Basis is a marketing instrument utilized by grain handling companies to attract grain when they need it or to discourage delivery when they don’t. Used for crops that have an active futures trading market like wheat and canola, basis is the difference between a local cash price for a commodity and its price on the futures market.
Basis levels are set differently by each grain company and are determined by several factors, including transportation and storage costs and the buyer’s profit margin. Currency changes also play a role for canola, since it’s traded in the futures market in U.S. dollars.
Brian Wittal, general manager of Paterson Grain’s Foothills Terminal in Bowden, Alta., believes it’s important for farmers to understand grain companies will hedge when determining basis levels as a way to manage market risk, but they’ll avoid speculating in the futures markets.
“When we hear of companies that have got into trouble, it’s because of something like that, where they take a speculative position,” says Wittal. “In the world markets, the way things can change so dramatically, that can be very dangerous.”
Most often, grain companies will offer a negative basis, or a cash price that is less than the futures price. Basis levels can turn positive though, with cash prices surging over futures prices, if there’s a general market supply shortage or when a buyer needs deliveries to cover a sale or fill a train shipment.
Supply and demand is a key part of the equation, which means buyers will typically widen their basis levels to discourage deliveries from grain suppliers (a weak basis) or narrow them to drum up more farm deliveries (a strong basis).
“What will often happen in an ebb and flow market is when prices fall, farmers become more reluctant to sell and eventually buyers will run out of products they have booked on the buy side,” says Neil Blue, a provincial crop market analyst with Alberta Agriculture. “The only way they have to encourage a farmer to continue booking with them is to strengthen the basis and, in effect, raise the cash price.”
In general terms, the strength or weakness of a basis at any point in time can be viewed as a bellwether that informs grain sellers where the market is at, and where it might be headed.
How can farmers use this market signal to their advantage? The obvious answer is a strong basis, or better yet, a positive basis, is a clear sign buyers really need grain — which for sellers means it could be a good time for a cash spot sale or to lock in that basis for a future sell.
The latter, according to Blue, can sometimes be the most profitable option. He points out when basis is strongest, it isn’t always the same time prices are at their highest — that’s because basis levels and futures prices sometimes move in opposite directions.
Blue maintains farmers can optimize their ROI if they’re able to lock in a favourable basis when prices are low; later on, should the futures market rally, they’ll have that strong basis locked in and can lock into the futures as the second step of their pricing to take advantage of higher grain prices.
Wittal says some grain companies will offer producers the option of locking in at a futures price without locking in the basis, or simply lock in a straight flat price, if that’s their preference.
“Each of those (options) is going to be a different decision and a different discussion, depending on what the market is telling (you),” he says.
Wittal believes one way grain farmers can maximize their gains is to consider historic prices and basis levels.
“If you saw an offer come out from a grain company that was above the historic level, we’d say that’s pretty good because historically (the grain company) would not be offering you a basis at this level at this time of the year,” he says. “You may want to consider locking this in on some of your grain for next year because it’s a better-than-average price.” GN