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The Basics of Basis

What is “basis?”

A tool to increase your price per bushel.

• Basis determines the cash price of grain.

• Basis reflects demand for grain.

• Basis includes margins for the buyer.

How is basis derived?

Basis includes the buyer’s costs of handling, administration fees, some types of freight, and elevation, among others. This basis is then deducted (or added) from a futures price to arrive at a cash price. Note, in some instances, freight is NOT included as part of the basis. Basis is typically quoted delivered to a particular destination, freight to get there – not included.

Basis – delivered a particular location

For this example, let’s say today is January 11, 2008. Your farm is located in Wetaskiwin and a buyer quotes a canola price of 20 under the March futures, delivered Edmonton, for February through March movement. You heard on the radio that the March canola futures closed at $573.20/MT. Then:

Winnipeg Commodity Exchange March canola futures: $573.20

Basis: -$20.00

Your price, delivered to Edmonton: $553.20 (or $12.55/bu)

 

The price of $553.20 does NOT, however, include freight. You can haul it yourself or hire a trucker. There are more calculations to perform before you reach a price “at the bin”.

 

Delivered price to Edmonton: $553.20

Freight cost from Wetaskiwin to Edmonton: -$8.00

Net cash price, at the farm gate: $545.20 (or $12.37/bu)

What’s a “good” basis?

Basis reflects simply supply and demand theories. What a “good” basis IS can change from year to year. The more in demand the grain becomes, the “narrower” the basis can become. If the grain is not required, the basis can become “wider”.

In the illustration above, consider “0” to be current price of a futures contract trading on the Winnipeg Commodity Exchange. If a buyer talks about the basis being “option”, that simply means the basis is zero. The other numbers are commonly seen basis levels for our canola market. The more negative (called wide) the number is, the more benefit to the buyer. The more positive or closer to zero (called narrow) the number is, the more benefit to the producer.

A Wide Basis

At harvest time, basis is usually wide. A wide basis reflects ample grain supply. Basis is typically wide at harvest because farmers are eager to deliver grain to receive much needed cash or due to lack of bin space. Buyers have a captive audience. Basis tends to be towards the left portion of the above line. If there happens to be a drought, though, resulting in less supply, the basis may not be wide.

A Narrow Basis

During seeding time, demand for canola is still active but most producers are busy and not so eager to deliver grain. Buyers may narrow the basis (offer a premium) to entice farmers to deliver grain. Basis tends to be towards the centre or right of the line. A narrower basis indicates the grain is in demand.

Changing basis levels

When basis levels are observed along with futures prices, there are four situations which give signals to the producer about grain marketing strategies. The more options a producer has when marketing grain, the better chance of an increased price per bushel.

Strong Price / Wide Basis

When futures markets are strong, it’s usually because of tight supplies internationally but at a local level, there could be an ample supply of grain, thus, the wide basis. Strategies:

• open basis contract (if you can find one)

• short the futures

Strong Price / Narrow Basis

Demand is outpacing local availability of product. Buyers are taking less margin (narrowing the basis) as an incentive to encourage farmers to deliver grain. Strategies:

• deliver grain (market signals in farmer’s favour)

• lock-in basis and futures (deferred delivery for new crop)

• short the futures

Weak Price / Wide Basis

A typical harvest situation. Futures can be lower due to ample supply at an international level. Basis levels are wide at a local level due to ample supply. A buyer with grain in-store may widen basis levels to discourage immediate delivery (if they’re full) which also reduces prices at the local level. Strategies:

• store grain (market signals against the farmer)

• buy call options

Weak Price / Narrow Basis

At an international level, the futures are low. At a local level, demand is high for product. Buyers are narrowing basis as an incentive for farmers to deliver grain. Strategies:

• deliver grain and go long the futures

• lock-in basis

What’s a basis contract?

Sometimes, a basis level comes along that says to the canola grower, “Pick me! Pick me!” Attractive basis levels present themselves for different reasons, at different times, throughout the year. A more narrow basis can be a market signal for the producer to lock-in just the basis portion of his canola price and hope for the futures to further increase. Most line companies and crushers will have basis contracts available to farmers. A basis contract looks like this:

 

Futures price (unknown) less basis (known) = cash price (unknown)

 

Let’s look at our example again. You may have wished to lock-in some canola for the fall of 2008 but thought the futures market had room to rally, however, a fairly narrow basis level (for fall time, anyway) WAS available from a local buyer. In this case, the buyer used November 2008 futures for October 2008 deliveries:

So, you locked-in the basis (the previous year when the narrower basis was available) and now continue to keep a sharp eye on the futures. To price the futures portion of this equation, most buyers establish the last trading day, of the previous month (to the futures month being used), as the final day to execute this. In this example, October 31, 2008 would be the last day to price out this basis contract. What’s happened to futures and basis levels since the basis was locked-in the previous year? So far in this example, by January 14, 2008, the basis has widened from 20 under to 40 under and the futures have risen considerably. The difference between locking-in the 20 under basis and the current 40 under basis, works out to over $800 per SuperB load! The most important decision to make with a basis contract is actually implementing a plan as to when to pull the trigger and price out the futures.

Basis contract tips

• Use basis contracts as one part of your grain marketing plan.

• Remember …. If you sign a basis contract, be prepared to deliver the grain to the buyer as specified.

• Review each buyer’s particularities … some may require the futures to be priced out during active trade, some may not.

• Some buyer’s allow you to price out the futures in allotments as small as 20 MT at a time, great for “averaging up” strategies.

• Basis contracts can be found for nearby deliver periods or even up to two years in advance.

• Find out what the penalties are IF you get hit with drought or hail and have NOT priced out the futures portion of your contract.

Susanne Leclerc