One thing not being talked about during these times is basis risk. Currently the market is obsessed with the futures price. It seems as if the market has forgotten about basis and why it matters. It matters because of what the basis truly is. Basis is the difference between the cash price and futures price. The basis is made up of so many little factors, like local supply demand, freight, and many other things which all play a factor in the farm gate price. For example, the price of diesel will affect the transportation cost whether it be rail, truck or ocean and that cost will be reflected in the local basis.
Why This Matters
Farm gate price can rapidly change. Typically, basis moves are relatively benign and somewhat predictable. However, in this environment the basis levels can rapidly change from an extreme positive to extreme negatives, a move that could easily be more than $2/bu.
The only way to protect basis is to either do a basis contract or a flat price contract. Remember, using a basis contract when the futures markets are this volatile is extremely risky as a futures move could easily negate all gains made on the basis.
Bulls and Bears
Current Basis Level: Narrow. Normal for this time: Wide
Current Basis Level: Widish Normal for this time: Wide
Things that will change basis this year.
Narrow: 2022 crop comes in lower than expected.
Widen: Large crop, excessive transportation costs, supply chain issues.
The cost of shipping has increased substantially. Translated in another way this means that a company must increase basis levels by $8000 per container. For ease of argument this means that the freight rate of a “Super B” (44MT) would have to increase by $180/mt just to cover the new freight charge. *Note: this is not a real example it demonstrates the impact of freight on basis.
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