Kraft wheat case poses test for commercial traders

Kraft Foods' old mill in Toledo, Ohio, grinds wheat into flour for Oreo cookies, Ritz crackers and other mainstays of the American cupboard.

In late 2011 company executives tried new grist for its mill: amassing an enormous position in wheat futures, a US regulator says.

The strategy netted Kraft $5.4m but also drew the attention of the Commodity Futures Trading Commission, which last week filed a civil complaint alleging Kraft rigged wheat markets. The case will test how aggressively commercial companies can trade on commodity exchanges where they claim to be hedgers trying to shed risk and enjoy special exemptions from position limits.

Groups representing commercials such as Cargill, the agricultural trading house, BP, the oil group, and Mondelez, the company that inherited Kraft's snacks business, have been fighting to maintain the freedom to trade as the CFTC separately considers a controversial new rule capping speculation in 28 commodities including wheat.

An industry adviser says the case could have "knock-on effects" for policy, including the scope of exemptions from position limits.

Scott Irwin, an agricultural economist at the University of Illinois, says the timing of the case may be coincidental, but it raises eyebrows because the pending position limits rule was justified to prevent "types of delivery manipulations like Kraft is being accused of".

Commercial companies have often been targeted in CFTC price manipulation cases, from BP in propane to Sumitomo in copper. This is because it usually requires a big position in physical commodities to be able to exert power over futures, contracts to buy or sell something at a set price by a certain date.

Indeed, Kraft was once embroiled in complaints that it pushed down cheddar prices on the now-defunct National Cheese Exchange - an affair dubbed Velveeta-gate.

Kraft is a large commercial user of wheat, consuming about 30m bushels (800,000 tonnes) per year, the CFTC complaint says. It historically obtained most supplies from farmers and merchants surrounding Toledo, not through the futures market.

In the autumn of 2011, Kraft was concerned about the high price of cash wheat around Toledo, the CFTC says. So executives devised the new strategy: "Kraft deviated from its practice of using the futures markets solely to hedge its cash wheat purchases. Kraft wheat procurement staff developed, and Kraft senior management approved, a strategy to use its status as a commercial hedger to acquire a huge long position in December 2011 wheat futures," the CFTC complaint says.

Mondelez says: "We don't have any comment other than we intend to vigorously litigate this matter." Kraft Foods Group, spun off from its parent in 2012, declines comment on the litigation.

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Market watchers have been puzzling over the reasons for Kraft's alleged trades. Wheat prices did not make waves at the time. "There wasn't anything excessive that I can remember," says Neil Rupp, president of Pettisville Grain in Ohio.

One piece of context is that the US wheat market was in steep "contango" in autumn 2011, meaning contracts for future delivery cost more than nearby contracts. This created an incentive for farmers and merchants to store grain - and potentially keep it out of the hands of customers such as Kraft.

< > By narrowing the December 2011-March 2012 futures spread, Kraft could have spurred the release of some wheat stocks into the market and helped push down cash prices, an industry adviser says.

Rates for wheat storage were also running at an abnormally high 20 cents per bushel per month in late 2011. A strategy that pushed up the December 2011 wheat price relative to March would enable a big customer to offset this cost by making it less expensive to replace the expiring contract with the next one, Prof Irwin says.

However, an executive at a US grain merchant says the steep contango - known as "carry" in agricultural circles - would have helped Kraft, as it could buy wheat relatively cheaply and sell products priced against wheat set at higher prices in the future. In fact, Kraft's mill was 80 per cent full as of November 2011, the CFTC complaint says.

"Why any cracker manufacturer would want to collapse that carry is beyond me," the executive says.

As it began the strategy Kraft had failed to renew its exemption from current limits on wheat positions, the CFTC complaint says. At the peak its December futures holdings rose to 5.25 times the permissible limit.

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