Review of Agricultural Economics—Volume 25, Number 2—Pages 483–505
What Killed the Diammonium
Phosphate Futures Contract?
Using a survey of industry participants, and an analysis of price relationships, this paper
investigates the demise of the diammonium phosphate futures. The results indicate the
diammonium phosphate cash and futures markets were not well linked. The results also
suggest that the initial specification of diammonium phosphate futures contract may
have resulted in its use as a forward contract with a high rate of delivery, reducing market
participation and limiting liquidity. Ultimately, the contract failed because it was a poor
hedging tool, and was perceived by the industry not to offer benefit beyond existing
contracting and risk management practices.
I
n October 1991, the diammonium phosphate (DAP) futures contract began trading on the Chicago Board of Trade (CBOT). Prior to futures trading, DAP producers extensively utilized tender offers, price negotiations, and fil programs
to distribute their product. These transactions were largely consummated using
phones and faxes. This type of marketing system can be prone to noncompetitive
and inefficien market prices. Industry representatives believed futures trading
would provide liquidity to the industry and create a more efficien and timely
means of price discovery. However, after initial modest success, the futures contract traded thinly and was finall delisted in July 1997.
The success and efficienc of a futures market depend on the underlying cash
market’s characteristics. Successful futures contracts are associated with a homogeneous product, standardized contracts with commercial relevance, cash price
Keith Bollman is a former research assistant in the Department of Agricultural and
Consumer Economics at the University of Illinois, Urbana–Champaign.
Philip Garcia is a professor in the Department of Agricultural and Consumer Economics at the University of Illinois, Urbana–Champaign.
Sarahelen Thompson is a professor in the Department of Agricultural Economics at
Purdue University.
Senior authorship is not assigned.
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Keith Bollman, Philip Garcia, and Sarahelen Thompson
484
Review of Agricultural Economics
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variability and uncertainty, an active and large commercial market, and publicly available market information. A well-designed futures contract can promote
more effective hedging and more eff cient prices due to (1) a high correlation between cash and futures prices, (2) market liquidity and low transactions costs,
(3) a futures price that is representative of market conditions, and (4) freedom
from market manipulation. Thompson, Garcia, and Dallaf or show how inadequate contract specif cation, market concentration, and little need for a new
hedging instrument led to the demise of the high fructose corn syrup (HFCS)
contract.
In concrete terms, for futures contracts to succeed, commercial buyers and sellers of the commodity must have reason to prefer using futures contracts as temporary substitutes for merchandising contracts (Gray). To attract hedgers, the
contract, delivery terms, locations, and prices must all conform closely to commercial movement. For hedging to reduce price risk and warrant commercial use
of futures markets, the basis (the relationship between the cash price and the price
of the futures contract used for hedging) must be less variable than the cash price
(Leuthold, Junkus, Cordier).1 The basis must be predictable between the time a
hedge position is established and the time that is lifted, that is, basis risk must be
small, so that the futures price may serve as a temporary substitute for the cash
price. Hence, the futures market must ref ect the cash market. Cash and futures
prices are ultimately linked through the possibility of delivery of the underlying
commodity in the expiring futures contract. The greater the degree futures prices
ref ect cash market conditions, the greater the hedging effectiveness.
Successful futures contracts also must attract long speculation to promote a
balanced futures market—one where there is demand for both long and short
futures positions—since hedging f rms have a tendency to favor the short side
(Gray). Speculators of all types (day traders, scalpers, and longer-term position
traders) prefer trading in liquid (low transactions costs) markets where the futures price closely corresponds to transparent cash market conditions (Thompson,
Garcia, Dallaf or). In general, speculators prefer not to take or make delivery on
a futures position, particularly for bulk commodities. Futures contracts that commonly serve as forward contracts and have a high likelihood of delivery thus
discourage speculation.2
The paper investigates the performance of the DAP futures contract and offers reasons for its inability to attract industry participation as ref ected in low
trading volume and open interest. More specif cally, the focus of the study is to
identify the factors that limited participation in the contract by examining information that could provide evidence of the contract’s failings. First we examine
the characteristics of the U.S. DAP industry and data on trading in DAP futures.
Results of a survey of members of the DAP industry and a time series of cash
and futures prices for diammonium phosphate for four markets are assessed. The
price analysis evaluates the degree to which cash prices are linked before and after the introduction of futures trading, and hedging effectiveness in the fertilizer
industry during futures trading.
The f ndings of this study are valuable to the Chicago Board of Trade and other
futures exchanges in understanding the determinants of (un)successful futures
contracts. The f ndings are also broadly relevant to understanding the diff culties
in establishing any new pricing instrument, such as those that may be offered
What Killed the Diammonium Phosphate Futures Contract?
485
virtually through e-commerce technology, in an industry with established and
well-functioning pricing and risk management tools. Finally, the results should
provide market participants with a better understanding of the factors that inf uence the riskiness of using poorly functioning futures contracts and other pricing
instruments.
DAP Industry
Trading in the DAP Futures Contract
Trading in four contracts (March, June, September, and December) began in
October 1991. One DAP futures contract represented 100 short tons of contract
grade DAP for f.o.b. delivery via railcar in Central Florida. The contract was
shortly thereafter amended to include other methods of delivery and expanded
delivery locations. Delivery also could be taken f.o.b. vessel from Tampa or
New Orleans, and also f.o.b. barge from Tampa, New Orleans, and Mississippi.
Price differentials were established for the alternative delivery locations based
on transportation and handling cost differentials representative of cash market
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DAP is a global market. The United States produces the greatest share of the
world consumption. The U.S. DAP industry is highly concentrated with the top
f ve f rms controlling roughly three-fourths of production, most of which is centered in Central Florida. Since there is large foreign demand for DAP, the export
market has been described as the price leader. U.S. producers have been accused
of keeping prices high, receiving a greater margin in the export market, and not
being concerned about the U.S. demand. Three of the major U.S. producers are
allowed by the U.S. government to collude in the export market and have formed
an export cartel, Phoschem, to bargain more effectively with international monopsonistic buyers. Although price collusion is illegal in the United States, many U.S.
DAP buyers are concerned with the industry’s producer concentration and the
potential for domestic collusion.
Desiring to maintain continuous production at capacity levels, producers forward contract 60 to 90 days ahead of production to assure favorable processing
margins and to keep the production process f owing. With DAP production concentrated in Central Florida, the industry utilizes this market as the basis for product pricing. Much of the contracting and pricing in this market is done through
private negotiations. Product can be taken by barge, rail, or truck in the United
States and rates are often a function of volume and frequency of shipments.
Prior to futures trading, DAP industry members did not have an organized
market for protecting against price risk in the cash market, and relied on a variety
of methods to price their product. Some producers managed risk by establishing
regular cash forward contracts for short-term delivery and received an average
price for all their sales. Other producers published a list price, but the f nal sale
price was negotiable depending upon volume and delivery terms. Many buyers
and sellers relied on “f ll” programs where buyers were offered the opportunity
to buy certain amounts of DAP at a given price for a predetermined period.3
Distributors and dealers also often relied on perceived market trends to source
product for “good buys” relative to the market.
486
Review of Agricultural Economics
Figure 1. DAP open interest and trading volume
Figure 2. DAP trading volume and price
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price differentials.4 Delivery was made by shipping certif cates issued by shipping
facilities approved by the CBOT.5
The DAP futures market initially attracted many participants. As participation
increased, so did trading volume and open interest. Figure 1 presents the historical
progression of the average daily contract trading volume and open interest for all
contracts through June 1995. Figure 2 shows the same volume f gures compared
to the monthly Central Florida price. These f gures indicate that initially volume
and open interest increased, peaking in the f rst quarter of 1993. The average daily
What Killed the Diammonium Phosphate Futures Contract?
487
Figure 3. Trading volume in near and distant contracts by trading
month, Oct. 91–Mar. 95
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trading volume was 389 contracts in February 1993, or 389,000 short tons of DAP
(260 barges or 3,890 railcars). After the expiration of the March 1993 contract,
volume and open interest began to decrease. The contract maintained an average
daily trading volume of 100 contracts until April 1994, when daily trading volume
dropped to 50 contracts. Trading volume and open interest declined from that time
on until the contract was delisted in 1997. Total trading volume for 1996 was 3,935
contracts. Only 144 contracts were traded in 1997.
Figure 2 suggests an inverse relationship between trading volume and price.
Starting in January 1992, DAP prices steadily declined, reaching industry lows
during February 1993. At the same time, the levels of trading volume and open
interest increased sharply. The DAP futures contract was most actively traded
when the market price was depressed, and became less active as price increased.
Between 1995 and 1997, DAP prices remained fairly steady and high relative to
historical norms, ref ecting strong world prices for grain and the demand for their
inputs.
Total monthly trading volume is broken down between near and distant contracts by trading months in f gure 3. In general, the nearest contract had the greatest trading volume with two exceptions. First, nearby contracts were not heavily
traded in the delivery month. This suggests that, as in many agricultural futures
contracts, traders avoided contract liquidation and did not wait until the delivery
month to unwind their market positions. Second, the March contract was the most
heavily traded both when it was the near and next-near contract. The distribution
of open interest, not presented here, is similar to trading volume. Usually open
interest was greatest in the nearby contract. When the delivery month is excluded,
83% of the open interest was held in the nearby contract. As judged by trading
volume and open interest totals, the March contract was the most heavily traded.
The March contract corresponds to spring planting demand in the domestic
market.
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Review of Agricultural Economics
Commitments of DAP Traders and Concentration Ratios
Commitment of trader levels are reported monthly by the Commodity Futures
Trading Commission (CFTC). Reports include a breakdown of the month-end
open interest and composition of traders. The commitment of trader reports describe (1) reportable and nonreportable open interest, (2) long and short holdings
of both reportable commercial and noncommercials, (3) spreading open interest,
(4) total number of traders, and (5) concentration ratios representing the percent
of open interest held by the largest traders. These concentration ratios are separated into two categories. “Gross position” ratios are based on the combined share
of the open interest maintained by the four largest traders. “Net position” ratios
result from offsetting each trader’s long and short positions. For DAP, a reportable
trader must have had a minimum of 25 contracts.
Table 1 presents reportable positions from October 1991 through March 1995
for the DAP futures contract. The number of reportable traders continually increased and exceeded 20 traders from September 1992 to February 1994. Most of
these traders were commercials who used the DAP futures contract for hedging.
However, the reportable commercial category does not identify whether these
traders are producers, dealers, distributors, or wholesalers. The highest number
of reportable commercial traders in the market at one time was 22 during November 1992. The highest number of reportable traders at any one time was 26 during
March 1993, the month with the greatest open interest. After February 1994, the
number of traders and open interest declined to only 5 reportable traders in March
1995.
Since the advent of futures trading, commercial shorts have consistently maintained the greatest proportion of open interest and the most number of traders.
Not surprisingly, when trading in DAP futures was most active during the decline
in DAP prices in 1992, trading largely represented short hedging.
Beginning January 1994, noncommercial reportable traders began leaving the
market as all spreaders disappeared from the market. In June 1994, noncommercial reportable short traders disappeared from the market. Hence, the demise of
DAP futures contract trading started with speculators leaving the market. Since
speculators provided nearly 50% of the liquidity in 1993, their exit reduced market liquidity and probably caused many commercial reportable long and shorts to
leave the market. Consequently, open interest fell below 1,000 contracts and volume decreased to below 100 contracts. No noncommercial traders held reportable
positions in the March 1995 contract.
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Beginning in October 1993, there was no trading beyond the nearest three contracts. From April 1994, there was no trading beyond the nearest two contracts.
This pattern continued until serial trading months were added by the CBOT to
contract specif cations in August 1994. Trading volume and open interest were
much greater with the original quarterly contracts than with the addition of serial contract months (futures contracts for every month of the year). An industry
member stated that while the serial months added f exibility for traders, it reduced the trading volume in all contracts. This suggests serial contract months
dissipated trading volume, reduced liquidity, and exacerbated to some degree the
thinness of the market.
What Killed the Diammonium Phosphate Futures Contract?
489
Table 1. Reportable positions for DAP, October 1991–December 1992
Open Int/
Traders∗
Oct-91
Nov-91
Jan-92
Feb-92
Mar-92
Apr-92
May-92
Jun-92
Jul-92
Aug-92
Sep-92
Oct-92
Nov-92
Dec-92
Jan-93
Feb-93
Mar-93
Apr-93
May-93
Jun-93
Jul-93
Long
Short
0
0
2
1
65
2
284
6
180
4
123
3
134
5
99
3
40
1
40
1
79
2
233
8
25
1
25
1
111
4
82
3
358
3
44
3
182
3
165
3
0
0
26
2
93
3
25
1
175
1
370
3
64
2
173
4
69
2
94
2
70
2
113
3
195
4
48
2
37
1
44
1
418
3
333
3
329
4
374
6
164
2
154
6
382
5
431
5
Spreading
Long/Short
0
0
77
2
0
0
37
1
92
1
107
2
138
2
204
2
105
2
240
3
100
2
198
4
86
1
383
4
33
1
60
1
368
3
977
6
810
5
685
6
113
1
190
3
Commercial
Total
Long
Short
Long
Short
295
5
357
7
207
2
247
3
195
4
221
5
249
3
256
3
165
4
287
7
259
7
301
7
481
10
745
14
520
11
661
12
418
10
721
8
710
7
529
8
593
7
692
9
268
2
333
5
176
5
480
7
524
3
468
4
565
5
290
3
368
5
700
9
406
4
826
6
1,032
8
1,198
8
825
7
981
6
1,044
7
1,036
10
1,228
12
991
10
542
7
718
9
295
5
436
9
272
4
568
9
467
9
451
10
521
9
559
7
310
7
567
11
438
11
732
17
592
12
1,153
19
664
16
803
15
1,144
16
1,742
15
1,702
13
1,379
15
706
8
908
13
361
5
435
8
351
6
887
11
680
5
748
8
772
8
588
6
543
7
1,053
13
701
8
1,072
11
1,155
10
1,625
12
1,276
10
1,374
10
1,741
12
2,387
18
2,202
18
1,830
18
1,037
12
1,339
15
Continued
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Dec-91
681
9
714
13
687
10
1,170
18
859
11
903
15
1,034
14
889
11
767
12
1,259
19
1063
16
1,374
22
1,393
20
1,906
24
1,514
20
1,729
23
2,057
24
2,642
26
2,587
25
2,101
26
1,266
18
1,588
24
Noncommercial
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Review of Agricultural Economics
Table 1. Continued
Open Int/
Traders∗
Aug-93
Sep-93
Nov-93
Dec-93
Jan-94
Feb-94
Mar-94
Apr-94
May-94
Jun-94
Jul-94
Aug-94
Sep-94
Oct-94
Nov-94
Dec-94
Jan-95
Feb-95
Mar-95
∗ The
Long
Short
292
1
133
5
244
7
226
5
346
8
239
5
166
4
129
3
104
3
26
1
36
1
36
1
70
2
104
2
104
2
79
2
50
1
45
1
0
0
0
0
423
4
393
1
467
1
63
1
284
2
268
3
423
2
0
0
38
1
31
1
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
Spreading
Long/Short
115
2
73
1
41
1
126
3
38
1
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
Commercial
Total
Long
Short
Long
407
6
388
6
518
11
196
6
297
8
439
10
668
11
388
5
455
7
545
5
171
4
224
4
283
3
103
2
30
1
0
0
88
2
128
2
121
2
156
4
465
6
451
5
646
8
650
7
656
7
705
5
714
6
688
6
629
6
499
4
182
3
261
5
328
4
215
3
202
3
148
3
187
4
229
7
113
3
153
2
814
8
594
11
803
18
548
13
681
16
678
15
834
15
517
8
559
10
571
6
207
5
260
5
353
5
207
4
134
3
79
2
138
3
173
3
121
2
156
4
Short
1,003
11
917
7
1,154
10
839
10
978
10
973
8
1,137
8
688
6
667
7
530
5
182
3
261
6
328
4
215
3
202
3
148
3
187
4
229
7
113
3
153
2
f rst row represents the breakdown of open interest and the second delineates the number of
traders in the market.
Source: Commodity Futures Trading Commission, 1991–1995
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Oct-93
1,353
16
1,066
17
1,337
25
1,106
19
1,153
24
1,140
23
1,293
23
834
14
793
16
749
11
351
8
408
10
515
9
372
7
324
6
241
5
349
7
379
10
401
5
326
5
Noncommercial
What Killed the Diammonium Phosphate Futures Contract?
491
Table 2. Commitment of trader concentration ratios for DAP, corn,
oats, and soybean meal, March 1993
Commodity
Net Traders
Top 4 Traders
No. of
Traders
Total Open
Interest
Long
Short
Long
Short
26
310
8
21
2,642
1,286,880
42,105
63,825
43.3
15.6
21.1
25.1
51.2
15.4
56.4
28.2
20.2
15.5
17.3
24.6
32.2
15.4
47.2
26.5
Source: Commodity Futures Trading Commission, 1993
Open interest and concentration ratios for DAP from the commitment of trader
reports were compared with those from successful mature commodity futures
markets. The commodities used for comparison are corn, oats, and soybean meal.
The corn futures market represents a successful agricultural futures contract with
a high volume of trading. The oats futures was chosen because the market represents a successful but thinly traded futures contract. Soybean meal was chosen
due to the contract’s use of shipping certif cates as the delivery mechanism similar
to the DAP futures contract. Table 2 shows comparisons of open interest and concentration ratios for DAP, corn, oats, and soybean meal for March 1993, a period
of relatively high trading volume and open interest for DAP.
The level of open interest for DAP was signif cantly lower than even the sparsely
traded oats contract. Open interest per trader for DAP was much lower than
in corn, oats, or soybean meal, suggesting that both commercial and speculative traders did not f nd the contract suff ciently liquid to take larger positions.
The concentration ratios indicate that large traders held a greater percentage of
open interest in DAP futures than in corn or soybean meal, but a comparable
amount to that in the oats contract, which is a successful, or at least viable, futures
contract.
DAP Industry Interviews
Due to a lack of public information, a telephone survey of industry participants
was developed and conducted to gather information about DAP pricing and
marketing. The survey also contained questions regarding industry use and attitudes toward the DAP futures contract. A telephone survey was chosen because
the questions were intended for individuals responsible for buying and selling
DAP—those who might potentially use the DAP futures market. The surveyor
and respondents were also able to have open-ended communication leading to
greater insight into the industry.
The survey used in this study was developed in response to concerns raised by
the CBOT and was based on an earlier survey developed by Thompson, Garcia,
and Dallaf or to study the high fructose corn syrup industry.6 The survey was
administered to industry members throughout the DAP marketing channel to
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DAP (CBOT)
Corn (CBOT)
Oats (CBOT)
Soybean Meal (CBOT)
Gross Position
Top 4 Traders
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Review of Agricultural Economics
Limitations to Trading DAP Futures
The respondents identif ed various limitations which kept industry members
from trading the DAP futures contract. Some were unique to individual f rms
while others were cited in numerous interviews. The market’s low volume, liquidity, and participation were the top three factors limiting the use of the DAP
futures contract. Respondents from all segments of the industry feared and were
unwilling to take positions in the futures market due to the contract’s low volume
and lack of liquidity. This was particularly true in more distant horizon, less liquid
contracts. Several respondents indicated that if they hedged, they would do so
f ve contracts at a time to prevent a large price effect from their trades. To hedge
a small purchase or sale, it often took a week to get the cash market position fully
hedged on the CBOT. This was viewed as being very ineff cient and discouraged
the use of the contract. Due to the thinness of the futures market, a small share of
the cash market trading was ref ected in futures trading.
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obtain a balanced range of viewpoints concerning the industry and the DAP
futures contract. The CBOT identif ed some specif c f rms to interview. Others
were obtained from the World Directory of Fertilizer Manufacturers (Cunningham).
The f rms chosen for interviews comprised all major participants in the U.S. DAP
industry; therefore, conf dentiality was a concern in reporting survey results.
Thirty-six interviews of industry participants were completed in June 1995.
Although all 36 interviewees were willing to participate in the survey, 3 had
never used the DAP contract. However, they were familiar with the contract
and expressed opinions regarding both the contract and industry. Twelve respondents were fertilizer producers, 8 each were retailers or dealers, traders, and
distributors.
The telephone survey asked the interviewees how they became familiar with
the DAP futures contract. A few of the companies had prior knowledge of
futures markets from dealing with other commodities. The majority learned about
the DAP futures contract through CBOT marketing efforts. Industry publications
and newsletters were the other main sources of information. In addition, Merrill
Lynch and Cargill were cited as assisting many industry members through seminars. Eight survey respondents provided support or assistance to the CBOT in
developing and promoting the contract.
The motivation for and use of DAP contracts varied across the industry. Most of
the industry representatives who traded DAP futures contract did so to hedge inventories. Some respondents (four producers, two distributors, and seven traders)
traded the contract for pure speculation. Several industry members who did not
trade at the time of the interview indicated they would like to use the DAP futures contract to hedge because the contract would be benef cial to their business.
About one-third of the respondents, primarily producers and dealers, did not use
the DAP futures contract. The futures contract also was used by some respondents
as a source of price information for making pricing decisions.
In general, the industry members interviewed favored the contract. Even if they
did not trade the contract, or did not have much faith in the contract’s survival,
they would have liked the contract to succeed and become useful to hedge price
risks.
What Killed the Diammonium Phosphate Futures Contract?
493
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Over one-third of the respondents thought the reason for low participation
was lack of understanding of the mechanics and benef ts of futures trading. One
interview revealed that companies did not place contract orders correctly. As a
result, they received margin calls and lost money. Other interviewees stated that
management would not allow them to use the contract for fear of the losses that
might occur. These companies did not want to hire professional traders or spend
the resources to monitor the futures market. Several respondents indicated that
further education of producers and others in the industry would be necessary to
increase DAP futures trading.
Other industry members believed the problem was deeper than a lack of knowledge and understanding of futures markets. Many interviewees stated that there
were often three separate markets at work—the domestic, export, and futures.
Due to the complexity of the DAP market, the transfer of information between
markets was believed to be poor and the three markets often reacted differently
to the same information. The limited degree of price correspondence across these
markets made it diff cult to consider switching marketing alternatives in light of
changing information. Six participants also cited a lack of convergence of cash
and futures prices during delivery and uncertainty regarding which market (domestic or export) the futures price would ref ect and converge toward. In a related
context, the DAP markets also suffered from a lack of accurate market information. Industry publications such as Green Markets (Pike and Fischer, Inc.) were
suggested by some to be information controlled by large industry members, and
not ref ective of industry transaction prices. Similarly, the industry was characterized by some respondents as a “closed club,” where producers did not really want
public price discovery mechanisms accurately ref ecting market information.
Satisfaction with present marketing alternatives was likely another factor inf uencing the low level of market participation. Most producers limited the amount
of price risk through their practice of continuous production and cash forward
contracting.7 They viewed themselves as in a never-ending position where they
were long the cash product and where price was usually set and risk offset by
a cash transaction. They might buy futures to offset a short cash position if they
oversold production, or had unforeseen production problems and were short
product. They also might take advantage of market opportunities via pure speculation, or buy futures when they trade at a discount to the cash market and sell
cash outright to arbitrage the price discrepancy. Otherwise, their use of futures
was limited. In a similar vein, over half the dealers and several producers responded that they were better off with price protection plans and f ll programs
offered by producer cooperatives. Some respondents stated the CBOT did not
fully understand the ability of buyers to hedge price risks through their supplier.
Because such programs offer downward price protection, they saw no reason to
use the DAP futures contract. Just two dealers indicated that they used the futures
contract to hedge, but reported diff culty in getting suff cient contracts to cover a
full hedge.
Other companies did not use the futures for idiosyncratic reasons. For example, one company believed it did not need to hedge with futures because it was
prof table. Another f rm believed it was successful in using its balance sheet as
a hedge, making use of the DAP futures contract unnecessary. Still another f rm
did not trade DAP futures because management believed it might have to make
494
Review of Agricultural Economics
Figure 4. Contract deliveries, total monthly trading volume, and
open interest on the first day of the delivery month in the expiring
future, Dec. 1991–Mar. 1995
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delivery which would disrupt inventory management. Some felt they could forecast price and did not need futures. Overall, these responses indicate that the DAP
futures contract competed against the preexisting business practices of tender offers, phone calls, and negotiations. Most industry participants were, in fact, very
comfortable with and reluctant to modify these practices.
Finally, respondents suggested that the CBOT may have been at fault in the
design and marketing of the contract. Some felt that urea would have been a better
candidate for a contract than DAP since urea has a larger world market. More
than half the respondents identif ed problems with the delivery mechanism and
suggested changes in contract delivery specif cations. As shown in f gure 4, the
number of DAP contracts delivered was high relative to total trading volume and
open interest in the expiring future in the delivery month. On average between
December 1991 and March 1995, the number of contracts delivered averaged
more than three times open interest in the expiring future at the beginning of the
month, with the highest deliveries occurring in the March and September 1993
contracts. Deliveries were greatest relative to open interest during the f rst 2 years
of trading in the contract until the exodus of speculators from the market in early
1994. Survey respondents stated that the CBOT erroneously considered the DAP
futures contract to be similar to grain futures contracts, and was not prepared
for such a high rate of delivery. Several respondents indicated that the high rate
of delivery ref ected misuse of the DAP futures contract. Others stressed that
the high delivery rate inconvenienced producers’ inventory management and
discouraged trading. Industry sources stated that much of the DAP taken for
delivery entered the export market. Industry members agreed that increasing the
storage premium, thereby reducing incentives to take delivery, and altering the
contract to trade in serial months were attempts to improve the contract, but these
changes in contract specif cation did not stem the trend to lower liquidity.
Two other issues related to contract design and marketing were identif ed. Respondents were not in agreement whether a Midwest delivery point would have
made the contract more useful. Some argued that since the domestic product
What Killed the Diammonium Phosphate Futures Contract?
495
Price Analysis
Procedures
The primary purpose of the price analysis is to determine the degree to which
cash markets and futures were related during the period when the contract was
most actively traded. Numerous procedures with varying degrees of sophistication can be used to perform this task. Here, we select several straightforward
procedures to develop an understanding of the degree to which prices were linked
through the marketing system, and hence the degree to which market participants
could hedge their price risk. The selection of our procedures was inf uenced, in
part, by the concern over the quality of the price data, which may not completely
ref ect transaction prices. The selection also was affected by the notion that we
wanted to use procedures that decision makers in the industry might have used
or would have been readily understood as being ref ective of market linkages,
and consequently might have inf uenced their behavior. As a result, our analysis
is based on methods that were rather commonplace at the time that the contract
most actively traded.
First, to assess the degree to which cash markets respond to the same information in the short run, the change in cash prices at one location are regressed on
the change in cash price at another location (Thompson, Eales, and Hauser). The
regression model is represented as
(1)
C yt = a + bC xt + e t ,
where Cyt and Cxt are cash prices at locations y and x at time t, and et is the
error term. A standard hypothesis test for a one-to-one relationship between cash
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is consumed in the Midwest, delivery locations should at least include Midwest
warehouses.8 Allowing delivery at inland terminals would further increase delivery options and bring the contract to the dealer level. Another concern cited by the
respondents was the CBOT’s impression that producers would be the major users
of the DAP futures contract. They argued that the CBOT should have redirected
marketing of the contract to dealers because they would buy and store DAP on a
consistent basis. Most industry members agreed that the contract was originally
marketed well, but a few believed the CBOT lacked continued enthusiasm and
support and should have followed up more once trading began.
Taken together, the survey results do not provide a single clear indication of why
the contract failed. Instead, the lack of consensus regarding the limitations of the
contract and suggestions for improvement reported by the survey respondents
may be the most telling result of the survey. Participants in the DAP market did
not appear to have a consensus set of objectives and expectations for the contract
in terms of whom and what marketing function the contract would best serve, and
what underlying cash market it should best ref ect. Several of the issues raised
in the survey will be empirically examined below in broad terms to assess their
importance. For example, how related were the cash and futures markets? Did the
export market have the closest relationship with the futures market? What was
the level of hedging effectiveness and was there convergence of cash and futures
prices towards contract expiration?
496
Review of Agricultural Economics
(2)
(Ft − C yt ) = a + b((Ft − C xt )) + e t ,
where Cyt and Cxt are cash prices at locations y and x at time t, Ft is the futures
price at time t, and et is the error term. This regression imposes a restriction on the
change in Cyt such that the cash price change at one location (Cyt ) is a weighted
sum of both the futures price change (Fyt ) and cash price change at another
location (Cxt ). Thus, equation (2) can be rewritten as
(3)
C yt = −a + (1 − b)Ft + bC xt + e t ,
where the coeff cients on Ft and Cxt sum to one. The null hypothesis that cash
price changes at one location correspond directly to cash price changes at another
location rather than to futures price changes can be examined by the test b = 1.
Small slope coeff cients from a regression of basis changes from one location on
those at another location imply that cash price changes are more related to futures
price changes rather than with other cash market price changes. Seasonal effects
are considered in the regression analysis by incorporating intercept and slope
shifters to determine whether the basis strengthened or weakened seasonally,
and whether the slope coeff cients vary seasonally with changes in fertilizer f ows
and transportation costs. A delivery month dummy variable indicates whether
markets become more linked during the delivery month due to convergence of
cash and futures prices.
The linkage between futures and cash market prices is a primary concern in
hedging effectiveness. The futures price should ref ect the value of the commodity
cheapest to deliver on the futures contract. The relationship between cash and
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price changes is H0 : b = 1, which assumes that price differences larger than transportation costs are arbitraged within the week. Analysis of the spatial price relationships during the time periods before and during futures trading may also
indicate the effects of introduction of the DAP futures contract on cash market
relationships.9
An analysis of the basis (cash price minus the nearby futures price) relationships
between cash market locations further examines the coordination of the markets
during the futures trading time period. Relationships between cash markets may
be mostly a function of their relationship to the futures market. Futures trading
may effectively increase the linkages among the cash markets. One method to
measure the relationship between and among the cash and futures markets is
to regress one basis change on another. This method identif es the proportion
of the cash market price change at one market that is explained by the price
change at another market, and not by the change in the futures price. If futures
trading exhibits no effect on the cash markets’ linkages, then the cash market
relationships will be the same as in the previous regressions (1) of the change
in cash price at one location on the change in cash price at another location. In
effect, regressing two bases on one another effectively removes the futures market
price variability from the cash prices. This allows the price variability at one cash
market to be explained by the variability in another cash market. This model was
chosen following Thompson, Eales, and Hauser, who examined similar issues in
the corn and soybean markets. The regression model may be written as
What Killed the Diammonium Phosphate Futures Contract?
497
futures prices ref ects the extent to which futures prices are substitutes for cash
prices. The bivariate regression is represented as follows:
(4)
C yt = a + bFt + e t ,
Data
Green Markets, an industry service that publishes weekly cash prices, supplied
cash prices for Central Florida, Midwest, New Orleans, and Tampa-Gulf. All locations except the Midwest correspond to delivery points on the DAP futures contract. Prices at export locations (Tampa-Gulf) are f.o.b. prices, and do not represent
export sales. The Green Markets price is an average based on a survey conducted
on Wednesday and Thursday throughout the industry and published the following Monday for 51 weeks of the year. These series were adjusted to include a
52nd week by simply averaging the two prices adjacent to the missing data point.
The cash price series published on the Monday really ref ects the previous week’s
cash market survey prices. Therefore, the cash price series was adjusted backwards by one week to correspond correctly to the appropriate futures contract
prices.
An average of the closing futures prices on Wednesday and Thursday was used
to correspond to the average cash prices reported in Green Markets. This procedure
allows for testing information transfers without subjecting the data to prior bias.
Therefore, the Wednesday and Thursday closing futures prices were averaged to
produce one futures price per week. The futures price series ref ects the nearby
futures contracts.11 To avoid an abrupt price change when switching from the
expiring futures contract to the next nearby contract, the switch was made one
week prior to contract expiration.
The effects of switching (roll over) between the expiring futures contract and the
next nearby contract were examined. A dummy variable was utilized to measure
this contract switch in the change-in-cash on change-in-futures regressions. Test
statistics were insignif cant, thereby supporting the existing switch methods. The
effect of keeping delivery month data in the futures price series was also tested
with a delivery month dummy variable in change-in-cash on change-in-futures
regressions. The test provided no evidence that there is a signif cant effect to
keeping delivery month observations in the time series.
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where Ft is the change in futures price at time t, Cyt is the change in the cash
price at location y at time t, and, et is the error term. This model of hedging effectiveness (HE) follows Thompson et al., who examined the HE of soybean futures
markets for reducing price risk in canola.10 The correlations between cash and
futures price changes indicate the degree of temporal linkages between the cash
and futures markets. The slope coeff cients from the regressions indicate whether
price changes are of similar magnitude as well as provide a measure of the optimal hedge ratio. The relationship between the cash and futures prices directly
relates to the eff ciency and ability to hedge risk. The “optimal hedge ratio” is
the slope coeff cient from the regression of cash price changes on futures price
changes. Hedging effectiveness can be measured by the coeff cient of determination between the cash and futures price changes.
498
Review of Agricultural Economics
Table 3. Results of regressions of cash price changes on cash price
changes, February 1988–July 1995
192 Obs. Before Futures
DEP
INDEP
Constant
R2
ADJ. R2
CF
EXP
NO
EXP
NO
CF
CFa
EXP
NO
EXP
NOa
CF
−0.1684
(0.1523)
.1444bc
(0.0418)
0.1316
0.1270
−0.1408
(0.1667)
.3224bc
(0.0567)
0.1453
0.1408
−0.0678
(0.1587)
.6071bc
(0.1354)
0.1960
0.1918
0.0611
(0.0919)
.3840bc
(0.0418)
0.3053
0.3016
0.1459
(0.1792)
.2252bf
(0.0532)
0.3310
0.3275
0.0631
(0.0816)
.6709bc
(0.0473)
0.4627
0.4598
CF (Central Florida), EXP (Gulf, export), and NO (New Orleans) are the three cash markets.
CASH is the change in the independent (cash) variable’s price.
a Heteroskedasticity-consistent standard errors are reported.
b Signif cantly different from zero at the 5% level.
c Signif cantly different from one at the 5% level.
All data series are f rst-differenced following Thompson, Eales, and Hauser
and others from the literature. Stationarity existed in both cash and futures price
change series as indicated by unit root tests.
Results of Price Analysis
The relationship between cash prices (equation (1)) was analyzed in two time
periods, before futures trading and during futures trading.12 Results of regressions
of cash price changes on cash price changes are presented in table 3. The regression coeff cients are based on ordinary least squares. Diagnostic tests indicated
the presence of heteroskedasticity in the form of ARCH(1) in the futures trading
period. Heteroskedasticity-consistent standard errors are reported. Monthly intercept and slope dummy variables were used to test for differences in cash price
relationships across months. These tests indicated no signif cant monthly effects
for either intercept or slopes. Thus, table 3 only reports the regression intercept
and slope coeff cients.
Each slope coeff cient presented in table 3 had a value signif cantly different
from both zero and one. The slope coeff cients from the regressions of New Orleans
price changes on Central Florida price changes are closest to one. However, the
regressions all had low coeff cients of determination. The strongest coeff cient
of determination was between New Orleans and Central Florida. During the
futures trading time period, the coeff cient of determination values increased
nearly 2.5 times over the prefutures time period. These results indicate that cash
markets were more closely linked following the introduction of futures trading.
Signif cant reductions in cash price variability (not shown) in the period with
futures trading, a f nding which is consistent with previous studies (Kamara), also
may suggest that futures trading improved the price discovery and eff ciency in
cash markets for DAP.
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CASH
192 Obs. After Futures
What Killed the Diammonium Phosphate Futures Contract?
499
Basis-change regressions (equation (2)) compare the basis behavior at the different locations during the period of futures trading (through July 1995). The
basis model allows the separation of cash and futures price effects in the analysis of the relationship between cash prices. From signif cance testing, monthly
slope dummies were found to be signif cant and were included for each regression (table 4). As with the cash-on-cash regressions, heteroskedasticity-consistent
standard errors are reported for two regressions indicated in table 4.
In the DAP change-in-basis regressions, all slope coeff cients are signif cant
but are less than one in all months (December is used as the base month). Most
DEP
INDEP
INTRCPT
SLPDUM
(JAN)
SLPDUM
(FEB)
SLPDUM
(MAR)
SLPDUM
(APR)
SLPDUM
(MAY)
SLPDUM
(JUN)
SLPDUM
(JUL)
SLPDUM
(AUG)
SLPDUM
(SEP)
SLPDUM
(OCT)
SLPDUM
(NOV)
DBASIS
RSQ
ADJ-RSQ
CF
EXP
NOc
EXP
MW
EXP
NO
CF
MW
CF
MW
NO
0.1116
(0.1090)
0.6278ab
(0.1097)
−0.4099ab
(0.1604)
−0.6495ab
(0.1411)
−0.5520ab
(0.1269)
−0.3546ab
(0.1507)
−0.4602ab
(0.2229)
−0.7176ab
(0.3347)
−0.2712b
(0.4183)
−0.4934ab
(0.1449)
0.1432b
(0.1958)
−0.4721ab
(0.1537)
0.3772ab
(0.0542)
0.6159
0.5900
−0.1525a
(0.0590)
0.7769ab
(0.0597)
−0.5273ab
(0.0873)
−0.7976ab
(0.0817)
−0.5875ab
(0.0651)
−0.2388ab
(0.0926)
−0.8230ab
(0.1191)
−0.4153ab
(0.1596)
−0.6004ab
(0.1940)
−0.2152ab
(0.0804)
−0.2759ab
(0.1112)
−0.6976ab
(0.0978)
0.3369ab
(0.0376)
0.5877
0.4476
0.1715
(0.1648)
0.7517a
(0.1659)
−0.9867ab
(0.2426)
−1.0131ab
(0.2133)
−0.9549ab
(0.1919)
−1.0135ab
(0.2279)
−0.9851ab
(0.3372)
−1.1889ab
(0.5061)
−0.6751ab
(0.6327)
−0.8891ab
(0.2192)
−0.2490b
(0.2962)
−1.1979ab
(0.2325)
0.0768ab
(0.0819)
0.5168
0.4842
0.0046
(0.0737)
−0.3905ab
(0.0939)
−0.2686ab
(0.1066)
−0.3293ab
(0.0889)
−0.4001ab
(0.0835)
−0.1104b
(0.1114)
−0.6261ab
(0.1672)
−0.0147b
(0.2106)
−0.6223ab
(0.2599)
−0.0607b
(0.0930)
−0.4839ab
(0.1252)
−0.3199ab
(0.1070)
0.6377ab
(0.0482)
0.7018
0.6763
0.1172
(0.1496)
−0.4392ab
(0.1682)
−0.7123ab
(0.2308)
−0.6723ab
(0.2124)
−0.6303ab
(0.1895)
−0.7663ab
(0.2171)
−0.6793ab
(0.3188)
−0.7971ab
(0.4840)
−0.4623ab
(0.5929)
−0.5748ab
(0.2137)
−0.3405b
(0.2792)
−0.9069ab
(0.2221)
0.4632ab
(0.0951)
0.5641
0.5347
0.1128
(0.1521)
−0.3254ab
(0.1702)
−0.7173b
(0.2246)
−0.5957ab
(0.2096)
−0.5317ab
(0.1872)
−0.7561ab
(0.2093)
−0.4949b
(0.3201)
−0.9054ab
(0.4650)
−0.2243b
(0.5853)
−0.6817ab
(0.1998)
−0.1524b
(0.2732)
−0.8610ab
(0.2179)
0.5379ab
(0.0935)
0.5905
0.5629
CF (Central Florida), EXP (Gulf, export), NO (New Orleans), and MW (Midwest) are the four spatial
cash markets.
SLPDUM is a slope shifter for the period indicated in parentheses.
DBASIS is the change in the spatial basis at location x.
a Signif cantly different from zero at the 5% level.
b Signif cantly different from one at the 5% level.
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Table 4. Basis change regression results with monthly slope
dummies (192 observations), October 1991– July 1995
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Review of Agricultural Economics
Table 5. Results of regressions of cash price changes on futures
price changes (192 observations), October 1991– July 1995
DEP
Constant
DNEARF
R2
ADJ. R2
EXP
CFc
NO
MW
0.0876
(0.1939)
0.3263ab
(0.0638)
0.2553
0.2514
0.0953
(0.0957)
0.2952ab
(0.0441)
0.1665
0.1621
0.1566
(0.1970)
0.1420ab
(0.0486)
0.3022
0.2985
0.1849
(0.1766)
0.0248b
(0.0684)
0.0178
0.0126
EXP (Gulf, export), CF (Central Florida), NO (New Orleans), and MW (Midwest) are the four cash
market prices. DNEARF is the change in the near futures price.
a Signif cantly different from zero at the 5% level.
b Signif cantly different from one at the 5% level.
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months have a preponderance of signif cantly negative slope shifters. Based on
the interpretation from equation (3), the results suggest that changes in the cash
market bases were generally not closely related. Further, the results in relation to
equation (3) indicate that cash price changes were more related with futures price
changes rather than with other cash market changes. The most connected bases
are between New Orleans and Central Florida, where the cash market coeff cient
is greater than the implied futures coeff cient for 5 months of the year. However,
since equation (3) forces a relationship between cash market price changes either
to cash or futures price changes, this may not necessarily mean that cash markets
are closely linked with the futures market.
The strongest coeff cient of determination from the basis-change regressions
is between New Orleans and Central Florida, followed by Central Florida and
the export market. Similar results were obtained from the cash price change regressions in table 3. As in these regressions, the slope coeff cient between New
Orleans and Central Florida basis changes is closest to one. This ref ects the competition between the two primary domestic DAP source markets. Since a buyer in
the Midwest can take barge load-out from New Orleans or barge or rail load-out
from Florida, it is intuitive that the price changes in these two markets should be
spatially related.
The OLS results from regressions of cash price changes on futures price changes
are presented in table 5. The regressions are based on cash and futures price
changes for all contract months together. Tests indicated no signif cant monthly
effects for intercepts, slopes, or delivery months. The slope coeff cients presented
in table 5 may be interpreted as hedging ratios; the R2 s are measures of hedging
effectiveness measures.
The slope values from these regressions indicate the number of futures contracts
necessary to hedge DAP in the cash market. For example, the slope coeff cient
of 0.33 from the export–futures regression indicates that 0.33 futures contracts
are needed to hedge 100 short tons of DAP. The hedging effectiveness estimates
indicate the amount of cash price variance that can be eliminated by holding
the futures/cash position implied by the hedging ratio. In the case of the export
market, 26% of the cash price risk can be eliminated by holding 0.33 futures
What Killed the Diammonium Phosphate Futures Contract?
501
Why Did the Contract Fail?
The contract’s low trading volume, low liquidity, and lack of industry participation were the top three factors limiting the use of the DAP futures contract
identif ed by the survey respondents. Of course these are symptoms and not the
underlying causes of the contract’s failure. Industry participants cited several reasons for the low participation and subsequent low trading volume and liquidity
including: (1) a lack of industry understanding of the mechanics of futures trading;
(2) a satisfaction with preexisting pricing and contracting methods; (3) a perceived
lack of price linkages between domestic and export cash markets, and between
cash markets and the futures market; (4) excessive deliveries on the contract;
(5) marketing of the contract by the CBOT to DAP producers rather than to DAP
dealers, who may have been more likely to hedge with futures; and (6) an absence
of a Midwestern delivery point. These diverse reasons and other statements made
by industry participants suggest that the contract did not achieve consensus in
its objectives and expectations in terms of whom and what marketing function
it would best serve, and what underlying cash market it should best ref ect.
While it is diff cult to isolate the most crucial factor causing the contract’s failure,
several factors are critical. First, the existence and reasonable satisfaction with
preexisting marketing and pricing arrangements clearly limited the demand for
the contract. For the producer, continuous production and short-term distribution
contracts reduced the value of hedging activities. For other market participants,
negotiated trades and f ll-type programs appear to have successfully reduced
price risk to an acceptable level. Second, the existence of a marketing system where
markets were responding to information differently limited the attractiveness
and effectiveness of hedging on the DAP contract. While the introduction of the
DAP contract appears to have increased the degree to which cash markets were
linked, these linkages never fully developed. Similarly, the hedging effectiveness
of the DAP contract was limited and did not offer the opportunity for effective
management of price risk.
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contracts (33 short tons) per 100 short tons of DAP. Overall, the results indicate the
HE of the DAP futures contract was poor relative to most standards (particularly
for the Midwest market), and brings into question its usefulness to manage price
risk.
To assess the basis behavior of the individual markets in more detail, the basis
for each cash market for each of the four contracts during the 12 weeks prior
to expiration was examined graphically.13 Bases should ref ect load out premiums/differentials established by the DAP contract for the export and New
Orleans markets ($8 for export and $12 for New Orleans), and ref ect the marketdetermined basis for the Midwest market. Taken together, the graphs for all contract months indicate that the bases for the export, Central Florida, and New
Orleans markets follow somewhat distinct seasonal patterns in the spring and
fall. The Midwest DAP basis is generally variable and does not appear to follow
any seasonal pattern. Hence, the graphs indicate to some degree the presence of
seasonal hedging opportunities for some locations, but not for the Midwest market where, consistent with the regression results, hedging appears problematic
due to high basis variability.
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Review of Agricultural Economics
Conclusions and Implications
The analysis has demonstrated that the relationships between DAP cash markets were weak and the DAP futures contract was ineffective as a hedging instrument. The poor hedging effectiveness may ref ect a poorly performing futures
contract or it may indicate that the futures-market-generated forward prices simply ref ected market conditions differently, and perhaps more accurately, than the
cash price series used in the analysis. The empirical f ndings are consistent with
observations from survey respondents, and underscore the diff culties in using
the contract for pricing decisions.
Since the cash DAP market lacks public price information, the DAP futures
market could have provided a valuable means of price discovery and price risk
management. However, diverse objectives, pricing needs, and expectations of
market participants, manifested in volume and liquidity problems as well as
the hedging effectiveness problems, limited and ultimately terminated industry
participation in the DAP futures contract.
It is possible that separate, more narrowly focused DAP futures contracts may
have traded with greater volume and liquidity, such as a contract with only two
domestic delivery months, March and September, and an export-oriented contract. The poor correlation between export and Midwest prices suggests that separate futures contracts may have been warranted. One futures contract could
function as a forward contract market for the export market and the other could
serve as a hedging vehicle for the Midwest market. A domestic contract could also
have allowed for delivery by Midwest warehouse owners, reduced basis variability between the Midwest and Central Florida, and brought more commercials into
the futures market
Notwithstanding these conjectural modif cations in contract design, as well as
those actually implemented by the CBOT, it is unlikely that the DAP contract
would have achieved the success of other long-standing agricultural futures contracts such as those for corn, wheat, and soybeans. Like the now defunct high
fructose corn syrup (HFCS) futures contract, the trade did not f nd the futures
contract very useful for pricing or managing risk. Unlike the HFCS contract, the
trade did give the DAP contract more of a try, as did the CBOT, and the contract
appears to have had multiple f ts and starts by different user groups, including exporters. But, ultimately, too few people in the industry found the contract enough
of an improvement over existing pricing and risk management practices to alter their existing strategies, particularly in light of contract delivery problems.
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Finally, the number of contracts delivered on the DAP contract was very high
relative to volume and open interest. The contract was amended in 1994 with
higher storage premiums, which may have accounted for the decline in deliveries after June 1994. The importance of the high rate of delivery in the early
portion of the contract life appears to have had a long-term effect of reducing
participation in the market.14 Speculators may have been reluctant to stand for
delivery, causing them to leave the market, while high delivery rates may have
signif cantly inconvenienced producer inventory management and discouraged
them from taking futures positions. Overall, the high delivery rate appears to
have negatively inf uenced conf dence in and attractiveness of the contract.
What Killed the Diammonium Phosphate Futures Contract?
503
Acknowledgments
We are grateful to Eugene Kunda at the Chicago Board of Trade for providing data and information
related to the contract, as well as to an anonymous reviewer for helpful comments.
Endnotes
1 For a glossary of terms used in the futures industry, refer to The Commodity Futures Trading Commission Glossary available on the Internet at: http://www.cftc.gov/opa/brochures/opaglossary.htm.
2 This paper does not discuss futures contracts that are settled by cash settlement rather than by
delivery.
3 Many fertilizer sales are completed with “f ll” type programs where the seller can be a producer,
cooperative, or distributor. Due to limited storage space at the point of production and in the marketing
system, sellers will often attempt to forward contract their sales for delivery. A f ll program is a
preseason purchase by a fertilizer dealer to “f ll” their storage in anticipation of demand and/or
market price increases. The terms of f ll programs are negotiated between the buyer and seller, and
can vary to the extent that a dealer can set market prices, delayed payment terms, extended shipment
periods, and price protection. Price protection involves agreements not to increase the transaction
price in the face of rising DAP prices. Member companies of the two producing cooperatives used
this approach extensively. Other producers often offered f ll programs when they could not sell into
the export market.
4 The following differentials were established for alternative delivery locations: f.o.b. barge from
Florida at a premium of $8.00/st, f.o.b. barge from Louisiana at a premium of $12.00/st, f.o.b. barge
from Mississippi at a premium of $10.00/st, f.o.b. vessel from on-water facilities at a premium of
$8.00/st.
5 Shipping certif cates represent a commitment by the facility to deliver the commodity to the holder
of the certif cate under the terms specif ed therein. This obligation may be met from current production
or through-put as well as from inventories. DAP facilities approved by the CBOT were located in
Central Florida, on-water in Louisiana, and on-water in Mississippi. Using shipping certif cates only
obligated the shipper to provide stocks of DAP at the delivery location when the buyer requested
load-out. According to Eugene Kunda from the CBOT, since DAP producers do not store product,
the shipping certif cate was the only viable delivery instrument. DAP dealers used their call on DAP
producers’ production as their deliverable supply. The CBOT did not allow DAP dealers to use their
DAP in storage for delivery via a warehouse receipt because it would not be in a deliverable location,
and would be out of position for most other dealers.
Downloaded from http://aepp.oxfordjournals.org/ at Pennsylvania State University on May 12, 2016
Industry members who had control of or inf uence over the market were also reluctant to change a market they traditionally dominated. Further, it is likely that
the industry just did not face much price risk to be managed after 1994.
The failure of both the DAP and the HCFS contracts introduced into established industries raises a more general question of whether new contracts or
pricing instruments like those offered virtually through e-commerce technology
can succeed in such an environment. Perhaps it is necessary that an industry or
the economy in general experience some signif cant transformation or structural
change such as f nancial market liberalization or a shift to a market-based economy for contracts to succeed in previously established industries. In situations
where traditional risk management institutions or procedures are no longer available or effective, or become very costly relative to new approaches, the benef ts
of adopting new pricing instruments most clearly exceed the costs of changing
pricing and marketing practices. This may explain some of the success of new
futures exchanges in formerly communist countries, and why e-commerce has
been most widely adopted in sectors where the gains in the form of reduced
transactions costs are greatest. Without such a radical change in an industry or
an economy or large cost savings, however, it seems questionable whether an industry will adopt new forms of pricing that replace preexisting industry-specif c
practices.
504
Review of Agricultural Economics
6 The survey is available upon request from the authors.
7 Some respondents noted that the DAP industry is different from the grain industry in that produc-
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tion is not seasonal while demand is. DAP producers manufacture at full capacity nearly year round.
One respondent stated that news of weather conditions and set-aside programs affect DAP prices, but
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8 The CBOT did eventually add a Midwestern delivery point to the contract in late 1996 or early
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9 Recently, threshold cointegration procedures that permit differential price adjustments when price
differences are larger than inferred transportation costs have been used to examine spatial spot markets
(e.g., Ejrnaes and Persson; Goodwin and Piggott). Further, these procedures decompose the price
relationships between markets into long-run and short-run dynamics. Our formulation is primarily
concerned with the short-run relationship most relevant in short-term hedging decisions, where we
assume that the effect of changes occurs within the week. Aside from the issue that these threshold
procedures would not have been available to academicians and market participants at the time the
contract was most heavily traded, the use of these procedures is complicated by the presence of the
futures market, which would have inf uenced the degree of comovement in spot price markets. In our
analysis below (equations (2) and (3)), we attempt to address this last notion.
10 Our straightforward bivariate formulation has been shown to produce representative results
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11 After the futures contract changed to serial delivery months, the nearby futures price series
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12 Prior to performing the statistical analysis, a graphical examination of the spatial price spreads
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the DAP contract was made. A complete set of prices for the Midwest market was not available for
the f rst period, and hence no graphs were generated to ref ect the differential between the Central
Florida and Midwest prices. The graphs demonstrated a marked reduction in the variability of the
spatial price differentials after the introduction of futures trading.
13 The graphs are not presented for brevity, but are available from the authors.
14 Interestingly, in the event of delivery, there is no basis risk for the contract holder. With delivery,
the futures price becomes the relevant cash price, and cash-futures price correlations may not be
relevant to traders holding DAP futures positions willing to stand for delivery. If DAP deliveries
largely represent product destined for export, export prices should be highly correlated with futures
prices and would be the most hedgeable cash price. However, as shown in table 3, there is a low
correlation between the export and other cash prices, and table 5 reveals a low correlation between
the export price and the futures price. These low correlations suggest that the futures contract was
either a poor substitute for the cash market, deliveries were not destined for export, a cash price series
that is not representative of market transactions, or some combination of the above.
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