Basis - How Cash Grain Prices are Established

 
 
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 Introduction | How basis works | Keep an eye on the basis | Basis strategies | Summary | Additional information | Return to Grains & Oilseeds Marketing page
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Introduction

Basis is the difference between a futures market price for a commodity and its local cash (or street) price. Basis for storable products, like grain, is influenced by the cost of getting grain from a local delivery point to the point of use, and the local supply-demand situation.

A farm manager can make better choices about when to market, where to market, and how to lock in prices by following basis levels.

How Basis Works

Grain buyers use basis to attract grain when they require it. Buyers who offer a higher local cash price are actually offering a stronger, sometimes called narrower, basis than their competitors. The higher cash price encourages delivery to the company versus its competitors.

Example 1, shows the costs that make up a Central Alberta canola basis. The example is based on a cash canola price of about $500 per tonne, 5 per cent prime interest and storage of $0.05 per tonne per day that begins after the first 10 days. ICE futures Canada Canola futures prices represent a value of canola delivered in-store (into an elevator) in the Saskatoon par region.

Elevator tariffs, interest costs, expected storage time, and the buyer’s perception of possible changes in risk and opportunity all affect the cash price offered by a grain company.

Example 1

Elevation (local elevator) $15.25/tonne
Freight (Central Alberta to Vancouver advantage over Saskatoon)$9.00/tonne
Inspection at export $0.70/tonne
Total fixed costs
$6.95/tonne
Interest on grain held (42 days) $2.95/tonne
Storage on grain held (42 days) $1.60/tonne
Risk and opportunity $5.00/tonne
Total variable costs
$9.55/tonne
Possible Basis (total fixed and variable costs)
$16.55/tonne

In Example 1, above, the company canola buyer has calculated that a reasonable basis for the company to offer for today’s delivery at one of its Central Alberta facilities would be $16 per tonne under the nearby November futures. Grain companies may offer a stronger basis to attract deliveries for a sale with a tight shipping window, or competition from a local crusher may cause them to bid more aggressively for their canola. The company canola buyer decides to offer a basis of $10 per tonne under the November futures to try to draw in more supplies.

Keep an Eye on the Basis

A strong (narrow) basis signals a high local cash price relative to the futures market, and usually means stronger local demand or limited local supplies. A weakening basis means weakening local demand or very large local supplies compared to the over-all supply-demand picture for that commodity. Strengthening and weakening can occur gradually or quickly.

Average southern Alberta basis ranges for canola are occasionally as strong as $10.00 over (futures) with weak/wide basis levels sometimes $40 under (futures).

Basis Strategies

Basis is an important tool for producers choosing a contract. The first step in making this decision is to compare the basis currently offered at the expected time of delivery to the typical basis at the time of delivery. This comparison will help to predict whether the basis will weaken (widen) or strengthen (narrow) between now and the time the grain will be delivered.

A weak (wide) basis suggests that a producer would be better off to use an open-basis contract, or to hedge using futures and wait for basis to improve. A strong basis, that is more likely to weaken by delivery time, suggests that other pricing mechanisms such as a deferred delivery contract or, at least, a basis contract be used to take advantage of the strong basis. Understanding how exchange rates factor into the calculation of basis is important and is explained in Wheat Basis Levels in the Agricultural Marketing Guide.

Summary

The futures market provides both forward pricing and hedging opportunities for both producers and buyers. Street or cash prices, reflect the futures price less (or plus) the basis. Basis is adjusted by buyers to encourage or discourage delivery of grain.

Basis is a signal of market forces at work and will change over time as the cash market price and futures market prices change. Basis reflects both the cost of marketing grain as well as the competition between grain buyers, and does not change as often or as quickly as futures prices.

Farmers should watch both basis trends as well as cash and futures market price trends to select the time to price their grain. Refusing to sell grain because basis is $5.00 per tonne too weak, could mean a lower cash price at a later date due to a $10.00 per tonne drop in futures prices.

Additional Information

See Hedging Grain by the Farm Manager in the Market Risk Management Section for an explanation of hedging using the futures market.
 
 
 
 
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For more information about the content of this document, contact Neil Blue.
This document is maintained by Erminia Guercio.
This information published to the web on July 21, 2006.
Last Reviewed/Revised on March 6, 2015.