Focus on Ag: Basis levels help guide grain marketing decisions
On any given day, farm operators and others can get grain price quotes from the CME Group, also known as the Chicago Board of Trade (CBOT), in “real-time” on their computer or iPhone.
Almost as quickly, they can get current and future corn and soybean market price quotes from local grain elevators, ethanol plants and processing plants. The difference between the local grain price and the CBOT price is known as “basis”. Understanding how basis works and the seasonal trends associated with basis can be an important factor in making corn and soybean marketing decisions.
More specifically, “basis” is the difference between the local grain price quote on a specific date and the CBOT price for the corresponding futures contract month. Local harvest price quotes for corn and soybeans would correspond to the December CBOT corn futures price and the November CBOT soybean futures price.
By comparison, storing the corn or soybeans after harvest and selling the grain via a forward contract in June or early July the following summer would have the basis level determined by the July CBOT corn or soybean futures price.
A “narrow or tighter basis” means that the local corn or soybean price is nearer or getting closer to the corresponding CBOT price, while a “wide or widening basis” reflects local grain prices that have a greater margin below the CBOT prices. In most instances, farmers in the Upper Midwest deal with “negative basis levels”, which means than local corn and soybean prices are lower than the corresponding CBOT prices. Areas near the Mississippi River ports or in the southern U.S may typically have “positive basis levels”, where local grain prices are actually higher than CBOT prices.
While the definition of basis may seem quite simple, the dynamics of understanding basis can be complex. Basis is variable at different locations and can vary throughout the year. It can also suddenly be adjusted due to changing dynamics in grain market fundamentals. Following are the main factors that affect basis and can lead to changes in basis levels:
- Geographic variations: Corn and soybean basis can vary greatly from location to location, largely dependent on the amount of local grain used as livestock feed or for use in processing and ethanol production. This is why basis levels tend to be wider in Western Minnesota and the Dakotas than in Southern Minnesota, which has a high amount of livestock production, as well as several ethanol plants and soybean processing plants.
- Transportation costs: This is the cost of shipping grain from the point of local sale to the final destination point, whether it be for use within the U.S. or transported to the ports for shipping to other countries. For example, areas that utilize a large percentage of corn and soybeans in the local area have less grain to be transported to the ports or to other portions of the U.S. In addition, being closer to the Mississippi River, an important port, or a major rail line tends to reduce transportation costs and result in tighter basis levels.
- Supply and demand: The overall U.S. grain supply, based on crop production in a given year and grain carryover levels from the previous year, along with the grain usage for livestock feed, processing, ethanol production and exports can result in year-to-year variations in basis levels. For example, the 2020 corn and soybean harvest price basis levels in many areas have been tighter than normal due to the strong demand for exports to China. Poor crop yields in a local area can also affect basis in a given year. As recently as early 2020, portions of southwest Minnesota and northwest Iowa had a temporary “positive basis” for corn due to the poor local corn yields in 2019 and strong local corn demand for feed usage and ethanol production.
- Storage and interest costs: In a normal year, both CBOT corn and soybean futures prices and cash prices tend to be the lowest at harvest time and then increase by the summer months in the following year. This normal trend in prices reflects the cost of storing the grain after harvest and the interest costs of holding the grain for several months. As the time gets closer to the actual date of delivery for the grain, the storage and interest costs typically decrease, and the basis tends to narrow. At times during the summer grain markets, depending on demand, the local grain prices may be stronger than the CBOT prices, resulting in tighter basis levels.
Iowa State University tracks statewide and regional corn and soybean basis levels across Iowa and southern Minnesota. The five-year (2014-15 to 2018-19) statewide average corn harvest basis level in October during the year of harvest was $0.42 to $0.44 per bushel, based on December corn futures. The basis level for July CBOT futures contracts were near $0.69 per bushel at harvest time in October; however, the basis decreased to an average of $0.33 per bushel by late June the following year. Average corn basis levels were fairly consistent across Iowa; however, basis levels were somewhat wider in southwest Iowa and southern Minnesota and basis levels were tighter near Mississippi River locations.
The five-year average Iowa soybean basis during that same period was near $0.76 per bushel at harvest time in October, based on November soybean futures. The soybean basis level for July CBOT futures contracts were near $1.08 per bushel at harvest time in October but decreased to an average of $0.63 per bushel by late June the following year.
Average soybean basis levels were also quite consistent across most of Iowa; however, basis levels were somewhat wider in southwest Iowa and were again tighter near Mississippi River locations, as well as in the Omaha markets. Average soybean basis levels in southern Minnesota were very close to the statewide average basis levels in Iowa.
There are many grain marketing tools available for farm operators to utilize in addition to cash sales, including a variety of hedging, options and basis contracts.
In general, a hedging or options contract locks in the CBOT futures price, but not the cash price, meaning that the farmer still has basis risk. For example, a “hedge-to-arrive” contract locks in a CBOT futures price, but does not finalize the basis until the futures contract is cleared and the grain is actually sold at the local level. By comparison, a basis contract locks in the basis, but keeps the final price open, depending on changes in the corresponding CBOT futures price and actual local cash price at the time of delivery.
As was mentioned earlier, the current local basis levels for corn and soybeans following the 2020 harvest season are tighter than normal. This could limit the basis improvement that is usually experienced by utilizing “hedge-to-arrive” contracts for the summer of 2021.
A basis contract to take advantage of the relatively narrow basis could be an alternative strategy, which would still keep the final price level open. Depending on an individual’s willingness to assume some market risk, they could also sell the grain for cash to realize the advantage of the current tighter basis levels and take a CBOT options or futures price position to keep some upside potential in the corn and soybean markets.
Most grain marketing strategies, including storing unpriced grain in a bin on the farm, involve some level of price and/or basis risk. Understanding the dynamics of basis in corn and soybean market prices is a key element in analyzing the various types of grain marketing contracts that are available to farm operators. Iowa State University has some good information available on understanding basis and various grain marketing strategies.
This information is available on the “Ag Decision Maker” website at https://www.extension.iastate.edu/agdm/.