Understand The Basics of “Basis”

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Created on Wednesday, 15 September 2021 22:09
Last Updated on Wednesday, 15 September 2021 22:09
Published on Wednesday, 15 September 2021 22:09
Written by Joe Schmidt
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  • Transportation: If a producer takes his grain to a grain elevator, they still have to transport that via rail barge or truck to an end user or an export location.  So, the farmer has to take into account that they're going to have that cost incurred. 
  • Profit margins: Grain buyers are in the business of buying grain and make their money through purchasing large quantities of grain.
  • Storage costs: Similar to the costs incured by storing grain on the farm, grain buyers have costs when they take in grain.   
  • Local supply and demand:  Basis is inherently localized.  For example, if a large weather event decimated yields in your area and surrounding areas, basis levels may strengthen.  This is an example of the big difference between futures and cash market influences — basis might improve when there’s a localized issue like this, but it’s unlikely futures prices will be impacted because it’s so small in terms of the national and global market.

When basis is stronger than normal, the producer’s cash-marketing strategy should be to lock in basis but not necessarily price.  On the flip side, when basis is weaker than normal, the strategy should lock in price but not basis.  And the exact opposite applies to the grain buyer’s strategy.

Over time, basis tends to move back to a normal level.  By following this basic marketing strategy, you will improve your grain marketing by adding the change in basis to the final selling price.

Understand Basis Contracts

A basis contract allows you to set basis, but leave the futures price open to set later.  Thus, your cash price on the contract is also not established until you set your futures price (cash price = futures + basis).

You would use this contract when you feel basis has reached a level you'd like to lock-in, but still want to give yourself time to set the futures price.  You will need to either price futures or 'roll' the contract before the futures month expires.  Typically, the contract will have a 'price by' date or similar field.  Keep in mind, there's usually a fee associated with basis contracts - ask your vendor.