While the concept may be confusing, basis is an important tool that farmers can utilize to increase the success of grain marketing. By definition, basis is the difference between the price of a given commodity in a local market subtracted by the price of that commodity in the futures market.
Mathematically speaking, Basis = Cash Price – Futures Price at a specified point in time. The time period generally used for calculating basis is the closest delivery month of the futures contract. For example, if you want sell grain in April, the May futures price minus the local cash price would be used to calculate the basis.
Many consider basis to be an indication of whether the market is willing to accept grain at that specific time. A small difference between cash and futures markets—or an improving basis—shows that the market is willing to accept grain. When the local price is higher than the futures price, the basis is considered positive and indicates low supply levels, usually several months after harvest when fewer cash grain sales occur.
A larger difference between local and futures markets indicates an ample supply level, so the markets are not as willing to accept grain at that point in time. When the local price is lower than the futures price, we see a negative basis, indicating a sufficient supply level and typically seen during harvest when farmers are making cash sales. During periods when the basis is wide, farmers should store their grain and avoid making cash sales in order to allow the basis to shrink and thus maximize potential profits.
Several factors may affect basis, one of which is transportation costs that, when combined with increasing fuel and labor costs, can lead to a widening basis. Another important factor is storage availability. If a large crop is harvested and elevators begin to run out of storage, the basis widens to discourage any more grain deliveries. By contrast, if harvest does not go as well as planned, we will generally see a narrowing basis to encourage cash sales at local elevators. Storage availability and costs do not affect futures prices, which explains why we see the changes in basis.
Supply and demand comprise another important factor that affect basis. As previously mentioned, low supply levels will lead to an improving basis to encourage local cash sales. Conversely, high supply levels will lead to a widening basis to indicate that markets are not as willing to accept cash grain sales at that time.