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Understanding basis is important to making wheat marketing decisions
Posted July 31, 2013
By Jessica Johnson
Extension Educator – Ag Economics
Understanding basis is essential to making marketing decisions for wheat. Just as quickly as prices change, so does basis. Being aware of basis risk will help in making informed marketing decisions such as hedging and forward contracting.
Basis is the difference between the local cash price and the nearby futures contract. It is a measure of the transportation costs associated with moving a commodity from the local elevator to a specified delivery point. Supply and demand of a local commodity has the greatest impact on basis. However, availability of transportation, storage, and interest rates also impact basis.
Basis is usually discussed as “stronger” (or “narrower”) and “weaker” (or “wider”). A narrower (stronger) basis is an indication of lower transportation costs, or that local elevators are demanding the commodity and are willing to pay more for the product. Conversely, a weaker (or wider) basis indicates a larger transportation cost or that the local market is not demanding the commodity.
The Nebraska Panhandle has traditionally been a wheat-deficit area with a negative basis. From 2007-08 to 2011-12, wheat basis averaged around 1.00 under. September is typically the weakest basis at 1.16 under, and May is the strongest at 0.88 under. The 2012-13 crop year was a much narrower year; all 12 months were stronger than the 2007-08 through 2011-12 average. September was the weakest month at 0.87 under, while April was the strongest at 0.38 under.
Changes in basis create potential for both losses and gains in hedging and contracting your crop.
Basis movements and patterns are important in determining the expected price when hedging. Basis can be used to predict the net local hedge price by subtracting the expected basis from the current futures price to acquire an estimated net price.
Once a hedge has been placed, basis affects the amount of return that you can receive. If the basis is narrower than expected, the returns will be greater. If the basis is wider than expected at the termination of the contract, the returns will be less.
Basis can also be used in deciding between a hedging program and cash forward contracting. Forward contract basis is calculated by subtracting the forward contract price from the futures price.
If the forward contract price basis is substantially wider than the expected basis (the difference between the cash price at the time of contracted sale and the futures price), it may be more logical to hedge rather than forward contract. However, if the contract basis is comparable to the expected basis, a forward contract may be more advantageous than hedging.
Moving into a new marketing year, knowledge of the stronger area basis will be a key player in wheat marketing decisions. Keeping a close eye on basis movements can help obtain greater returns for your operation.