Reading the Basis: The Value Which Determines When Grain Is Moved

I am harvesting one of my bigger corn crops.  In fact, I wonder where it all is going to go.  However, it is a very good thing because as farmers that’s what we planned for all year.  We face a perfectly elastic demand curve for our crops.  In other words, it doesn’t really matter what we produce, it has no impact on the price we get for our commodity.  We are price takers.  So every spring in southwestern Ontario I go out to the field hoping to produce as much as I can.  In 2015, for me it looks like record levels.

That is a good thing for me because despite all the problems I had with weather this year, for whatever reason I’ve got a good crop.  It also means that my neighbors across the road have a good one too.   So in Ontario we’ll have to figure out what to do with the abundance. It certainly sets up the specter of too much supply overwhelming our Ontario demand.

That is where it surely gets interesting when it comes to pricing our Ontario farm commodities. As we all know, our commodities are priced on the futures market with an adjustment for basis.  With so much crop coming out of Ontario fields this year it should certainly lead to some interesting basis gyrations.

Of course, I defined basis as the value, which determines when grain is moved.  If the basis for corn is +$1 over the nearby futures in Ontario that is the value, which grain is being moved.  If it is +50 or -50 the definition remains the same.  It’s the same for any type of basis value for soybeans or wheat.  Is a reflection of the localized supply and demand for grain at a certain time in the local area?  Key in my mind is to keep the definition of basis simple.  Anticipating basis levels and changes however can be very difficult to determine.

I had a discussion with an American grain analyst today regarding basis.  She had just written an article on “basis” for a popular American agricultural magazine.  In the article basis was mentioned as a function of localized supply and demand as well as elevator and end user presence in your area.  It was all great stuff, which you can apply to Ontario.  In essence, the job of basis is to get grain from where it is to where it isn’t.  At least that was one of the very good points from the American writer.  The challenge of course is to understand and to get market intelligence on how the localized supply and demand is playing out.  That is extremely difficult.

I say that because it is difficult to know whether farmers are selling or not.  It is difficult to know whether boats for export are being loaded at Ontario ports.  It is difficult to know in the oligopoly world of Ontario grain end users, what they are thinking.  Simply put, it’s just difficult to know how basis will change under the circumstances until it has.  When you add the foreign exchange component of Canadian basis into the mix it makes it that much more difficult to know.  However, having said that, basis is not an enigma.  It is simply the value which grain is moved.

There is a huge difference between the American definition of basis and the Canadian definition of basis.  99% of that has to do with the foreign exchange difference between the US and Canadian dollar.  When I question my American friends about basis levels they usually do not take into consideration the foreign exchange across the US Canadian border.  That is understandable because the cross-border trade in grain between Ontario and Michigan is a localized phenomenon in a much bigger American grain world.  So when you read the American genre about basis keep in mind it’s all good stuff but usually does not contain anything about foreign exchange.

In Ontario and Quebec the movement in the Canadian dollar over the last two years has had a tremendous impact on Canadian basis levels for grain.  At the present time in Ontario we have a +70 cent basis for corn and a plus $2.20 basis for soybeans in southwestern Ontario.  To a large extent, this is simply a foreign-exchange conversion of the futures price.  With corn in Ontario and Québec it is slightly different, with foreign exchange being important but the litmus test is always the US replacement price of corn coming into Ontario.  Typically, corn needs to be exported out of Ontario at harvest time and imported back in later in the year.  This usually leads to an import basis much higher than the harvest basis.  It never quite works out that way but in general that’s how it works.  It’s a fluid situation every year.

Needless to say, daily market intelligence is key to identifying basis opportunities.  Keep in mind, once again, the definition of basis is simple, it is the value which grain moves at.  With the Canadian dollar being so low in the $.75 US range it creates somewhat of an optical illusion that cash prices are pretty good, when in fact they are based on futures values, which are quite low.  In Canada, as grain producers this is our constant.  In the United States, it doesn’t work this way, the US dollar is the US dollar and that’s just the way it is.

So this year in 2015, basis is tighter in the Eastern Corn Belt where wet spring weather damaged crops vs. the Western Corn Belt, where crops were good.  At the same time last summer in Ontario, wheat basis dropped $1.10 overnight on quality concerns.  Basis might be simple, but it can be so complex too.  It’s simply the value which determines when grain is moved.  It’s like an elastic band, constantly flexing.  Getting on the right side of it sometimes can be a real challenge.