Over the last few weeks we’ve seen tremendous volatility in the commodities. My colleague DTN Darin Newsom talks about “chaos theory” and the “butterfly effect”, a small-unforeseen butterfly flapping its wings in Lower Gongoland, which may cause havoc in the markets in Chicago and New York. So when that Tsunami wave washed ashore, it was “Chaos theory” squared. Limit up and down markets certainly define market volatility.
With futures constantly in flux, especially now with things glowing in the Japanese darkness, our basis seems lost too. In Ontario farm country, with futures pushed in all directions over the last six months, there has been much angst regarding the disparity between futures and cash prices.
Understanding basis isn’t easy. I’m paid to comment on Ontario corn basis levels and I try to give the best information I can come up with. However, at the end of the day, I find basis to be a mysterious concept. It is such a moving target, shaped by market forces played out in private, but at the same time public. Make sense? I know, that’s doesn’t add up. In 2011 that’s becoming more and more of a problem for Ontario farmers.
The classic definition of basis goes something like this. The local cash price offered for corn, wheat or soybeans is the futures price adjusted for such variables as foreign exchange, freight, handling, storage, quality and localized demand. The price difference between futures prices and the cash price is called “basis.” If you find that confusing, I like to go a step further, ignoring that to consider basis this way. Basis is the value, which determines when grain is moved. (Bought or sold) That works for me.
On Tuesday March 22nd I’ll be speaking to delegates at the Grain Farmers of Ontario Commodity Classic in London Ontario with a presentation called, “Market Volatility and Our Changing Ontario Basis Environment”. It’s there I hope to have a wide debate on just what “Ontario cash basis” means.
In Ontario the corn basis is determined by the US replacement price. Ontario corn end-users at Casco and the ethanol and large feed plants determine cash prices. The soybean cash basis is largely determined between the two biggest processors in Windsor and Hamilton vs. the export price. Wheat cash basis in southwestern Ontario is determined off the Toledo price. In central Ontario the wheat cash basis is determined off the central Ontario flourmills and in Eastern Ontario it’s determined off the export price. Of course Ontario quality is very important for cash basis. If Ontario quality is not there, good cash prices aren’t either.
Having said that, there is more. Sometimes cash basis in Ontario involves a huge “fudge factor”, or what I like to describe as “the unexplainable.” It’s mainly a function of the effect of the non-commercial interests in the futures market. Since 2007, frenetic volatile agricultural futures have skewed basis. Simply put, end users will not pay those higher prices especially at times of high volatility, which in 2010/11 is almost all the time. So basis grows wider, with a huge “fudge factor” built in. Gone are the days of a formula to figure out “cash basis”. Of course gone are the days of cash corn being $2.50 plus or minus a nickel. The psychology of “cash basis” has simply changed.
The problem lays in the fact that even though the psychology and mathematics of basis has changed, many Ontario farmers have not moved on with it. In other words, if we’re still trying to calculate basis on a formula, when essentially it doesn’t exist anymore, our marketing decisions get skewed. In 2011, we need to consider the known “basis factors” then add this “fudge factor” or “unexplainable” concept of basis into our decision making process. It’s not as difficult as it might seem, as long as you throw away what you’ve always considered the gospel of traditional basis calculations.
Think of the “fudge factor” or the “unexplained” this way. In times of extreme market volatility, end users don’t want to pay and they lower their risk by lowering basis. In Ontario, our market structure is such that export prices determine our cash prices for wheat and soybeans. There are few Ontario processors for a crop that out strips localized demand. So end-users hold back. With corn it’s a bit different as there are more end users. However, even with corn, Ontario end users operating in a competitive market place, watch US replacement price and hold back. When the futures market is volatile, the “hold back” is substantial.
To change our Ontario cash basis environment, we need a change in market structure. We have it to some extent in corn with the large industrial component now in place, which was largely subsidized by the Ontario government. To change it in soybeans and wheat, the same type of market structure change would be required. Using up these commodities in a “different way” than just exporting needs to be job one. The only problem is, it would take large gobs of government investment to do it, just like the $512 million plus dollars the Ontario government poured into the Ontario ethanol complex.
Will it get done? I doubt it. However, never is a long time. Ontario cash grain basis will remain in flux. Yes, it’s determined a certain way. Needless to say, it’s not straightforward. It’s always open to debate. The reality is, it is what it is. Despite contrary notions, that’s the best I can do.