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New CME Wheat Contract Takes Aim at Black Sea BreadbasketWriTTEN By BruCE BlyThE

The Black Sea, according to historians, was once

known as the “Hospitable Sea” after the ancient

Greeks colonized its southern shores, setting the stage

for centuries of commerce and conflict to follow. About

3,000 years later, CME Group aims for a foothold of

its own with a futures contract based on the region’s

fertile soils and bountiful grain production.

On June 6, Chicago-based CME Group launched Black

Sea wheat futures trading on its CME Globex electronic

network, offering opportunities to hedge and speculate

in a market that’s playing an increasingly important

role in the world’s food supply.

The contract is based on food-grade wheat readily

available throughout the Black Sea region, which

accounted for about 20 percent of global wheat

exports in the 2011-12 marketing year, compared with

just 1 percent to 2 percent a decade ago.

Yet the market lacks a liquid futures contract, can be

subject to export restrictions and consistent price

information can be difficult to come by. CME Group

officials say the new contract will provide much-

needed transparency and risk-management tools,

and has potential to become a regional wheat pricing

benchmark.

“It’s an underserved market,” said Fred Seamon,

Senior Director of Commodity Research & Product

Development with CME Group. While there are several

existing wheat futures contracts, “there is not a high

price correlation” with the Black Sea crop, Seamon

said in an interview. “There is not a good hedging tool

for participants in the market.”

With delivery locations at eight Russian or Ukrainian

ports, along with one in Romania, the contract should

have strong correlation with the region’s cash market,

CME Group has said.

FABulouS FArMlANd, uNiquE MArkET riSkS

Producers in the Black Sea region face “a unique set

of risks” compared to their counterparts in other crop

areas, said Nick Higgins, a London-based analyst

with Rabobank Group. “Conditions tend to be more

volatile,” and there is “potential for price movements to

be exacerbated by political reactions to failing crops,”

such as Russia’s temporary suspension of wheat

exports in 2010 amid a severe drought.

“There is a need for a contract,” Higgins said, though

he cautioned these needs “are sporadic in nature,”

raising questions whether a futures contract can build

sufficient trading volume to prove useful.

About 130 years ago, the Black Sea region was

considered the “breadbasket” of the world, though

wars and Soviet-era mismanagement hampered

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crop production. More recently, the area assumed

an expanding role in meeting growing global grain

demand. With most U.S. crop acreage fully utilized,

the importance of the Black Sea and other “non-

traditional” producing regions will increase as the world

seeks to meet growing food demand, Seamon said.

There is “absolutely fabulous” farmland in the Black

Sea region “on par” with high quality soils in the U.S.

Midwest, Seamon said. “There’s incredible potential

for producing not only wheat, but other crops as well,”

such as corn and oilseeds.

The Black Sea region has potential to be the “swing

producer” for world wheat supplies, akin to Saudi

Arabia in crude oil, Seamon said. “When the world

needs an extra barrel of oil, Saudi Arabia can produce

it,” he said.

In wheat, the swing producer role was historically

played by American farmers. “That extra ton of wheat

was produced out of the U.S.,” Seamon said. “But we

believe that has shifted and the marginal tons of wheat

in the world are in the Black Sea region.”

CBoT SoFT rEd WiNTEr CoNTrACT doMiNATES

FuTurES TrAdE

During the marketing year that ended in June 2010,

Russia and Ukraine combined to export about 27.3

million metric tons of wheat valued at nearly $6.3

billion, accounting for 22 percent of global exports

totaling $29.1 billion, according to Global Trade

Information Services, Inc., a South Carolina-based

market data firm (the two countries’ share shrank to

6 percent the following year, largely because the 2010

drought slashed Russia’s crop).

At least 10 wheat futures contracts currently trade

worldwide, including versions listed on a Ukraine

exchange, on Moscow-based MICEX-RTS, NYSE

Euronext, and Intercontinental Exchange, Inc.

But CME Group dominates the trade with its CBOT soft

red winter wheat contract, which is based on a U.S.

crop but often used by hedgers as a proxy for grain in

other parts of the world.

In 2011, an average of 114,935 soft red winter wheat

futures and options contracts, or more than 15.6

million metric tons, traded each day on CME Group.

That amounted to more than 70 percent of global

wheat futures and options trading. Wheat futures have

traded in Chicago since 1877.

The new CME Group contract will also offer spreading

opportunities against U.S. and Europe-based wheat

futures, analysts say. Priced in U.S. dollars, Black Sea

futures represent 136 metric tons, or 5,000 bushels,

per contract, the same as CME Group’s soft red winter

wheat contract.

CorrupTioN, MANipulATioN CoNCErNS prESENT

oBSTAClES

Still, CME Group faces plenty of obstacles to

establishing a viable market in an area still relatively

new to free-market mechanisms such as futures

contracts, several analysts said. Corruption and market

manipulation are concerns, some say, and Ukraine has

a long track record of government intervention in the

grain industry, according to a recent Bloomberg News

report.

Dmitri Rylko, general director with the Institute for

Agricultural Market Studies, a Moscow consultant, said

there are “several important justifications” for a Black

Sea wheat futures contract, yet also factors that make

its launch “quite risky and vulnerable.”

One potential problem is that delivery conditions, in

Rylko’s view, are “too strict and inflexible.” While the

contract’s delivery specifications may work perfectly in

other parts of the world, Black Sea market psychology

“is tuned to possibility of physical delivery, whether it

happens or not,” he said.

Another problem is Black Sea wheat is highly

dependent on one rather dominant player, Russia,

Rylko said. “Unlike many other markets, the

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international community’s knowledge about Russia

and Russian wheat market situation is very limited,”

he said. Concern over manipulation, Rylko said, “may

partly undermine the contract credibility, at least at

initial stages of its existence.”

Pat Arbor, a veteran Chicago grain trader,

acknowledged the concerns with the Black Sea

market, but said the time may be right for the new

CME Group contract. While pricing in the region can

be “spotty,” there’s potential for an active arbitrage

market between Black Sea and CME Group futures,

according to Arbor, a former Chicago Board of Trade

president.

Launching the contract “makes a lot of sense,” Arbor

said. Capitalism and democracy “are both ugly, not

perfect, but they’re the best we have,” he said, referring

to free-market growing pains in the Black Sea region.

“The natural laws of supply and demand will eventually

prevail.

Bruce Blythe has been a Chicago-based business journalist since 1992 and has covered agriculture, futures exchanges and other industries for Bloomberg, Reuters, Dow Jones Newswires and Crain’s Chicago Business.

You can contact Bruce Blythe at

Twitter@bruceBlythe, on LinkedIn, and at

bruceblythe7@gmail.com

*disclaimer: This information was obtained from sources believed to be reliable, but we do not guarantee its accuracy. Neither the information nor any opinion expressed therein constitutes a

solicitation of the purchase or sale of any futures or options contracts.