What's Going on With Wheat Futures?

One of the primary ways farmers have to manage price risk is via the futures market.

Before getting to a potential problem that has emerged, I'll first provide a short primer for those unfamiliar with futures markets 

An Oklahoma or Kansas wheat farmer is likely to begin planting sometime in September or October, but when planting they don't yet know what the wheat price will be at harvest in June or July the next year.  So, to protect themselves against adverse price fluctuations, a farmer might turn to the Kansas City Hard Red Winter Wheat Futures Contract.  The CME Group has a futures contract that settles every year around harvest in July.  Right now, the July 2017 contract is priced at about $4.50/bushel.  

For simplicity sake, let's say a farmer faced the same July 2017 futures price back in September of 2016, and they wanted to protect the price associated with (i.e., hedge) 5,000 bushels of wheat (which is exactly the size of one futures contract).  In September 2016, the farmer would sell one July 2017 contract, receiving  5000*4.50=$22,500.  This action has now contractually obligated the farmer to deliver 5,000 bushels of wheat come July to "offset" their selling position [addendum: while other futures contracts work in this way, this isn't true for winter wheat; rather than delivering wheat, the farm has contracted to deliver a "registered electronic warehouse receipt"].  Normally, however, a farmer doesn't want to go through the hassle of actually having to deliver physical wheat to a delivery point, so they instead buy back (in this example) one futures contract to offset their position when June or July rolls around.  If the price of the July 2017 contract falls from September to July, the farmer makes money from the futures market (e.g., if the price falls to $4.00, the farmer has has to spend 5000*4=$20,000 to offset their original position of $22,500, making $2,500), which helps them offset the loss in expected wheat price they receive when they sell their wheat in the cash market.  Exactly the opposite happens if the price of the July 2017 contract increases - the farmer looses money from the futures market, but receives a higher than expected cash price.  This is why it is said that using the futures market "locks in" the price at the time of planting.  

Although most farmers never actually delivery their wheat to settle their futures contract, this threat of delivery is what ties the futures price to reality.  If, for example, a farmer notices that come July 2017, the July 2017 futures contract is trading at a price well above the cash price being paid for wheat "on the ground" in grain elevators, they have a strong incentive to offset their futures position by actual delivery rather than buying a futures contract.  These arbitrage opportunities are what should force the futures market price to eventually equal the cash market price when July 2017 rolls around.   

All of that is a lead in to this video put out by Art Barnaby at Kansas State University.  It seems that farmers, at least in some situations, are not actually able to deliver wheat to offset their futures positions.  Aside from fundamental concerns about what is being measured by futures market in this case, one farmer in the video says:

A lot of us were relying on that and felt very betrayed by the fact that what we understood to be a contract was not.

[Addendum Barnaby sent me a note of clarification.  The underlying issue here is that farmers have been generally taught and told that they can settle wheat contracts by the delivering physical commodity, when in fact the underlying contract says something different. He indicated: "Farmers are not obligated to deliver 5,000 bushels of wheat; they are obligated to deliver a registered electronic warehouse receipt issued by warehousemen against stocks in warehouses.  This is the reason farmers can’t deliver wheat on a short futures.  You will find this in the contract  . . .The market is trading the value of a CME approved warehouse receipt because that is the only thing that can be delivered."]