Managing risk basis: Demystifying the variables

Canola is canola, whereas wheat is, well — it’s complicated

The range of classes, grades and protein levels makes wheat one of the most complex commodities to market. Photo: File

Many farmers have a reasonably good handle on canola basis. When it comes to wheat basis, though, most producers are finding a very complex beast.

That’s the clear-cut message from two of Manitoba’s leading commodity experts when asked for insight for producers managing basis risk.

“Farmers understand canola,” said Mike Jubinville, of ProFarmer Canada in an interview. “There’s a long history of canola on the market. That’s not quite the case with wheat; there’s not quite enough info yet. And when it comes to wheat, it is the most complicated of all commodities. It is priced on a vast grid of grades, proteins and is much more complicated.”

John DePape, of Farmers Advanced Risk Management Co. (FARMCo), concurs.

“The canola basis is straightforward,” said DePape. “There are two grades of canola and one use: oil. With wheat there are different classes, different uses and different protein requirements. It’s a totally different animal than canola.”

Agreement

Basis is the difference between a cash price and the futures price of a particular commodity on a given futures exchange. Futures prices represent the price offered for a futures contract, a legally binding agreement that dictates quantity, quality, delivery and timing of a specified grain. Factors that affect basis include predicted supply and demand, variations of grade, availability, storage and transportation costs.

Generally, any forward price offer will be comprised of a futures price and expected basis. Manitoba producers can manage basis with forward contracts — either priced or unpriced (basis).

These types of contracts are applicable to those commodities that have a futures market component associated with them such as canola, wheat, corn, soybeans, and to a lesser extent, oats.

For wheat producers, forward contracting with a set price is seen as the least complex of the two options as both futures and basis risk are eliminated with a stroke of the pen leaving no exposure as long as the contract criteria is met.

Guarantee

Basis contracts guarantee that the basis risk will be eliminated without locking in a price at the time of the contract. As with the fixed price contract, the contracted producer must deliver a specified amount in a stipulated time frame.

Farmers have been dealing with the wheat-marketing dynamics since the Canadian Wheat Board’s single desk ended August 1, 2012.

Coming from a system of one buyer to an open market comes with a steep learning curve. Again, Jubinville and DePape found common ground on how producers need to shift their way of thinking around basis risk.

“A lot of people think basis is a cost,” said DePape. “Basis should be considered as a price. If supply is down and demand is the same, the price increases. Basis improves. It behaves like a price.”

“Basis can be a mystifying variable,” echoes Jubinville. “It has always been associated with cost. But it should be a price number not a cost. Basis is simply a price that the grain company is willing to pay.”


Mike Jubinville’s Four Quadrant approach

ProFarmer Canada’s Mike Jubinville uses a Four Quadrant approach of futures/basis combos to help manage the marketing efforts of his clients.

“Basis has always been a signal of what are cash grain demands of that buyer,” he said. “if the elevators are full, they don’t need deliveries, the power is with the buyers. if there are empty elevators and the transportation system is ready to roll, that gets added to the basis system.”

  • StrongFutures/StrongBasis
    Signal: Sell outright
  • StrongFutures/WeakBasis
    Signal: hedge on the futures side; leave basis open for now
  • WeakFutures/StrongBasis (scenario mid-Sept. 2015)
    Signal: Do basis-only contract; hold futures until price bounces back
  • WeakFutures/WeakBasis
    Signal: Store the grain; consider farm storage

 

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