, which would result in a lower insurance payment than justified by the actual conditions 

in the cash market. Under the CRC Insurance program, however, as shown in Example 3, a 

higher futures price could result in a higher revenue guarantee and therefore a higher insurance 

payout. 

These examples demonstrate how the increasingly large difference between the futures 

price and the cash price for wheat, together with the failure of these two prices to converge as a 

futures contract nears expiration, can lead to higher or lower crop insurance payouts than 

warranted by the actual market conditions. 
APPENDIX

EXHIBITS AND CHARTS AVAILABLE UPON REQUEST. 

For a copy, contact Mary Robertson (202/224-9868 OR mary_robertson@hsgac.senate.gov)