May 2, 2002

Market Advisor: Basis Important to Marketing Tool Selection

By George Flaskerud, Crops Economist
NDSU Extension Service

Producers can manage price risk by hedging in the futures and options markets directly or by using the many elevator contracts that are based on these instruments. Basis is a key parameter for these hedging mechanisms.

Basis is the relationship between the local cash price and a futures price for a commodity. The new crop basis for wheat can be estimated by subtracting the Minneapolis September spring wheat futures price from the local cash forward contract price. The basis can be positive or negative. The basis is characterized as strong if it is less negative or more positive than an average basis.

The new crop wheat basis averaged a negative 31 cents during 1992-01 at Hunter, N.D. On April 29, the new crop basis was a negative 29 cents, only 2 cents stronger than the 10-year average.

During the past 10 years, there has been a tendency for the new crop wheat basis to strengthen into harvest. It strengthened during seven of the last 10 years at Hunter.

Several factors can cause the basis to be different than expected. They include supply and demand, protein, moisture conditions at harvest, quality, availability of transportation, storage available at harvest, storage costs, the harvest pace and location differences relative to demand centers. The producer’s need for cash may be an additional factor.

If you expect that the basis will weaken and that the futures price will decrease, then the best strategy may be to sell a portion of the crop using a cash forward contract (CFC). Since the current basis for wheat at Hunter is nearly the same as the 10-year average, fixing the basis would not appear advantageous.

However, there may be times when it is advantageous to fix a favorable basis but not the cash price. This can be done at elevators through a basis contract, sometimes called a basis-fixed contract, where the basis is fixed relative to a specific futures month at the time of the contract.

The hedged-to-arrive (HTA) contract may be more appropriate this year than the basis contract and CFC. In the HTA contract, the futures price is fixed when the contract is initiated, and the basis is established later. Sometimes called a basis-open contract, the HTA contract is just the opposite of a basis contract. It accomplishes the same purpose as a regular futures hedge.

If less risk is desired, a minimum price contract (MPC) should be considered. Cash contracts based on the options market are referred to as MPC and offer about the same price flexibility as options. They differ from options in that a producer has a delivery obligation with the MPC. Another difference is that the relationship between the cash price and the futures price is fixed. Since the basis being offered at Hunter for new crop wheat is about average, this tool may be worth considering.

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Source: George Flaskerud, (701) 231-7377, gflasker@ndsuext.nodak.edu
Editor: Tom Jirik, (701) 231-9629, tjirik@ndsuext.nodak.edu