By Natalie Noble
Gone are the days when the most successful farmer sat on the tractor in the field the longest. Today’s farmer is connected, tech-savvy and efficient to the max, playing the marketing game to get the most bang for their buck.
Securing the most strategic contracts calls for diligence, discipline and a solid understanding of all the ways to play. Risk is high and variables many, so knowing the basics, or in this case, the basis, is a good first move.
“Basis is one of the ‘basics’ of grain marketing, but as I’ve worked with farmers … over the years, I’ve come to believe it’s not that well understood,” says Dave Reimann, market analyst with Cargill’s MarketSense grain marketing advisory service.
Ins and Outs of Basis
The basis is either a deduction (under) or a premium (over) the futures price in order to determine the net price a buyer will pay. Put simply, it’s the difference between the cash value of grain and the underlying futures contract value.
“If the cash bid for canola at a certain elevator is $430 per tonne and the underlying canola futures contract is trading at $450 per tonne, the basis is reported as -$20,” says Reimann.
Basis movement reflects the local situation, including supply and demand. When basis levels increase, or widen, they signal less demand for the product at that time, such as harvest time when supply is abundant. When they decline, or narrow, the market needs supply and it’s a good time to deliver.
So, when canola supplies tighten in an elevator’s draw region while export demand is up, basis strengthens. “At times, this can become so extreme that cash levels trade above the underlying futures. This is reported as a “+” or “positive” basis,” says Reimann. “On the other extreme, there could be very large supplies of grain in a given region and little demand. This would cause a grain company to weaken their basis.”
Lorne Boundy, merchandiser with Paterson Grain, says wheat follows similar seasonal patterns to canola. “Wheat basis tends to be widest at harvest with high available supply. Moving into early December, it typically increases and then levels off through the holidays, improving again into late February and early March,” he says, adding it’s been this way since 2012 with little exception.
Demonstrated above, determining basis levels in canola can be fairly straightforward. Other crops, including wheat, soybeans, corn and oats, are traded in U.S. dollars and more complicated. “In these cases, foreign currency (FX) comes into play and must be factored into the price presented to farmers,” says Boundy.
Marketing experts tackle this in different ways. Many companies will put 100 per cent of the FX into the basis and quote the farmer as if the futures price would be the same.
“At $5 per bushel in U.S. dollar futures, they would equate it as $5 per bushel in Canadian dollar futures because they are sourcing the futures prices from a data provider and it is easier to not have to convert live or delayed quotes into Canadian dollars,” says Boundy.
Simple enough, but this method has a big drawback. Because futures prices make up the majority of the farmer’s net price—up to 90 per cent—a considerable portion of the basis value is the FX on the futures, skewing the basis level.
Boundy prefers to convert both futures prices and basis into Canadian dollars, adding that canola basis moves in small increments relative to large moves in futures, but wheat can have huge swings due to FX rate changes even with static futures.
To maximize basis as a marketing tool, sellers must be informed around both futures prices and how much foreign currency (FX) is being factored in. There is risk when currency exchange values move, even if futures prices do not.
He referenced a recent group of Manitoba farmers locking in wheat basis which looked good with FX built in, but by fall, Minneapolis wheat future didn’t move but the Canadian dollar plummeted. The farmers couldn’t jump in on the FX move and had poor returns pricing out their basis contracts.
In this case, locking in a basis against futures that had been converted to Canadian would have allowed farmers to participate in the rising futures price due to the exchange. For example, December Minneapolis wheat futures priced at $5 per bushel with an FX rate of 0.7560 would leave $1.54 per bushel of exchange in the futures conversion to be included into the basis.
Contracting to Win
If a farmer signs a basis contract, they lock in the current basis offered by the grain company but agree to a deferred delivery, holding off the futures pricing component until a later date. This provides the opportunity to lock in a narrow basis prior to the delivery month, a bonus should market prices rise during this time.
“A good grain marketing advisor will tell you basis contracts should only be used during rallies in futures markets,” says Reimann. “In that case, they can be very effective in getting the farmer an attractive basis as well as higher futures, a very good combination.”
He adds that these contracts can be risky if futures fall too far before the farmer triggers their price, in which case they can lose more value than the strong basis provided.
Still, in many cases, Boundy says these contracts are underutilized, especially in wheat contracting.
“The global flat price of wheat is fairly stable, so if we assume it does not move, then the fluctuations in futures values will influence the basis to arrive at a net price for producers,” he says.
As with any major business decision, it’s wise to seek professional advice before selling on the futures market, as many farmers do to varying degrees. Reimann and Boundy broke down some basics to help with on-farm decision making.
First, farmers should track their local grain prices and basis levels at their local elevators and continue to analyze them over several years. Staying on top of global market factors is also key to market planning and sales decisions.
“That way, you’ll start to develop a good idea of what a good basis looks like for your farm,” says Reimann. “It makes it easier to decide when to capture basis or when to store your grain. An advisor who has been working in your area should be able to access this kind of information and help interpret it.”
Second, as a rule, basis tends to be strongest when futures prices are low and weakest when futures are high. Boundy suggests that when futures prices are high, farmers sell futures only and then wait for them to fall before locking in a basis. As futures fall, basis will improve.
Finally, it requires discipline and timing. While many farmers are properly using basis as a marketing tool, Reimann notes some farmers use it when futures fall, which can lead to lost revenue. “It can be really tough to stay on top of futures prices and to have the discipline to set the futures price at the right time before you lose out,” he says.
He adds that farmers can spend more time looking for a strong basis and less time considering what the current flat price is relative to the return on their investment.
“A strong grain marketing advisor will help their clients see that they can still achieve a higher final price, even if they receive a weaker basis than their neighbour,” says Reimann. “You have to be quite disciplined to use a basis contract, and if you don’t have the right information, you may have trouble acting at the right time.”