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Corn Basis Predicted to Stay Strong

September 7, 2012
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A reduction in corn production, demand from ethanol and livestock producers are all supporting corn basis in the Corn Belt.


Source: iGrow, South Dakota State University

Corn basis in eastern South Dakota, as well as many areas of the Corn Belt, has had a stronger-than-average basis this past summer, said Darrell Mark, Ph.D., Adjunct Professor of Economics at South Dakota State University, during a recent iGrow Radio Network interview.

"While the expected sharp reductions in corn production have been the primary driver to the stronger basis, decent demand from the ethanol and livestock industries were supportive as well," Mark said.

He explains that basis is the difference between cash and futures prices. While aggregate supply and demand fundamentals are reflected in futures price levels, local supply and demand conditions are evident in local basis bids. Areas with low corn supply and high demand tend to have stronger (i.e., less negative, or more positive) basis levels while areas with a lot of corn supply and/or lower demand would tend to have a weaker (i.e., more negative, or less positive) basis.

"Looking ahead, it appears like corn basis will remain stronger than normal for several months, even during harvest when basis tends to be seasonally weakest due to high available local supplies," he said.

Mark says several factors contribute to this outlook. First, corn production is expected to be short everywhere, but actual harvested acreage and yields will not be known with any certainty for about four months. This uncertainty will likely cause corn producers to be slow marketing their grain in expectations of higher prices ahead. For corn buyers (livestock feeders and ethanol processors), that same uncertainty and risk for higher prices into 2013 could cause them to try to buy cash grain during harvest time during what are usually the seasonal lows.

Second, storage space will be more than adequate this year, which will enable producers to store much of their crop without delivering and selling much to elevators. In the past two years, a lot of new grain bins have been erected on farms - several of which may go empty this year with the crop shortfall.

"Interestingly, the corn market is trading at an inverse carry right now - deferred futures prices are lower than the nearby December contract," Mark said. "There is no incentive to store corn under a storage hedge (short futures hedge). Instead, the market is paying the best price for immediate delivery of corn. So, the only way to profit from storing corn is to have prices increase (and not have prices locked in on the upside through a short futures hedge, cash forward contract, short call option, etc). Still, it is likely that farmers will end up storing most of their crop on farm because they physically can, it makes harvest quicker, and they are hopeful for a price increase."

Mark adds that income tax management is another factor that is likely to slow selling this fall.

"With an average crop harvested last year and higher than expected prices this spring and summer, many producers are facing a higher tax burden this calendar year than they planned," he said. "With the need to build working capital, less favorable tax depreciation rules in 2012, and having already bought a lot of needed depreciable assets for the past two years, it is likely that farmers will not try to increase the expense side of the tax ledger this year."

He says that crop insurance indemnities that would be collected in 2012 will add to the potential taxable income this year.

"There are tax provisions that may enable some producers to defer that income until 2013, so consult your tax advisor to determine if this benefits you," he said. "Many farmers will likely want to push back crop sales until the beginning of the new year. Of course, grain sales could be made earlier than that and checks be deferred; however, that carries with it the risk of default by the grain buyer."

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RELATED TOPICS: Corn, Marketing, Crops, Analysis

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