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Basis Basics

30 Oct Markets | Comments
Basis Basics
 

GrainStorageElevator-1

This post is a rerun of the article “Basis Basics” that appeared in the fall 2012 issue of Sorghum Grower magazine

Dr. G.A. “Art” Barnaby, risk management extension specialist at Kansas State University, answers your questions about grain sorghum basis basics.

What is basis?

Basis is calculated by subtracting the nearby futures price from the cash price, where nearby is defined as the futures contract closest to the expiration without going into the delivery month. Basis captures the effects of local supply and demand, as well as transportation costs on commodity prices.

What is your basis?

Kansas State University’s AgManager.info site has an interactive crop basis tool that can be used to examine historical weekly nearby basis for sorghum, corn, soybeans and wheat for various locations in Kansas, Nebraska, Missouri, Oklahoma and parts of Colorado and Texas. Use the AgManager Interactive Basis Tool online.

How does basis work for sorghum?

Sorghum basis is priced off of the corn futures contract. Elevators and other grain buyers will use the corn contract to hedge their inventory if they are holding sorghum. So, it is the difference between the cash price at that location versus the board price.

Why is sorghum not on the Chicago Board of Trade?

There is simply not enough volume of grain sorghum to be traded on the CME. In the futures market, liquidity is really important, and you get liquidity with volume. Grain sorghum was traded at Kansas City at one point, but because of the liquidity issues, grain buyers continued to use the corn contract, which suggested the basis risk between corn futures and cash sorghum wasn’t anything that couldn’t be managed.

How does basis vary across the Sorghum Belt?

Basis is going to vary for a number of reasons. It depends how close you are to markets. For example, if sorghum gets approved as an advanced biofuel, I would expect the basis to get much stronger to the point it might even exceed corn prices in some areas close to ethanol plants where sorghum is produced. Another example would be a situation we had a couple years ago where Mexico was allowing the importation of U.S. sorghum for livestock feed but not corn. Corn and sorghum prices became very close in South Texas.

How is basis related to supply and demand?

In effect, your cash price represents local supply and demand, and the CME is more of a national and international price. For example, if you are in an area where there has been a drought and there are a lot of feedlots or ethanol plants, those operations either have to shut down or truck in grain. The grain merchandiser then has to pay the transportation cost, and as a result of that low grain supply and high demand, the basis shrinks. The cash becomes very high relative to the futures at that point, because you have to pay enough in cash to pay for what it costs to truck it to the buyer. So, it’s more of a local cash supply situation.

How do changes in the market impact basis?

The short crop in the Corn Belt this year is a supply issue that supports a strong sorghum basis. If grain sorghum is approved as an advanced biofuel, you would assume that would increase demand and make the basis stronger. The shipping of sorghum to Mexico for cattle is an example of a stronger basis that was demand driven. So, any of those factors, especially local conditions, are going to drive that number more than anything else. If you have a really big crop and the elevators are stacking grain out on the ground, you don’t even have to ask what the bid is for grain—you know the basis is going to be really wide. They’ll buy it, but only at a really reduced cash price, which means a weak basis.

How does basis change throughout the year?

In general, basis is typically weaker at harvest time when farmers are selling grain off the combine. Then it tends to get stronger toward the end of the crop year. It also depends on what is going on in the Corn Belt and in the rest of the world. This year, for example, the drought in the Corn Belt has resulted in a pretty strong sorghum basis this summer.

How does on-farm storage benefit a producer in relation to basis?

In the case of harvest time, elevators are buying grain at its weakest basis—the lowest cash relative to futures. If you have on-farm storage, you don’t have to deliver your grain at harvest time. You can retain it and wait for the basis to get stronger before you make the cash sale. That is where on-farm storage pays for itself. And, depending on your setup, you could potentially eliminate your wait time at the elevator if you have got your own facilities, and you can keep the combines moving.

Describe how basis can affect producer profitability.

The stronger the basis, the higher your cash price is relative to the board. So, if you can pick up an additional $0.15/bu, those additional dollars can add up just off of managing basis. There are many farmers who sell grain this way. For example, because of on-farm storage and a farmer’s ability to manage basis, their decision to sell is often driven by how strong the basis is. When the basis is strong, the local market is telling the farmer it needs grain, and it is bidding the cash price up to get it.

Is there a relationship between basis and crop insurance?

The short answer is no. Both corn and sorghum crop insurance set their price elections based off of the CME. The farmer’s actual selling price does affect his insurance indemnity calculation. However, since sorghum is not traded on the CME, RMA uses an average basis from multiple locations to arrive at a percentage of the corn price election for sorghum. NSP helped develop this calculation methodology, which has considerably increased the sorghum price election compared to the historical RMA calculation. Historically, sorghum has gotten shortchanged on the price election used in crop insurance.