Better Farming February 2017

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Better Farming

February 2017

BETTER

BUSINESS

waiting for a short-term gain in

futures price. The futures price is

locked in at a future date at the

farmer’s discretion. Farmers can

enter into such a contract to secure a

desirable exchange rate – which,

according to Kell, is a good use of a

basis contract.

Waiting to lock in a futures price

does provide other benefits, accord-

ing to Moyse. Some benefits include

the “upside opportu-

nity (that can be

found in rising)

futures, some storage

fees can be avoided

and a desired delivery

period (can be)

locked in.”

In addition to

these benefits, basis

contracts do come

with risk. On top of

the risk that futures

could decline, grow-

ers also have to

monitor the futures and decide when

to lock them in, according to Moyse.

There is also no chance to take

advantage of any narrowing basis, as

the basis would already be locked in.

For Backx, the farmers’ risk in

basis contracts may be too great; he

normally does not recommend them

to clients.

If a farmer does not want to lock

in futures, “the basis

contracts have to be

rolled forward before

the delivery month

the basis is on,” said

Backx. “If you are on

March futures, (for

example, the con-

tract) has to be

moved forward before

the end of February.

(Because) there is

usually carry in the

futures, (farmers) end

up with a lower basis

– plus grain dealers charge three to

five cents per bushel to do the roll.”

“Rolling a basis contract works

well in a market where the futures

are inversed and very poorly when

the futures are in a carry position,”

said Kell.

An inverse market means that the

nearby futures values are higher than

the deferred futures months. This

situation often happens when grain

supplies are tight. “In these situa-

tions, rolling the basis contract will

result in an increase in the basis level

of the contract. However, inverses

only occur when the commodity is

scarce. No inverse futures markets

exist in our ag commodities (cur-

rently) due to the

substantial supplies of

corn, wheat, and

soybeans,” said Kell.

When there is a

carry in the futures,

prices are lowest for

the closest delivery

contract as there is a

good supply of the

commodity in

question. “In these

situations, the futures

spreads are essentially

paying people to

carry (or store) their grain to the

further away delivery periods,” said

Kell. When you roll a basis contract

in this type of market, however, the

contract holder will be paying more

than they would be to simply store

the grain; the seller will need to pay

the carry in the futures to cover the

merchant’s cost to roll the hedge.

“For example, if a person rolled a

December wheat

basis contract at the

end of November

when the December

futures were $3.90

and the March futures

were $4.12, the

resulting roll (would

cost) $0.22 per

bushel. (This cost is)

more than simply

paying storage; rolls

can be costly,” accord-

ing to Kell.

Flat price contracts

In flat price contracts, by compari-

son, farmers lock in both the futures

and the basis at the same time.

Consequently, these contracts are

unaffected by any falls or rallies in

the market.

Flat price contracts, or deferred

delivery contracts, “are easy to

understand, provide the farmer with

the locked-in net price, have no

downside risk from basis or futures

moving, have no fees (as there is no

rolling), and the contract is final,”

said Moyse.

The main negative aspect of these

contracts? “There are no upside price

opportunities,” she said.

Final tips

“I recommend producers only do flat

price contracts, and sell incremental-

ly by breaking their crop into five

equal parts,” said Backx. “Forward

selling one to two increments before

planting is advised if prices are in the

profitable zone.”

Moyse, in contrast, saw benefits in

basis contracts if the conditions are

favorable. For her these benefits

include the opportunity to play the

futures when it is speculated they

will increase in strength and being

able to lock in a suitable basis when

it is speculated the basis will weaken.

Kell similarly believed there are

times when the market will pay for

farmers to create basis contracts and

have them rolled forward. This

situation occurs when grain supplies

are tight and there is no carry in the

market, he said.

Frank Backx

Jenny Moyse

The basis is normally decreased

in value at harvest time.

DarcyMaulsby/iStock /Getty Images Plus photo