Stochastic Storage Cost Model for Grains Futures

The world is experiencing the biggest supply shock to global grains markets in recent history. Prices of various crops, including wheat, soy, and corn, have skyrocketed. Take wheat as an example, the futures prices have jumped to record high in March.

Along with the prices, there is also an increase in trading volume in the grains futures markets. Nevertheless, for years traders have observed significantly higher expiring futures prices for corn, wheat, and soybeans on the Chicago Board of Trade (CBOT) compared to the spot price of the physical grains, even though the standard no-arbitrage pricing theory asserts that spot and futures prices must converge at expiration.

As shown in Figure 1, the differential between futures and spot prices, called the basis, can be positive or negative, but are more likely to be positive over a multi-year period. The basis reached its apex in 2006, where at the height of the phenomenon, CBOT corn futures had surpassed spot corn prices by almost 30%!

There’s also a clear seasonality in the basis. The average bases for corn, soybeans, and wheat is highest during the harvest months (August-October) as storage rates are high due to grain silo capacity constraint. For instance, the average basis for soybeans exceeds 12% in September. From February to June, the basis tends to be smaller since the storage costs are lower due to empty grain silos before the next harvest begins.