Factors affecting Basis

The difference between local cash price and futures price is due to transportation costs, storage costs, supply and demand, local conditions, and other factors. 

Transportation Costs

The local cash price and Chicago cash price differ by transportation costs. The transportation cost differential is due to the added cost of shipping grain from Odessa to East Med market. For example, the cost of shipping corn from Odessa to the East Med market is usually lower than the cost of shipping it from Chicago.

Storage and Interest Costs

Storage costs and interest (charge against money held in unsold grain inventory) vary throughout the year. Grain offered for sale at harvest incurs no storage and interest costs. However, as the year progresses, storage and interest costs accrue and the cash prices increase to cover these costs.

However, futures prices do not increase during the year due to storage and interest costs. Regardless of when a futures contract is traded, the storage and interest costs from harvest until contract delivery are included in the price. For example, regardless of whether July futures are traded during January or the following June, the storage and interest costs from harvest until July are included in the futures price.  So, cash prices tend to increase relative to futures prices from harvest through the marketing year.

Supply and Demand

Basis is also affected by supply and demand conditions. Heavy farmer selling, especially at harvest, will tend to lower cash price but will have little effect on futures price. So basis is traditionally wide at harvest (more than can be explained by storage and interest costs and transportation). Conversely, light selling (often during spring planting) will tend to strengthen cash price but will have little effect on futures price. So basis will narrow. Variations in export demand further affect basis.

Geographic Variations

Basis patterns vary from one geographic area to another. A geographic area that uses more grain than it produces is called a grain “deficit” area (versus a grain “surplus” area) and needs to import grain into the area from outside. This will increase cash price relative to futures price and the basis will narrow.

Localizing basis

The relevant basis for a farmer is the basis at the local elevator.

What is Spread

Spread is the difference between futures prices.  Because grain is a storable commodity and produced only once every year, the futures prices for several delivery months represent the same crop.  For example, corn futures prices for December, March and July all represent the same crop and tend to move together. The September delivery month tends to be a transitional month between the old crop and the new crop. The difference between futures prices of different delivery months of the same crop is due to the costs of storage and interest between the delivery months. For example, the December futures price is usually the lowest of the futures contract months because delivery in December is close to harvest and only a small price premium is needed to cover storage and interest costs. The July futures price is usually higher because storage and interest costs from harvest until the following July are incurred.

Using Basis in Hedging

The two critical times when basis information is important for hedgers are in deciding whether to place a hedge and, if placed, when to lift the hedge.

Placing Hedges
Basis is important when considering whether to place a hedge because it is used to convert the futures price to a local cash equivalent price.

The producer considering hedging needs to determine the period when the grain will be marketed. Once the marketing period has been selected the appropriate futures contract delivery month is chosen. The expected basis during that time period is subtracted from the current futures price to obtain the estimated net price from hedging (not including transaction fee or interest on margin money).

For example, if you are considering placing a hedge using July futures and if you anticipate lifting the hedge in June, you can estimate the net hedge price by subtracting the expected June basis from the current July futures price.

Lifting Hedges
If it is time to lift the hedge and the basis is narrower than expected, the hedge returns will be larger than expected. With a storage hedge, the producer may lift the hedge earlier than anticipated if the basis is unusually narrow.

However, if it is time to lift the hedge and the basis is wider than normal, the producer may delay lifting the hedge until the basis approaches more normal levels. Of course, there are other factors to consider in making this decision.

Knowledge of basis patterns is useful in deciding between using a hedge or a forward contract with an elevator. If the contract price basis is significantly larger than the expected actual basis, a producer may consider hedging rather than forward cash contracting. The contract basis can be computed by subtracting the contract price from the futures price. However, if the contract price reflects a normal basis, it may be advisable to forward contract rather than hedge in the futures market.

Grain Basis vs. Livestock Basis

Many agricultural producers who understand livestock basis patterns try to transfer those principles to grain basis. However, there are some differences.

Grain is a storable commodity and the same grain can be used to satisfy several futures contract delivery months. So grain futures prices tend to be tied to one another.
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