Getting to the bottom of basis


basis is a hot topic throughout the entire growing season but discussions usually peak right around harvest when there is surplus grain in local markets. Frustration can also grow when marked differences between the Ontario basis and the basis in nearby states like Michigan and Ohio vary significantly.

The common explanations for these differences are the exchange rate and transportation costs. But, the Ontario Grain Farmer wanted to delve a bit deeper. We have posed the following question to four  market commentators and one farmer: 

Why is there such variation between the Ontario basis and the basis in the nearby US markets?

Here are their responses.

kevin hachler, london agricultural commodities
Chicago Board of Trade futures prices are a general reflection of supply and demand forces on crop prices across the US (or even the world) as a whole.  This one-size-fits-all approach to price discovery works well to establish a base value for a given commodity but does not take into account regional market conditions, freight costs, elevations and currency exchange rates.  Basis levels compensate for these differences by adjusting local prices relative to Chicago futures so as to allow for the flow of goods from surplus to deficit markets. 

During the 2010 marketing year for example, Ontario corn producers took advantage of bin-busting crops and high prices by selling aggressively during the fall and winter months.  This selling pressure overwhelmed the marketplace and excess supplies needed to be priced low enough to be exported to less saturated markets such as Michigan.  Producer selling pressure was so large and front-end-loaded that exports actually overshot the Ontario marketplace, throwing the province into deficit corn status by summer.  Basis levels then rallied sharply to the point at which the cheapest corn became that which could be purchased and shipped back in from nearby states.

Being that we live in Canada and wish to conduct business in terms of Canadian currency, basis levels are also used to adjust the prices paid to producers so as to take into account exchange rates.  Exchange rate swings are often more dramatic than are changes in local supply and demand and have a tremendous effect on prices.  If a bushel of soybeans picked up at the farm gate in Ontario is worth $13.00 in US funds, a Canadian dollar of $1.05 US would mean that this bushel is worth only $12.38 in Canadian funds.  By the same token, if the Canadian dollar is trading at $0.70 to the US dollar, this same bushel would be worth $18.57 Canadian.  Unfortunately, because the Canadian dollar is essentially a commodity-based currency, it would be difficult to imagine a sustained situation of both high commodity prices and a weak Canadian dollar. 

moe agostino,
The corn price for the new crop is completely dependent on the weather. In the US, if everything evens out on a national level when it comes to corn yield, futures will probably correct but the Ontario basis will remain fairly strong as it is shaping up to be a tough year in the province.

Ultimately, it all comes down to supply and demand. In a year like 2010 where we had lots of corn in the province with the same number of buyers, you’ll see the basis go down. In a year like 2011 is seemingly shaping up, less corn with equal number of buyers equates to a high basis.

Exchange rate differentials also factor into the basis. If you compare the current basis with the basis of four years ago when the Canadian dollar was much lower, you can see what an impact this factor has. However, the current demand for Ontario corn has significantly off-set this impact. We have much more demand than we used to, which is lucky or else we’d see a significantly lower basis.

Transportation can also play a role in the Ontario basis and for this reason, it’s important to shop around. Always leave your options open and call a few different buyers before delivering to help manage that basis risk.

steve kell, parrish &?heimbecker
Basis is a complicated beast. We’ve seen a big paradigm shift as the speculation funds take on a bigger role in the futures market; the swings have become a lot bigger. It’s not uncommon to see a $0.40 swing in the wheat futures when nothing has actually happened in the wheat industry in terms of real supply and demand.

As always, the basis swings in the opposite direction and in this new, more volatile environment, those swings are much larger as well.

Basis is really just the flat price corrector. If you take future and basis and add them together, that’s the actual value that grain transacts at; that is what grain is worth. You can’t look at futures or basis on their own – that’s a misrepresentation of what grain is actually worth.

The difference between the basis in Ontario and the basis in the nearby US has a lot to do with the number of buyers and the number of sellers. In the wheat industry, there are simply more buyers in Michigan and Ohio which is why you see the differential between our bases. Within the Ontario basis, the cost of transport to Toledo must be taken into account and there is also an unwritten barrier that may be seen in these numbers. Just like the local food movement has swept Ontario, it has also swept the US. Some may say that American flour mills prefer American wheat and that preference can be reflected in our basis.

Our basis is also reflective of cultural practices in the Ontario wheat market. Ontario farmers have a greater tendency than our nearby American counterparts to dump wheat at harvest. Room must be made in the bins for soybeans and corn and therefore, more wheat is sold at harvest when prices are seasonally low.

This year, I’m optimistic for a positive market for Ontario wheat farmers. With a slightly smaller crop, I wouldn’t be surprised to see more farmers storing wheat and waiting for better prices.

todd austin, grain farmers of ontario
Each commodity traded on a futures contract has a parallel market for trading the physical commodity; the cash market. The two markets are related to each other through basis which represents the difference between a futures contract price and a local price.

Basis is adjusted by buyers to either encourage or discourage delivery of grain. In other words, it is a barometer of local market strength or weakness. Basis tends to be weakest at harvest, as this is usually the period of greatest supply.

We often see a marked difference between the basis in Ontario and the basis in the nearby US. There are many reasons for this difference and most people know the usual suspects: transport costs and the exchange rate. Another player that is often forgotten when discussing this difference is management  practices on the farm. In Ontario, grain – especially wheat – tends to move more quickly at harvest than it does in the US. There is a more widely developed infrastructure of on-farm storage in the nearby US compared to Ontario. This storage provides US farmers with a
slight advantage of not being forced to sell at harvest when prices are historically low. These differences can often be seen reflected in the basis at harvest time.

Another factor that is often forgotten is the extra cost of trucking across the border. Although it is common for most to consider transportation fees in their understanding of basis, it is easy to forget about added fees associated with
cross-border transportation. Not all trucks are certified to cross the border carrying grain and there are often additional brokerage fees.

kevin marriott, farmer, lambton county
I try to think of the basis in the same terms that I think of the Chicago market. Chicago is a large-scale price setting mechanism that’s a mixture of all these different opinions. The Ontario basis is exactly the same, but on a smaller scale.

In each market, you have buyers who can afford to pay more and buyers that believe they should pay less. The market acts as a mechanism that takes these different opinions and sorts out the true value of any given commodity. The basis is just another market. It’s the tugging and pulling of buyers, what they need and what they’re willing to pay for it. In Ontario, there are fewer buyers and sometimes, their needs don’t always fall in line with what’s happening in Chicago.

Last year, the corn market seemed to make no sense. The Chicago price was attractive and therefore, everyone in Ontario wanted to sell. Unfortunately, buyers in Ontario only need so much corn at one time and when everyone wants to sell, the basis is driven down because our local market cannot handle the supply.

Understanding that the Ontario basis is a supply and demand market just like Chicago can help guide selling decisions. When there are lots of sellers and few buyers, the basis will be low. When there are few sellers and lots of buyers, the basis will be high. The Ontario basis acts as a mini-Chicago in this way.

As for the difference between our basis and the local US basis, it all depends on our local buyers and sellers. There are costs to transport grain across the border and we don’t have as much access to those markets as we would sometimes like. Sometimes, the US basis sets a ceiling or floor for our basis, but this is simply a general guide. Ultimately, Ontario acts as its own mini-market. •