Econ 337, Spring 2012 ECON 337: Agricultural Marketing Chad Hart Assistant Professor

Econ 337, Spring 2012 Basis  Basis = Cash – Futures  Futures reflect global supply and demand  Basis reflects local supply and demand  Cash = Futures + Basis

Econ 337, Spring 2012 Basis Basics  Specific to time and place  Typically use nearby futures  Convergence  Less variable than cash prices  Relatively predictable

Econ 337, Spring 2012 Basis Factors  Relative storage capacity  Transportation availability and cost  Time to expiration  Quality issues

Econ 337, Spring 2012 Basis Terms

Econ 337, Spring 2012 Interior Iowa Daily Grain Prices Closing cash grain bids offered to producers as of 2:30 p.m. Dollars per bushel, delivered to Interior Iowa Country Elevators. US 2 Yellow Corn Prices were generally 5 to 8 cents higher for a state average of US 1 Yellow Soybean Prices were mostly 10 cents lower for a state average of Iowa Regions#2 Yellow Corn#1 Yellow Soybeans Range Avg Range Avg Northwest 5.88 – – North Central 5.83 – – Northeast 5.72 – – Southwest 5.84 – – South Central 5.86 – – Southeast 5.83 – – Corn basis to STATE AVERAGE PRICE for the CBOT Mar. contract is -.21 Soybean basis to STATE AVERAGE PRICE for the CBOT Mar. contract is -.56

Econ 337, Spring 2012 Specific to Time and Place

Econ 337, Spring 2012 Average Iowa Corn Basis, Source:

Econ 337, Spring 2012 Iowa Corn Basis, May Futures, Source:

Econ 337, Spring 2012 Iowa Corn Basis, May Futures, Source:

Econ 337, Spring 2012 Basis Information ISU Extension and Outreach, Ag Decision Maker  Corn  Soy  Cattle  Hogs USDA-Ag. Marketing Service   Local elevators, ethanol plants, processing plants, etc.

Econ 337, Spring 2012  Basis and price forecasting tool  Enter specific information  Location  Date  Weight  Frame score and grade  Sex  Number

Econ 337, Spring 2012 Grain Basis vs. Livestock Basis  Grain is a storable commodity and the same grain can be used to satisfy several futures contract delivery months. So grain futures prices tend to be tied to one another.  Livestock is not storable so livestock futures prices for alternative delivery months tend to move independently.  Because grain is a storable commodity, the grain basis is tied closely to grain storage costs and interest costs. Livestock are not storable so there are no storage costs built into the basis.

Econ 337, Spring 2012 Grain Basis vs. Livestock Basis  An inverse basis in grain futures (cash above futures) is unusual and indicates there is something amiss in the grain industry (lack of transportation, for example). An inverse basis in grains will usually last only for a short period.  An inverse basis in livestock futures is not unusual for distant delivery contracts and can exist for extended periods of time. Only during the nearby futures contract delivery periods do we expect livestock futures to be above cash price.

Econ 337, Spring 2012 Convergence

Econ 337, Spring 2012 Convergence Issues Typically, as futures contracts reach maturity, futures price and cash prices at delivery points tend to converge to the same level. For several grain and oilseed futures contracts over the last few years, this has not occurred. “Poor Convergence Performance of CBOT Corn, Soybean and Wheat Futures Contracts: Causes and Solutions”  Scott Irwin, Philip Garcia, Darrel Good, and Eugene Kunda  University of Illinois, March 2009

Econ 337, Spring 2012 Why Is Convergence An Issue? 1.Non-convergence indicates the market is out-of- balance. “When a contract is out of balance the disadvantaged side ceases trading and the contract disappears.” (Hieronymus, 1977) 2.Non-convergence adds to the uncertainty in basis and limits hedging effectiveness. Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report

Econ 337, Spring 2012 Factors  The relationship between the spread between futures contracts and the cost of carry (think storage costs)  In the settlement process for corn and soybean futures, the delivery instrument is a shipping certificate.  If it is advantageous to the holder of a shipping certificate, they can delay delivery and effectively store the grain, paying CBOT set storage costs.  Structural issues related to the delivery process  Does the general trade flow of the commodity line up with the possible delivery points under the futures contract? Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report

Econ 337, Spring 2012 Delivery Points Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report CornSoybeans Wheat How much of the commodity is moving through the delivery point areas?

Econ 337, Spring 2012 Class web site: Spring2012/ Lab in Heady 68 this week