Basis, Basis, Basis
Special thanks to Jim Squires of Glendive and Lola Raska of Great Falls for sharing your knowledge on basis.
Montana MarketManager® is a marketing education program for grain and livestock producers. Producers are strongly encouraged to visit with their grain merchandiser or elevator manager in regards to the specific grain contract(s) which currently exist or will exist in the future, and to fully understand the obligations and implications of any contract before authorizing with your signature. Please read our disclaimer.
Basis is the relationship between the cash price and the futures price of a particular commodity. An important formula to remember is Cash Price = Futures Price + Basis. The basis price represents the costs of freight, elevation (including a profit margin) and carrying charges. Understanding and following basis levels can help producers manage some of the risk involved in marketing grain.
Basis is generally more stable and predictable than the futures price and can be locked in independently of either futures or cash by using the appropriate marketing tool. Futures prices have recently been trading at historically high levels and many producers have taken advantage of these prices by forward contracting some of their anticipated production. If a futures price has been locked in with the local elevator using a Hedge-to-Arrive contract, it will be necessary to fix a basis price for that contract before delivery in order to arrive at a final cash price.
Basis levels are representative of local supply and demand and, as such, move independently of the futures market. For example, when farm deliveries are slow and demand is strong, basis levels may become stronger in an attempt to pull grain into the system with higher cash prices. Conversely, when demand is low and grain stocks are high, basis levels tend to be weaker. Historically, as the following chart shows, basis values for hard red spring and hard red winter wheat are lower during the harvest months of July and August.
Managing basis risk is an important skill in effective grain marketing. By studying basis charts and learning trends, producers can learn to recognize a good basis bid and can maximize the price they receive for their commodity.
Keeping in mind you've already agreed on a Futures price, you don't actually settle on a cash price for your grain until you've agreed upon a basis with your elevator. When you find a basis value that you'd like to lock in, simply call your elevator and let them know you'd like to set the basis at today's stated level. Of course, we would like to remind you of the old saying "If you wait for the top, you might get the bottom."
How do I calculate basis for HRS, HRW and Barley?
DNS or HRS local basis is local cash market quoted at the elevator minus the nearby Minneapolis futures contract.
HRW local basis is local cash market quoted at the elevator minus the nearby Kansas City futures contract.
For barley, futures are not trading currently on any US exchanges. Therefore, one could use nearby corn from the Chicago Board of Trade.
How does PNW(Pacific Northwest) basis relate to local basis? Which location should I use when calculating basis for my crop?
It is important to know that there is a difference between the PNW basis and your local basis. To calculate your local basis, subtract your local elevator's freight and margin cost from the PNW basis. If you are unsure what your elevator's freight and margin costs are, call your local elevator manager and ask what he is taking off the Portland price to arrive at a local price. The formula for calculating your local cash price then remains the same:
Local cash price = Futures Price + Local Basis.
Preferably, you would use the bid at the local elevator (or wherever you conduct business) to calculate basis. However, reliable records are not always available from individual elevators. Also, a local elevator's bids will fluctuate depending on his needs at the current time. Your best bet is to follow the PNW basis, which is more consistent and stable over time.
This is where you are in luck! The Montana MarketManager website has weekly PNW basis charts for 11, 12, 13% HRW and 13, 14, 15% HRS. The charts are under the password-protected portion of the site, which is available free of charge to members of the Montana Grain Growers Association or the Montana Stockgrowers Association. If you are a current member and don't have a password, call the MGGA office at (406) 761-4596.
The most predictable feature of the basis is its tendency to strengthen - by the amount of reduced storage costs - as the delivery month approaches. Thus if storage costs of $.04/bu/month are included in the basis, it is likely that the basis will strengthen at the rate of $.04/bu/month. This assumes other components of basis remain unchanged. This tendency for the basis to become stronger as the delivery month approaches is known as convergence.
One description of basis is that it is a barometer of demand. When it narrows or gets more positive it is telling you time is passing and/or there is greater demand for the grain. If it widens or weakens, it becomes less positive and is telling you that the elevator doesn't want the grain. If you are able, store it until you see an improvement in basis. You must still remember that there are two parts to price, the futures portion and the basis portion. If the futures are acceptable to you, lock it in with a HTA contract. Other options can be viewed here.
Disclaimer: Montana MarketManager® is a marketing education program for grain producers. It is not a marketing advisory or brokerage service. The content herein is intended solely for informative purposes and is not to be construed, under any circumstances by implication or otherwise, as an offer to sell or a solicitation to buy or trade in any commodities or securities herein named. Information is obtained from sources believed to be reliable, but is in no way guaranteed. No guarantee of any kind is implied or possible where projections of future conditions are attempted.