GRAIN BASICS
BASIS
What it is and how it works
By Mark Welch Texas A & M AgriLife Extension Economist
What is the price of grain ? That sounds like a pretty simple question , and it is once we agree on what kind of grain , where it is located and when will it be available for sale . If I am a corn grower , I am probably interested in the price of # 2 yellow corn , since that is the kind most commonly grown . It is the standard grade for livestock feed and ethanol production , the two corn use categories that account for about 90 percent of domestic consumption .
Location is important for price determination . Most often when someone quotes the price of corn , they are referring to the price being traded at a futures commodity exchange . A futures price is simply a forward contract with four basic elements : a specific amount of a commodity , of specific quality , delivered to a specific place , at a specific point in time . The only negotiable part of the contract is the price . For our corn , that means we are interested in the price being traded at the CME in Chicago . The contract size is 5,000 bushels of # 2 yellow corn delivered to the Chicago area during the contract month — March , May , July , September , or December .
The futures price is the reference price for corn because it is widely traded on an open exchange . Buyers and sellers from all over the world present offers and bids that perform the price discovery process . The closing price each day represents the consensus of global opinion as to what a bushel of corn is worth .
If our corn is not in Chicago , we may be more interested in the local price . The amount that the local price of corn is above
or below the price quoted on the futures exchange is called the basis ( basis equals cash minus futures ). The basis is impacted by several factors , including transportation costs , storage and handling charges , interest costs , quality , and local supply and demand conditions . Generally speaking , the farther the grain is from the delivery point or point of consumption , the weaker the basis ( cash relative to futures is lower ). The closer the grain is to that point of delivery or consumption , the stronger the basis ( cash relative to futures is higher ).
The price of corn in three primary production / use locations illustrates this point ( see Figure 1 ). We will consider the price of corn the first week in March for a normal year , 2007 ( the yield the year before was right at trend , the stocks to use ratio was average , and we had not yet entered the ethanol boom years ), a short crop year , 2013 ( following the drought of 2012 ), and a surplus supply year , 2017 ( following record high yields in 2016 and the highest stocks to use ratio in more than 10 years ).
In a normal year , the basis in south central Illinois the first week in March was -20½ cents ( the cash price 20½ cents below the futures price ), the basis in the heart of cattle feeding in the Texas panhandle was + 26 cents , and the basis at the gulf in Louisiana was + 39½ cents . These basis levels demonstrate the typical handling and transportation costs for corn from a farm in a major production region of the Corn Belt to either a delivery point for corn in Chicago or to primary corn use markets .
In a short crop year , if we assume the basic handling and transportation costs were unchanged , the change in the basis demonstrates the impact of changing supply and demand conditions on this cash / futures relationship . Corn users bid up cash prices
16