Run the numbers and don’t be buffaloed by basis

Your grain company likely uses unadjusted basis in U.S. dollars, 
but you want basis and the cash price in the same currency

Run the numbers and don’t be buffaloed by basis
Reading Time: 2 minutes

Wheat basis has been a hot topic this year and a weak loonie has continued to make it an issue, says a provincial market analyst.

Basis is calculated as the difference between the cash market price and the relevant futures price. Spring wheat futures, as traded on the Minneapolis Grain Exchange (MGEX), are generally used as the reference futures price for hard red spring wheat. When this price is deducted from the elevator cash price, the result is the “basis” as quoted by most grain companies operating in Canada.

“It is important to remember that MGEX futures are traded in U.S. dollars,” said Todd Bergen-Henengouwen. “So to calculate the basis; one should convert either the futures price to Canadian dollars or the local cash price to U.S. dollars. This way, the basis can be measured in U.S. or Canadian dollars.”

Since each individual buyer sets basis levels, many producers monitor basis levels as a way to gauge how badly the elevator wants their grain. Grain companies offer contracts that allow producers to lock in just the basis level and later lock in the related futures price.

So upon signing a basis contract, the price that the producer will receive depends on the futures price. For example, if a producer signs a basis-only contract at a value of $0.50 per bushel OVER and later chooses to settle on a futures price at $5 per bushel, the producer would receive $5.50 per bushel for the grain. The contracted basis of $0.50 per bushel would remain the same regardless of any market forces that could affect it during the span of the contract.

“Understanding how wheat basis is reported is important for producers to understand before they enter contracts,” said Bergen-Henengouwen. “Some key questions to ask are: What currency is the basis in: Canadian dollars or U.S. dollars? When the basis contract is settled against a futures position, is the contracted basis applied directly to the U.S. denominated futures, or is it applied after the U.S. denominated futures is converted to Canadian dollars? In other words, from the time that basis contract was signed, does a change in the Canadian dollar exchange rate also affect the final price, or is the U.S. futures price the only factor that can affect the final cash price?”

The accompanying graph shows two different methods of calculating basis. The blue line shows the unadjusted basis used by most grain companies. The red line converts MGEX futures to Canadian dollars first and then subtracts the Canadianized futures from the cash price — an adjusted basis.

This adjusted calculation method is the standard method for calculating livestock basis levels, where U.S. futures prices are also used.

“Here is an example using the graph,” said Bergen-Henengouwen. “At the beginning of November 2014, you can see that the unadjusted basis value (blue line) was around 0.53 over the futures price. Present-day unadjusted basis values are about 0.98 over. Since last November, the unadjusted basis has strengthened from 0.53 over to 0.98 over. However, the adjusted basis value (red line) shows an opposite trend. The adjusted basis has actually weakened from 0.21 under to 0.67 under. The two different methods for calculating basis display opposing trends as shown by the black arrows in the chart.

“The execution of a basis contract may differ from one company to the next, so it is good business to ask these questions and understand the answers before signing.”

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