Understanding Agricultural Basis: Factors, Basics, and Forecasting

1. ECON 337: Agricultural Marketing Lee Schulz Associate Professor lschulz@iastate.edu 515-294-3356 Chad Hart Associate Professor chart@iastate.edu 515-294-9911

2. Basis Basis = Cash – Futures Futures reflect global supply and demand Basis reflects local supply and demand Cash = Futures + Basis

3. Basis Basics Specific to time and place Typically use nearby futures Convergence Less variable than cash prices Relatively predictable

4. Basis Factors Relative storage capacity Transportation availability and cost Time to expiration Quality issues

5. Basis Terms

6. Futures Futures Cash Cash Futures Cash Basis Basis Basis Strengthening Strengthening Weakening Futures Cash Futures Futures Cash Cash Basis Basis Basis Weakening Weakening Weakening

7. Interior Iowa Daily Grain Prices http://www.ams.usda.gov/mnreports/nw_gr110.txt Thu Jan 17, 2019 Closing cash grain bids offered to producers as of 1:30 p.m. Dollars per bushel, delivered to Interior Iowa Country Elevators. US 2 Yellow Corn Prices were mostly 6 cents higher for a state average of 3.42. US 1 Yellow Soybean Prices were generally 13 to 14 cents higher for a state average of 8.13. Iowa Regions #2 Yellow Corn #1 Yellow Soybeans Range Avg Range Avg Northwest 3.37 – 3.53 3.43 8.06 – 8.15 8.11 North Central 3.32 – 3.45 3.41 8.08 – 8.18 8.12 Northeast 3.32 – 3.46 3.39 8.02 – 8.28 8.11 Southwest 3.39 – 3.50 3.45 8.10 – 8.21 8.17 South Central 3.36 – 3.54 3.42 8.08 – 8.20 8.14 Southeast 3.27 – 3.56 3.39 8.10 – 8.24 8.16 Corn basis to STATE AVERAGE PRICE for the CBOT MAR contract -.38 Soybean basis to STATE AVERAGE PRICE for the CBOT MAR contract is -.94

8. Specific to Time and Place

9. Average Iowa Corn Basis, 2012-16 Source: http://www.extension.iastate.edu/agdm/crops/pdf/a2-41.pdf

10. Iowa Corn Basis, May Futures, 2012-16 Source: http://www.extension.iastate.edu/agdm/crops/pdf/a2-41.pdf

11. Cash vs. Futures Prices Iowa Corn in 2018 The gap between the lines is the basis.

12. 2018 Basis for Iowa Corn

13. Data Source: USDA/AMS

14. Data Source: USDA/AMS

15. Data Source: USDA/AMS

16. Data Source: USDA/AMS

17. Data Source: USDA/AMS

18. Basis Information ISU Extension and Outreach, Ag Decision Maker Corn http://www.extension.iastate.edu/agdm/crops/html/a2-41.html Soy http://www.extension.iastate.edu/agdm/crops/html/a2-42.html Cattle http://www.extension.iastate.edu/agdm/livestock/html/b2-42.html Hogs http://www.extension.iastate.edu/agdm/livestock/html/b2-41.html USDA-Ag. Marketing Service http://www.ams.usda.gov/mnreports/lsddgr.pdf http://www.ams.usda.gov/mnreports/nw_gr110.txt Local elevators, ethanol plants, processing plants, etc.

19. Basis and price forecasting tool • Enter specific information • Location • Date • Weight • Frame score and grade • Sex • Number

20. Basis Forecasting

21. Seasonal Price Patterns & Basis • Period of increasing supplies, prices are expected to decline. • Cash market reflects today's supply conditions and price. • Futures market reflects upcoming conditions of expected larger supplies and lower prices. • Basis may be very narrow or cash price may be above futures. • i.e., Hogs: mid-August to mid-September. • Period of decreasing supplies, prices are expected to increase. • i.e., Hogs: late-Dec and early-Jan against the Feb futures. • Seasonal price period of relatively large supplies and low cash prices, but the Feb futures contract reflects a delivery period of expected smaller supplies and higher prices. • Low cash prices and high futures translate into a wide basis.

22. Threat of Delivery & Basis • Hedgers can deliver on a futures contract. • If enough producers deliver on futures contracts, cash prices will tend to move up relative to futures. • The threat of delivery tends to limit how wide the basis will be during the delivery period. • The variation in basis during delivery periods tends to be less than during periods with no delivery option.

23. Grain Basis vs. Livestock Basis Grain is a storable commodity and the same grain can be used to satisfy several futures contract delivery months. So grain futures prices tend to be tied to one another. Livestock is not storable so livestock futures prices for alternative delivery months tend to move independently. Because grain is a storable commodity, the grain basis is tied closely to grain storage costs and interest costs. Livestock are not storable so there are no storage costs built into the basis.

24. Grain Basis vs. Livestock Basis An inverse basis in grain futures (cash above futures) is unusual and indicates there is something amiss in the grain industry (lack of transportation, for example). An inverse basis in grains will usually last only for a short period. An inverse basis in livestock futures is not unusual for distant delivery contracts and can exist for extended periods of time. Only during the nearby futures contract delivery periods do we expect livestock futures to be above cash price.

25. Convergence

26. Convergence Issues Typically, as futures contracts reach maturity, futures price and cash prices at delivery points tend to converge to the same level. For several grain and oilseed futures contracts over the last few years, this has not occurred. “Poor Convergence Performance of CBOT Corn, Soybean and Wheat Futures Contracts: Causes and Solutions” • Scott Irwin, Philip Garcia, Darrel Good, and Eugene Kunda • University of Illinois, March 2009

27. Why Is Convergence An Issue? • Non-convergence indicates the market is out-of-balance. “When a contract is out of balance the disadvantaged side ceases trading and the contract disappears.” (Hieronymus, 1977) • Non-convergence adds to the uncertainty in basis and limits hedging effectiveness. Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

28. Factors • The relationship between the spread between futures contracts and the cost of carry (think storage costs) • In the settlement process for corn and soybean futures, the delivery instrument is a shipping certificate. • If it is advantageous to the holder of a shipping certificate, they can delay delivery and effectively store the grain, paying CBOT set storage costs. • Structural issues related to the delivery process • Does the general trade flow of the commodity line up with the possible delivery points under the futures contract? Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

29. Delivery Points How much of the commodity is moving through the delivery point areas? Corn Soybeans Wheat Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

30. Class web site: http://www2.econ.iastate.edu/faculty/hart/Classes/econ337/Spring2019/index.htm