Wheat basis levels

Introduction

Basis is a factor in price for commodities that have a related futures market. The basis refers to the difference between a cash price and the futures price for a commodity. Specifically, the basis is calculated as the cash price minus futures price.

Basis includes all the factors between a certain cash price and the delivery location of the futures contract to which that commodity relates. Included in the basis could be:

• elevation
• cleaning
• freight by truck and rail
• government inspection fees
• administration fees
• interest and storage charges
• allowance for risk and profit for the grain dealer

For more information on basis, read: Basis: How cash grain prices are established.

Basis varies between grain company locations and between grain companies, and it is used to meter a commodity into their handling system. Simply, grain companies will adjust their basis to attract or deter grain delivery commitments.

Calculating basis

Basis is easy to calculate for a product like canola. Canola has a futures market that trades in Canadian dollars so the comparison of cash to futures is easy. The most common grade for harvested canola is number 1 and that is the base grade for the canola futures contract.

Wheat pricing is not so simple. There are several types of wheat, each with different uses. Pricing of hard red spring wheat is particularly complex as there are several grades and each grade can have several protein levels with premiums or discounts.

Those in the grain trade have used the Minneapolis Hard Red Spring Wheat futures for hedging Canadian hard red spring wheat. The Minneapolis wheat futures is a US dollar contract. The Chicago Mercantile Exchange (CME) has listed a Canadian hard red spring wheat futures market based on Vancouver port location, and it also is US dollar based.

In comparing the price of our Canadian hard red spring wheat to the Minneapolis futures, the currency difference needs to be accounted for. Most, but not all grain companies operating in western Canada are quoting hard red spring wheat basis in Canadian dollars and they are listing that basis as the difference between the local cash price and the United States denominated Minneapolis futures price. Grain companies are stating that the currency difference is accounted for as part of their basis.

Producers should understand how wheat basis is reported before they enter into sale contracts. Some questions to ask are:

• What currency is the basis in, Canadian dollars or United States dollars?
• When is the basis contract settled against a futures position?
• Is the contracted basis applied directly to the United States denominated futures or is it applied after the futures is converted to Canadian dollars?

In other words, from the time that the basis contract was signed, does a change in the Canadian dollar exchange rate also affect the final price, or is the United States futures price the only factor that can affect the final cash price?

The execution of a basis contract may differ from one company to the next, so it is good business to ask your questions and understand the answers before signing the contract.

Basis calculation examples

August 2023 prices

Example 1

Basis calculated without an exchange rate adjustment to the futures price:

• C$9.60 per bushel central Alberta area CWRS wheat cash bid
• Minus US$8.02 per bushel Minneapolis Grain Exchange December wheat futures
• Equals $1.58 per bushel basis

Example 2

Futures price converted to Canadian dollars with the exchange rate at 74 cents per United States dollar:

• $9.60 per bushel central Alberta area CWRS wheat cash bid
• Minus $10.84 per bushel Minneapolis Grain Exchange December wheat futures in C$
• Equals ($1.24 per bushel) basis

Calculating the basis using currency-adjusted futures results in a dramatically different result, especially with a weak Canadian dollar exchange rate. For those grain buyers that do not calculate the basis in this way, it is important that producers make the exchange rate adjustment in comparing basis levels of different companies.

As reference, the below graphs illustrate central Alberta upper grade hard red spring wheat prices and basis levels from June 2014 to June 2017.

Figure 1. Cash versus futures price for upper grade CWRS wheat, central Alberta.

Figure 2. Basis difference in United States dollars quoted futures versus Canadian dollars adjusted futures for upper grade CWRS wheat, central Alberta.

Figure 3. Basis exchange rate adjusted versus no adjustment for upper grade CWRS wheat, central Alberta.

This graph shows 2 different methods of calculating basis. The blue line shows the unadjusted basis used by most grain companies. The red line converts MGEX futures to Canadian dollars first and then subtracts the Canadianized futures from the cash price – an adjusted basis.

This currency-adjusted futures calculation method is the standard for calculating livestock basis levels, where United States futures prices are also used. In livestock basis contracts, currency is not part of basis. Therefore, a cattle basis contract does not lock in the currency, leaving that aspect open unless locked in otherwise.

In Figure 3, look at the area in black ovals. At the beginning of November 2014, you can see the unadjusted basis value (blue line) was around 0.53 over the futures price. January 2016 unadjusted basis levels were about 1.50 over. During that interval, the unadjusted basis fluctuated significantly and strengthened from 0.53 over to 1.50 over. However, during the same period the adjusted basis value (red line) shows an opposite trend. The adjusted basis has weakened from 0.21 under to 0.50 under. The 2 different methods for calculating basis display opposing trends as shown by the black arrows in the above chart.

Comparing the 2 methods of calculating basis are not simple. Remember that grain companies who quote the basis without adjusting the futures for exchange rate state that the currency exchange is contained within their basis. Therefore, they may suggest that adjusting the futures to Canadian dollars is at least a partial duplication of the currency effect.