Futures markets exist primarily as a risk management tool for participants. As such, a futures contract is most effective if and when it reflects the fundamentals in the underlying cash market. On August 5, 2016, CME Group announced several changes to its live cattle futures contracts to do just that.
John Lothian News spoke with Dave Lehman, managing director of commodity research and product development at CME Group, about the changes which, pending CFTC approval, will go into effect later in August 2016.
“We are going to be applying a seasonal discount at Worthing, SD, one of our delivery points, of $1.50 per hundredweight in October only…and then we are going to upgrade the quality specifications by moving the choice percentage to 60 percent from 55 percent, and then the select percentage down from 45 to 40 percent,” says Lehman. “This will allow the futures delivery terms to better reflect the underlying cash market.
To read the entire press release, click HERE.
So, why the Worthing discount? Lehman points to an independent study, that found the price in the region is consistently below other regions in the fall, as reflected by the October cattle contract.
“What’s happened,” explains Lehman, “as the feeding industry has gradually moved to the Northern Plains where there is cheaper feed – distiller’s dried grain is more available in the region due to ethanol production, and that’s closer to the corn supply than, say, Texas, Oklahoma or Kansas – livestock production has grown, but the slaughter capacity has not kept up with the increase in production. Cattle produced in the region have to be transported farther away to find slaughter capacity in the fall, when that supply is heavier. That transportation cost is reflected back in the basis in that region.”
While this marks the first time CME Group has instituted a premium or discount in its cattle contract, these are quite common in the exchange group’s other agricultural products. But once they are set, according to Lehman, CME tries not to adjust them too often. The flagship corn and soybean contracts, for example, will be reset for the 2019 contracts, marking the first adjustment since 2000.
“We will look at them and monitor them, and if they need to be adjusted, we will work with the industry to make those adjustments,” says Lehman.
And that’s no bull.