Hedging The Basis
Stated simply, the “basis price” in agricultural commodity markets is the difference between the local cash price of a commodity at a given location and the futures price in the contract month closest to delivery. However, the basis price is itself actively traded and influenced by a complex set of economic and environmental factors.
Producers and grain elevator operators trade basis prices to hedge against falling local prices. They will typically sell futures contracts at an agreeable price to take a short position in the futures market and buy them back after harvest when they sell their crops in the cash market. Similarly, food and feed manufacturers trade basis prices to protect against rising local prices. They will routinely take a long position by buying future contracts to secure a manageable price while the crop is growing and sell those contracts when they go to buy their supplies in the cash market. During the period that they hold futures positions, they hedge the difference between futures and cash prices by trading basis.
While futures and cash prices are affected by global commodity movements, US basis prices are mainly affected by local conditions. Certain areas typically have a negative basis while others will typically have a positive basis. Local basis prices in most of the US Corn Belt states are routinely negative; it is common that the local cash price is less than the current futures price. The major grain-producing states are frequently flush with corn, soy, and wheat. Local supply is high which reduces local prices. Conversely, areas with lots of soybean crushers, ethanol plants, and feedlots can experience shortages which boost basis even though supply isn’t far away. Basis near North Carolina’s enormous hog industry has stayed significantly positive for years.
There are other aspects to consider as well. High transportation costs encourage cash price discounts for corn in places like North Dakota, where producers need to stay competitive in the market. Corn farmers and elevators in North Dakota are typically exposed to huge negative basis prices that are offset by other factors like cheaper land prices.
Under certain circumstances global events can also affect basis. The trade war between the United States and China that began in July of 2018 caused US soybean basis prices to drop to record lows in Louisiana and other Gulf export regions as Chinese demand for US soybeans almost completely stalled. In the same vein, the global trade contraction that was part of the 2008 financial crisis also caused basis prices to plummet.
The chart above shows daily high and low basis prices for soybeans for delivery in 30 days by barge to Louisiana Gulf export elevators. In late September 2018, the basis prices for soybeans at these locations collapsed as a result of the tariffs placed on US soybeans by China.
The Role of Weather in Basis Prices
Weather can play a large role in determining local cash and basis prices. For instance, a prolonged drought in the eastern part of Wisconsin may not significantly affect futures prices, but will likely increase local cash and basis prices for corn and soybeans as it will cut into local supply. In the summer of 2012, the US suffered a prolonged drought which significantly knocked back production of both corn and soybeans. Toward the middle of July 2013, elevators across most of the US were scraping the bin bottoms for 2012 remnants. Futures prices were buffered by supply from other sources of global corn and soybean production, but corn and soy basis prices sat at record highs for many localities in the Midwest due to the shortage of available supply. Then in the last week of July, basis prices for both corn and soy dropped nearly 20 percent overnight as prolonged rains and cool weather ensured strong new crop production. The promise of a good crop crashed cash prices as elevators dumped the last of the 2012 old crop to make room for the coming new crop.
The chart above shows the increase in yellow corn basis prices as corn stocks from the meager 2012 crop began to dwindle. In late July of 2013, rains throughout the Midwest ensured strong production which caused basis to collapse.
The above map illustrates the extensive precipitation throughout the US Corn Belt states that preceded the 2013 collapse of corn basis across many US storage locations.
In a normal year, grain flows from the producing areas in the Midwest down the Mississippi River to export terminals on the Gulf Coast. The ongoing flooding that’s frozen Mississippi River barge movements has cut basis in areas with big supply and bumped it up in demand centers. Following the closing of the river at St. Louis, basis prices for spot delivery by barge have increased over the past few weeks in Ohio River locations like Cincinnati, Ohio and Evansville, Indiana. Points along the Ohio and Arkansas Rivers now host some of the only operable elevators south of the St. Louis blockage, so they can charge a premium on their dwindling stocks. At the same time, AMS-reported regions that lie along the Illinois River north of St. Louis have discounted basis prices for spot delivery by barge since the flooding began. But because harvest is still a few months away, basis has remained relatively stable compared to the near-panic that would occur under similar flood conditions in August or September.
The above chart illustrates the increase in basis prices for yellow corn intended for immediate delivery to barge loading elevators in Cincinnati, Ohio (green), Mt. Vernon-Evansville, Indiana (blue) and the decrease in the same prices for locations on the Illinois River North of Peoria (red). The price divergence began early in April, a few weeks after severe flooding began on the Mississippi.
International Trade Considerations
Small disruptions to local markets can have immediate consequences in basis prices. In late May 2013, a farmer in Oregon noticed that unexpected GMO wheat had sprung up in ground near his farm. This discovery caused a panic in the spring white wheat market. Asian countries including Japan and South Korea prefer to use soft white wheat in the production of noodles and crackers, but have stringent regulations prohibiting the use of GMO crops in manufactured food products. Japan and South Korea immediately cancelled thousands of tons of wheat shipments as the USDA scrambled to confirm that the reported GMO wheat was not a warning of a much larger issue. In the end, the alarm turned out to be an isolated incident, but basis prices suffered over the ensuing weeks. AMS did not report cash or basis data for export elevators in Portland during the month of June, but industry reports from that period indicate that basis bids in Washington and Oregon slid over the course of the month. When reporting resumed on July 1, spring white wheat basis prices in Portland had fallen 25 cents.
The chart above illustrates the data gap in AMS Grain basis prices caused by the cancellation of all shipments of soft white wheat to export markets in Asia at the end of May following the discovery of GMO wheat in Oregon fields. The situation turned out to be an isolated incident, but sent basis 25 cents lower when shipments resumed at the beginning of July.
Cash and basis price dynamics are complicated. Trade uncertainty, weather volatility, shifts in consumer preferences, and commodity demand all interact in ways that can make financially optimal courses of action tough to figure out. With the addition of AMS Grain to the long list of data sources on the Gro Intelligence platform, market participants looking to hedge their positions in the futures and cash grain markets can more easily visualize information and build models to make better informed decisions.
AMS Grain provides daily insight into local cash and basis prices for a basket of important commodities across the US, and can also be used to better understand weekly, monthly, and annual market trends. These data can be used to gain insight into how local supply and demand, transportation logistics, location, and a variety of other factors influence local pricing dynamics. The ready accessibility of data like AMS Grain on the Gro Intelligence platform gives experts the power to quickly and easily analyze a complex set of changing circumstances in the US cash grains market in near-real time.