Chicago, Spring Valley and Peoria, Illinois
Midwest Tour Blog, day 1.
Written by Jessica Awery, Josh Caley, Travis Jansen, and Tina Simonton
Today, we officially started the 2018 Midwest Farm Tour! The day started with a fantastic breakfast at the CBT thanks to Adrian, the manager at the Cellar Market. After breakfast, our tour began by heading up to the observation level, which overlooked the trading pit. After an hour of comments and questions from both the students and our hosts, we returned downstairs and jumped on the bus to head to our next destination. The second part of the day was spent at a Cargill grain transport facility on the Illinois River. This facility moves grain by barge, moving the equivalent of 58 semi-loads on a single barge and moving 15 barges at a time. The facility and its employees gave us welcomed insight into the practical side of communities, as well as a hotdog snake before our departure.
Part 1, Chicago Board of Trade / Chicago Mercantile Exchange
About the Chicago Board of Trade
Founded in 1848, the Chicago Board of Trade (CBT) is one of the oldest exchanges in the world. Here, futures and options contracts are traded in two ways. The more common method is to trade contracts through an electronic trading program called Globex. Although currently less common, trades were historically made in a trading pit through an open outcry system. In 2007, the merger between the CBT and the Chicago Mercantile Exchange (CME) created the current trade conglomerate that our group visited. The aged architecture, fountains and view were prominent and created an air of authenticity and authority as soon as we arrived.
The tour was led by Mr. Matt King, the Vice President of Service Trade for Archer Daniels Midland (ADM). Here, Mr. King provided us with a crash course on the history of the CME and described the process of trading and how it has changed over the years. The group was then joined by Mr. Steve Freed, the Vice President of Research for ADM. Mr. Freed talked less about how the exchange functioned and more about the different things that impact market prices.
Figure 1, Group photo outside the Chicago Board of Trade after our tour concluded. Chicago IL, August 27, 2018.
Evolution of Trading at the Chicago Board of Trade
One of the themes that emerged in our discussion was the impact of technology on how trades are made. Mr. King used his experience at the CBT to demonstrate how technology has changed the way that the CBT works. He began by explaining how when he started his career, he worked as a runner on the trading floor. This involved relaying messages between people on behalf of the company that he worked for. Despite studying agricultural economics, Mr. King highlighted the fact that the people who work on the trading floor come from many different backgrounds. To be effective on the trading floor, he explained that experience was far more important than education. When the trading floor is open there is little room for error and you need to be able operate in a system that is high paced and uses complex communication.
Although the trading floor and the traditional “open outcry” system was common in the past, over the past ten years trades are increasingly being done with computers. The electronic trading system is called Globex and has almost completely replaced open outcry trading. This shift was visible on the pit floor where very few traders were present. Mr. King estimated that about 75% of traders present were speculators, who used their own money to buy and sell contracts, while the remaining 25% were representing clients. As students, It was surprising to hear that so many traders were speculators given that we were always taught about how difficult it was to do this successfully. However, the electronic trading system is exciting given that it makes trading far more accessible for producers.
World Trade - What Impacts Market Prices
The discussion with Mr. Freed covered a wide variety of topics and described the way that they impact the market. These topics included weather and crop reports, the trade war with China, US demand and growing competition from other countries. We quickly learned the role of information in establishing prices and that there are a lot of variables that impact what happens at the CME. Students were able to ask in depth questions relating to markets, the ongoing trade disputes, and what that means for the future of American farms. Mr. Freed noted how the market is a dynamic system that is able to shift around trade barriers and the very real risk of lost commodity contracts to the US, something many people expected.. He predicted a future where few farmers run more land but with fewer total US acres in operation. With strong supply growth from Brazil, Argentina and Russia, he believed that in the future, the US may not play as large a role in supplying global wheat and soybean markets which was surprising to hear from a trader. As students and farmers, the prospect of North America losing some of its key customers was solemn reminder to all of us that nothing lasts forever and in business nothing is guaranteed.
Challenges with Technology in Trading
With the vast majority of trading now occurring online, security is a primary concern. One of the examples that they provided was that for larger contracts, the electronic trading system would continue to inflate prices until the contracts were filled. On the trading floor, when a broker would look to fill these contracts, they would be able to spread them across different purchasers without anyone knowing the actual position of the seller. These were not malicious errors with the electronic system, rather the system was simply filling the contracts the way it was programmed to do. Such problems have been addressed in recent years but the risk of such upsets, perhaps caused by malicious intent, continues to exist. This is a growing concern for many people.
Risk Management Tools Through the Chicago Board
With a mixed group of students, many were not familiar with exchanges and earned a crash course in how commodities are priced and markets operated. The exchange deals with futures and options contracts but 98.5% of them are never actually delivered. The futures price is established by global supply and demand. Options are contracts that require an upfront payment by purchasers but the purchaser is not obligated to fill the contract, unlike a futures contract. These concepts were confusing at first and tough to conceptualize. However, at our next stop at Cargill, learning about how businesses used these risk management tools made it easier to see how they worked.
Part 2, Cargill Spring Valley South grain transport
Cargill is a privately owned, global company that began as a small elevator in northern US in 1865. Today, the company is segmented into industrial, agricultural, food, and financial divisions and employs over 140,000 people across 65 countries.The particular facility that we visited was a grain terminal on the Illinois River.
How The Grain Terminal Worked
This grain terminal was operated by five full time employees, has 1.3 million bushels of storage space and runs about 15 million bushels of grain through its facilities each year. Here Cargill purchases grain from local farmers and elevators, process the grain and load it onto barges to be shipped down into the Gulf of Mexico. Once the grain reaches the Gulf, it is unloaded at another Cargill facility and reloaded onto larger ships to be taken overseas.
Figure 2. The barge loading dock at Cargill on the Illinois River. The belt system takes grain from storage bins and loads it onto barges. A single loaded barge has the capacity of 58 semi trucks.
Barges Compared to Rail or Semi Transportation
Unlike the semi trucks and rail systems that are common in Canada, the barges used by this facility are far larger and more efficient. To provide some context, one barge has the equivalent carrying capacity of 58 semi trucks. Oftentimes, barges are moved by a boat in groups of 15 which is a total of 870 semi loads per shipment! However, barges can be slower than rail or semis. Coming from Northern Illinois, it takes approximately two weeks for the barges to reach New Orleans. This trip can be extended by different bottlenecks in the system. The example provided was at the different locks along the way. Barges can only be moved through the locks in groups of two so if several boats show up with 15 barges it can take several days for a shipment to get through. Despite these limitations, the sheer volume of grain being moved appears to outweigh the extended shipping times.
Figure 3. A view of the working section of the Illinois River near the Cargill facility. A loaded barge is docked by the grain system while a bridge work barge is seen on the right. In the background a harbour tug boat is visible.
Invasive Species in the Illinois River
After the groups had attended the presentations at Cargill, we were treated to an early dinner of hot dogs and chips. While we ate, one of the harbour boats showed us the significant infestation of Asian carp in the Illinois River. By disturbing the water with the boat’s motor, the fish were stimulated to jump several feet in the air, with many of them hitting or landing on the parked barge. One staff member said that while they were loading grain, the fish would come up to the surface and be so dense that it looked like you would be able to walk across them along the river. Although the Asian carp do not directly impact Cargill’s operations, all water vessels do play a role in helping to keep these carp out of other waters. Taking care that fish are not transported further up river and beyond barriers is key to current attempts to stop their spread.
Basis Trading at Cargill
The originator specialist at Cargill explained to us that Cargill is a basis trading company. Basis trading is a strategy used by elevators to profit from the difference between future prices at the CME and the local price at the elevator. While CME prices reflect global supply and demand, the basis is more of a reflection of the local market environment. Shane described how Cargill makes use of their storage to turn a profit on grain by selling when prices move higher than what the grain was purchased for. Basis pricing and how it changes seasonally throughout the year, typically for corn and soybeans the basis is highest in late August, when last year’s inventory is running low as the upcoming harvest approaches. Cargill also takes part in the CME futures market as part of their company structure.
Weather Limiting Barge Capacity
Another limiting factor for Cargill is that a barge must be filled relative to the depth of the river. Currently, water levels are low and this reduces the volume of grain that can be loaded onto each barge. While low water levels are an issue, high water levels presents a much greater risk. A dike system protects the grain storage facilities but there is always the risk that significant rainfall may push the river high enough to pour over its edges. Although this has never happened, the staff at Cargill highlighted the significance of this risk. High water levels also mean that occasionally, barges can’t be loaded because they sit too high, the spout cannot reach them.
Figure 4. This Cargill facility moves 65 million bushels of grain every year, they have the capacity in this bins to hold 1.3 million bushels at a time. This is very useful when grain sales slow, as they currently have, but can cause difficulties in bad weather. Here we were shown not only the storage capability but the dike and pump system that protects it. These systems have not failed to date but as record floods become more common the potential loses and costs of improvements mount.