Mecardo Analysis - Basis is basic
- By: "Farm Tender" News
- Cattle News
- Oct 25, 2018
- 551 views
- Share
By Andrew Whitelaw | Source: CME, Mecardo.
The grain price in Australia has reached stellar highs in the past three months. This is not due to international values increasing but due to strong basis. In this article, we aim to provide an insight into what basis is and where current levels are.
The term basis is commonly used and understanding it is one of the key pillars of any grain marketing strategy. We often get asked by many what basis actually is, with many believing that it is a bewildering concept – it isn’t!
The ‘basis’ component of a price can be simplified down to the difference between the local price and the price of a futures contract. This basis can either be negative or positive, however, in recent years, we have been lucky to have strong (positive) basis levels for most of the time. Many factors impact the basis level such as grower selling, domestic supply & freight costs. If for example there was limited grower selling and traders required grain to fill shipping requirements, we would expect basis to strengthen (or increase).
In recent months we have seen a rainfall deficit. In the previous paragraph, I mentioned that domestic supply can have an impact on basis levels, therefore lower rainfall (and reduced crop potential) will reduce supply and therefore reinforce basis levels.
In Figure 1, we have plotted that basis levels for four major ports around Australia. This chart displays the basis between the APW1 spot contract versus the current Chicago futures contract. As we can see there has been a clear rise in basis from June onwards.
The farmers who tend to be most successful at marketing their grain and utilise risk management strategies will separate their pricing into at least futures & basis. Through locking in each component separately, more opportunities are available to the farmer. It is therefore important to understand basis, and its implication to the end price.
What does this mean?
Basis is a simple concept, it is just the difference between two prices. If we know the basis being offered by a grain trader, we can have a better indication of whether a price is really attractive or not.
The basis level is the best indicator of whether physical or derivates products should be used.
Key points
* Basis is simply the difference between two prices.
* In most instances in the Australian grain industry, it is the basis between the local price and Chicago which is referred to.
* Basis strength is determined by several factors, however, supply (or lack of) is the biggest driver in Australia.
Share Ag News Via