Farmers face a lot of risk every year. Corn, soybean and cotton growers face production risk, weather risk and price risk.
Farmers have been able to reduce production risk with improved seed technology and better tillage practices. You can reduce the financial risk of bad weather by purchasing the right type of crop insurance.
The price risk component can be further broken down into futures risk and basis risk. If you look at the history of managing risk, nine years out of 10, using new-crop hedges or hedge-to-arrive (HTA) contracts is the right merchandising decision.
By using futures hedges you reduce risk and also have a lot of flexibility. You can wait for your local basis to improve, roll the hedge ahead if you have storage and shop around for the best basis bid before you deliver.
This year was the one year in 10 that the wide basis levels this fall meant that a cash forward contract worked better than hedging.
These are the four normal variables that create seasonal basis patterns:
Freight cost and availability. The cost of railing grain to the Gulf or shipping a barge load of grain from Minneapolis to New Orleans changes on a daily basis. The cash bids can show some huge day-to-day price swings as the Gulf bid and freight rates change.
Storage cost and availability is another key component in grain merchandising. When on-farm and commercial storage are available, producers and elevators will store if they don't like the current basis bids or if they anticipate better basis levels in the future. When all of the storage is full and grain is forced into the market, basis levels will widen until more storage is found or grain is piled on the ground.
Interest rates impact the cost of holding and moving grain. While interest rates are still low in the long-term historic sense, short-term rates are now double last year's level.
Export demand is often the key factor in Gulf cash prices, and therefore river terminal bids. A small crop harvested when export demand is strong can create a very strong basis. This year the U.S. has a huge corn and soybean crop at a time when export demand is less than earlier projections — that has been a bad combination for corn and soybean basis bids.
Here are some of the unusual factors this fall that caused the basis distortions and some of the worst basis levels in 30 years.
Sharply higher fuel costs forced trucking companies and railroads to raise rates and implement fuel surcharges. With crude oil going up to more than $70/barrel and diesel prices rising to more than $3/gal., higher shipping costs were translated into lower cash basis bids.
Hurricane Katrina hit key Gulf export facilities in September, shutting down barge traffic for five days and greatly reducing export loading for the next two to three weeks. It has been hard to get the jammed pipeline back into sync.
Huge 2004 carry-over meant many elevators were full before harvest. As farmers hauled in the last of the 2004 corn and soybeans in August and September 2005, many elevators in the western Corn Belt filled bunkers before harvest even got started. This made finding storage for the 2005 crop an impossible situation in October 2005.
Record western Corn Belt crops that came in well above trade estimates aggravated a bad situation. Most farmers have storage for 80-90% of a normal crop. A typical Minnesota farmer with 1,000 acres of corn with a 160 bu./acre yield would usually store 140,000 and haul 20,000 bu. to town. This fall with a yield of 200 bu./acre he stored 140,000 and tried to haul 60,000 bu. of extra corn to town — three times more than usual. Until all of the corn piled outside — either on farms or stored on the street in small towns — is picked up, basis levels will stay wide.
Looking ahead to the spring and summer of 2006, odds favor a significant basis improvement. However, look for a wide basis again in the fall of 2006 if fuel prices stay high and U.S. corn and soybean farmers have a trend line or better crop again next year. You may need to rethink how much storage you need.