If I were betting on the most frequently asked question or commonly misunderstood item on a grain buyer’s bid sheet, it would be BASIS. It seems just hearing the word causes people to shut down…but not today! Today’s the day we tackle basis!
Before I answer four commonly asked questions, I’ve defined a few key terms to help build the foundation needed. First, let’s take a moment to understand the calculation of cash price & basis.
CASH PRICE = FUTURES PRICE + BASIS
which means…
BASIS = CASH PRICE – FUTURES PRICE
Now that you have the calculation down, let’s address some terminology related to basis that may have confused you in the past.
Have you ever heard your farmer say that basis ‘strengthened’ or ‘weakened’ from yesterday. If basis ‘weakened,’ it means that it’s MORE NEGATIVE than it was yesterday. For example, yesterday’s basis level for December delivery may have been $-.20 CZ19, and today it’s $-.25 CZ19, which means it weakened $-.05.
When basis ‘improves’ or becomes ‘more positive’ it’s also referred to as ‘strengthening’.
When basis becomes ‘more negative’, it’s said to be ‘weakening’.
Let’s tackle some of the most commonly asked questions about basis:
- What factors impact basis?
- Who determines the basis level?
- Why does basis differ among buyers in the same area?
- Are there times of the year when basis is typically better?
What factors impact basis?
- Transportation Costs: The buyer you deliver your grain to often has to transport that grain to an end user. The farther the grain buyer’s location is from the end destination, or the more expensive rail or truck rates are, the ‘weaker,’ or less positive, the basis level will be. For instance, consider basis levels in two different areas of the country–central Nebraska and eastern Missouri. Typically, basis levels for corn in central Nebraska are negative. However, if you’re a farmer near in Missouri along the Mississippi river, you likely experience positive basis levels. Why? One reason is location. Consider the proximity to the export market if both facilities export the grain they buy. Since the Missouri grain buyer is along the Mississippi River and much closer to the port for export in New Orleans, transportation costs are lower.
- Profit Margins: Grain buyers are in the business of buying, storing, managing the grain to sell later for at a higher price. Remember, since the grain buyer has no control over the futures price, basis is the mechanism of price they can control to ensure that the cash price posted is profitable.
- Storage Costs: If you store grain on your farm, you are likely familiar with some of the costs associated with storage. For instance, the electrical costs associated with running a dryer or bin fan or the cost of damage/quality issues if the bin or grain pile is poorly managed are a couple of the costs incurred when storing grain. As the cost of storage for the grain buyer increases, the basis level tends to weaken, or become more negative.
- Local Supply & Demand: There are times you may see basis strengthen in your area due to low supply of grain or increased demand. For instance, as harvest approaches and on-farm storage is emptied, a soy processing plant may end up in a tight inventory position and in need of soybeans to keep the plant running. In this case, the plant will likely strengthen basis because their demand for soybeans is high and local supply is low. They will strengthen basis in an effort to entice farmers to sell the soybeans they have left and keep the plant running.
Who determines the basis level?
The grain buyer determines basis levels at their facility. Remember how I mentioned that your local grain buyers have no control over the futures price? That’s still true. However, the grain buyer is able to control the cash price paid for the commodity, which is where basis comes in. Considering that basis is the difference between the futures price & the cash price, it’s the mechanism grain buyers use to ensure they are buying grain at a profitable level for their facility, taking into account the factors above.
Why does basis differ among buyers in the same area?
You may notice variation in the basis levels posted by buyers in your area. Considering the factors we outlined above that go into the determination of basis, there are a multitude of reasons basis may differ. Often, you’ll notice that basis at an end user (ethanol plant, soy processor or feedlot) will be stronger, or more positive, than basis at a country elevator. An end user does not incur the same transportation costs that a country elevator has to get the grain to the end user. Additionally, all facilities are different, and some are more efficient than others. To account for the higher cost of running an inefficient facility, less efficient locations will likely have weaker basis levels in order to maintain profitability.
Are there times of the year when basis is typically better?
Historically, basis is the weakest at harvest. Supply and demand can explain why this occurs. Since harvest is the time of year with the greatest supply and need to move grain, basis levels are typically weaker. Since most farmers can’t store their entire crop, grain buyers have an influx of grain coming across their scales at harvest. Thus, there’s no need to strengthen basis to entice grain to move. Farmers with on-farm storage have the flexibility to avoid weak basis levels at harvest and store their grain to deliver during a time of lower supply and typically stronger basis levels.