Scheve: Strong Basis Levels Open Up Opportunity Even In The Face Of Weak Futures Prices
Apr 15, 2019
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Market Commentary for 4/12/19
The futures market continues to face an uphill battle with demand while the USDA's reported supply indicates carryout could be back to burdensome levels. This is keeping a lid on futures prices.
Strong Basis Levels Open Up Opportunity Even In The Face Of Weak Futures Prices
Right now, farmers are unhappy with cash prices, so they aren't selling. This is making basis stronger. End users can't control futures prices any more than farmers. The only way an end user can control how much supply they can source is to adjust basis. When supply is easy to source (i.e. harvest time), they'll lower the basis bid. When it's difficult meeting demand (i.e. planting time), they will increase it.
The basis market can be as complex as the futures market for two big reasons. One, there are many companies trading grain by basis and moving product by vessel, barge, rail or truck from one basis market to another looking for inefficiencies in the cash market and trying to maximize profits from it. Two, the freight movement and the costs associated (i.e. fuel costs, back-haul rates, and regional freight demands) from this movement can vary a lot from region to region for many different reasons.
For instance, if an end user has difficulty procuring supply, they'll raise their basis. This can have several different possible outcomes. It may encourage local farmers to sell some grain. But it also could entice the transport of grain from outside of the end users local growing area from other farmers or grain elevators. It’s the process of moving grain from a lower-priced basis area to a higher-priced basis area.
This constant bushel shifting and shuffling creates basis opportunity and why the basis values are always moving. Corn might be moving in one direction during the year, and a different direction months later. There's also no guarantee grain will move the same direction or to the same end user every year.
Why Are Basis Levels So High Right Now?
Reason #1 - The addition of on-farm storage (i.e. bins, bags, etc) decreased the anticipated pressure at harvest on the whole grain complex and has continued on until now. Many elevators across the US were reporting less grain delivered at harvest than they were expecting. Initially many believed it was due to lower yields; however, the March 29th USDA stock report suggests more farmers have stored more of their own grain at home.
Reason #2 - Farmers aren't selling at these lower futures values, because historically if farmers wait long enough prices, specifically futures, have usually rallied. In 10 of the last 12 years, July futures eventually were above $4 after April 1st. In 2017 (after the '16 crop), July futures topped out at only $3.87 in June. And in 2010 (after the '09 crop), July futures topped out at only $3.78 in May. As of Friday, July futures were at $3.69.
These strong basis values may last until farmers know if they will have a good crop year, which is usually sometime after July 4th.
Market Action – Basis sale
In the last 10 years, I've sold my cash corn to 8 different end users. Following lists all possible end users available near my farm in Southeast Nebraska:
- 2 shuttle loaders within 10 miles
- 2 feed mills within 20 miles
- 1 dry milling plant within 30 miles
- 2 ethanol plants within 60 miles
- Many large cattle feed yards are about 200 miles away
- The chicken industry is 400 miles away
It's difficult to determine which end user will have the strongest bid until late spring or summer. I also rarely sell my grain to the same end user as the year before, because of the reasons listed above (i.e. different freight rates, regional growing conditions, export sales, ethanol demand, etc.).
On our farm we almost never haul our own grain off the farm. While occasionally we will hire commercial truck drivers for local and long distant hauls, most of the time end users provide better bids when they pick up the grain on our farm directly. That could be because they have better freight rates or because they want flexibility to take the grain to different locations and look for the inefficiencies in the market.
For our farm, basis levels are the best I've seen in several years. With farmers generally not selling throughout the US, it's created good opportunities for me to maximize my basis profit potential. Usually, 2 of the end users listed above will have matching bids that provide the best opportunity for me to set my corn basis at any one time. In the last month my best bids were from 4 different end users. I have never seen such strong demand from so many end users at one time.
While basis levels are strong, I still want to keep my grain stored as long as possible to capture as much market carry profit I can. However, I need to be sure the grain I'm storing every year stays in good condition. So, I usually core out the middle of my bins in late winter or early spring to remove the fines and check the condition of my stored corn.
At the end of March, before the upcoming busy planting season, I set my basis at -28 against May futures with four different end users on 25% of my ‘18 production. This is much better than my -42-cent average basis for the last 3 years picked up on my farm. Since the March 29th futures collapse, basis in my area, as well as across the whole corn belt, has improved at least another 5 cents. This means my remaining stored bushels still have some opportunity left for potentially even higher basis prices than this recent trade. I’m not disappointed that I sold early though. I needed to core the bins, and this price was better than the previous month. I try to keep the perspective that I want every sale I make to be the worst of the year, because I always have more grain to sell down the road.
While futures prices may be disappointing right now, basis prices are very good. This is another example of why it's important to maximize the profit potential within each factor that makes up the cash price (i.e futures, carry and basis) independently. Focusing only on the cash price limits farmers' opportunity. Separating futures from basis, allows me to maximizes basis potential now, while futures values are down.
Some in the industry are saying a significant futures rally could hurt basis values. Maybe, but, last year futures rallied 30 cents in the spring, and basis went up too. Basis is a better indication of actual grain movement. As a general rule - when basis drops, grain is moving or demand is weakening. When basis is up, there is lack of movement or supply is limited. Basis can occasionally be a good indicator of potential futures market direction.
Want to read more by Jon Scheve? Check out these recent articles:
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