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Audio Transcript:

00:06 – Grain Marketing Options
James Mintert:
Thanks for joining us today for the Purdue Commercial AgCast, the Purdue University Center for Commercial Agriculture’s podcast, featuring farm management news and information. I’m your host today, Jim Mintert, director of the Purdue Center for Commercial Agriculture, and joining me today is Dr. Nathan Thompson, who’s an associate professor of agricultural economics here at Purdue. We’re going to talk a little bit about the importance of crop basis when marketing grain.

So, one of the things to think about, Nathan, is what are the options that are available to a farmer here in Indiana or anywhere in the Corn Belt with respect to marketing grain?

Nathanael Thompson:
This is a good place to start this conversation because there’s a lot of different tools or alternatives available to producers today in terms of ways that they can market grain. Right? So, we just have some examples here to kind of prime the pump, so to speak. So, you know, obviously spot or cash price, forward contracts, those are two tools most farmers that we work with are obviously very familiar with. Maybe up the rung on the ladder a little bit in terms of complexity or what we see in terms of producers using, you could hedge obviously with futures and options. So again, we’re using the Board of Trade there. We’ve got things like hedge to arrive, again, a tool that’s being utilized which is utilizing the Board of Trade. But again, the elevator maybe has taken the position on the futures market there on behalf of the farmer. And then, you know, you can go down this kind of rabbit trail of these grain contracts that elevators are offering to producers.

And again, there’s just so many of those that we won’t even kind of go down that route. But that’s obviously a big place where we have lots of alternatives for producers to price grain. And really the point in kind of going through all these various alternatives of tools is to decide among those. Producers need to have knowledge of basis.

And that’s what we’re talking about today. What is important when we think about these different alternatives is understanding, it doesn’t really matter which of those you are using or which of those you’re evaluating against each other, you need to have some information as it relates to basis to pull the trigger and make a decision.

02:08 – What is Basis?

James Mintert:
Yeah, I think that’s a key point as you think about it, Nathan. You know, fundamentally grain prices are established at the futures exchanges, right, for corn, soybeans and wheat, and basis is really about what’s taking place locally. So, no matter what you choose, you’re going to look at that futures market with respect to what the national market is for that particular commodity. But then it’s going to be the basis that dictates what is actually going to happen to you from a local standpoint. So that begs the question, we probably ought to just define basis, right?

Basis is the local cash price minus the futures price. And that means we can kind of rearrange things from an equation standpoint and say, hey, local cash price can be decomposed into its two components, the futures price and the basis. And once we do that, we’ve really done something pretty important for risk management. Now, we’ve really in a way, kind of doubled our opportunities to manage price risk and that complicates things a little bit, but it also creates opportunities to make some money, right?

Nathanael Thompson:
Yeah, exactly right. When we divide out those two components, the futures component and the basis component, like you said, we’re really offering a lot of flexibility in the risk management aspect, right? In what we really have drilled down on in some of the stuff that we’ve been doing lately is this idea that futures prices and basis follow different seasonal patterns. And when you understand that there’s a difference in those seasonal patterns, separating those two components now gives the producer the opportunity to take advantage of favorable opportunities on the future side, and on the basis side, at different points in time and kind of maximize their potential price opportunity when it comes to their marketing.

James Mintert:
Yeah, that’s a good point. That one we probably don’t stress often enough. If basis and futures prices had the exact same seasonal pattern, there wouldn’t be near the advantage to differentiating between the two in terms of how you manage price risk. But the fact that they don’t move in tandem creates the opportunities and the fact that we can have some knowledge of what’s likely to take place, not guaranteed, but likely, can really improve our opportunities to make money.

04:18 – Forecasting Basis

James Mintert:
So that brings up the next question, which we’ve kind of implied this, but we ought to come right out and say it. Futures prices are inherently difficult to forecast. Lots of research supports the idea that it’s very difficult to forecast what futures prices are going to do. But basis is a little different. Basis is (I’m not going to say easy to forecast, but it’s) far simpler because it does have a tendency to follow some very strong seasonal patterns. And you’ve actually done a fair amount of research on that.

Nathanael Thompson:
Yeah, that’s right. I mean, essentially basis tends to be less volatile than futures prices. And therefore, it’s much like you said, (easier might not be the right word but it’s) much more predictable. Forecasting is a lot easier in terms of using historical data to build an expectation of where we think basis is going according to those seasonal patterns.

James Mintert:
One of the things to think about if you’re interested in marketing corn, for example, in October here in Indiana is harvest time, knowing what corn basis was in your market area in the recent past can be pretty helpful. If you go back and look at what corn basis did last year, the year before that, maybe the year before that, that gives you a pretty good idea of what basis is likely to be this year, at least as a starting point. Now, there could be some aberrations, and we saw some of that here in the fall of 2022, when we had some disruptions with respect to river markets, etc.. There can be some significant movements that maybe those averages wouldn’t capture. But in general, they’re pretty reliable, right?

Nathanael Thompson:
Yeah, that tends to be the case. So, again you need some access to historical data, right. That tells you, okay, in my local region, this is the pattern. And then you really need several years of data. Like you mentioned, any individual year can be affected by what’s going on in that particular year. We typically like to look at, maybe three, maybe four or five years, and we average those together, which kind of smooths out these year to year variations from particular events that might influence basis in a particular locale. And then when we create that historical average, that’s what builds this kind of expectation or forecast of what we think basis is going to be in that particular year, in that location, in that time of year.

James Mintert:
And you’ve actually done some research with one of your graduate students here recently where you looked at what were optimal models with the best tools you could come up when forecasting basis. And you concluded in the case of corn here in the Eastern Corn Belt, a three year average was certainly the best starting point in terms of forecasting basis, right?

Nathanael Thompson:
Yeah, that tends to be where we default to – three years for corn. And two years for soybeans is where the research has landed. But again, you know, there weren’t a lot of differences, say, between a three-year average and a five-year average. The difference was pretty minimal, but statistically speaking, that was where we landed in terms of a thumb rule. And again, you can adjust that over time. So, for example, here lately we’ve had very volatile basis from a number of different factors. So just as kind of a robustness check, so to speak, I’ll go in and look at a three-year average and a five-year average to kind of compare how different those two might be. A lot of times the differences aren’t major, but it can, as you know, when we have some of these exceptional years, adding a particular year into that average can really swing things one way or the other. So sometimes adding more data smooths out those patterns to give us a better idea of maybe what a long-term average might be. But starting with three years on corn and two years on soybeans are kind of the thumb rule that we use.

07:55 – We Built a Tool to Help! (The Purdue Crop Basis Tool)

James Mintert:
That brings up the question, some producers maybe maintain records of what basis is done in their local community at the local markets that they typically deal with. But in our experience, most people don’t have those kind of databanks available. And so, you know, one of the challenges is how do I go about getting that? And that’s really a discussion you and I had several years ago, and we decided to build a tool that would make historical basis data readily available to people here in the Eastern Corn Belt. Right?

Nathanael Thompson:
Yeah, that was the goal. Because of this lack of information, you know, we decided to go to USDA and look for some funding to support the building of this tool. A big piece of which was the purchase of the historical data. So, in terms of publicly available data, like USDA data, there is a cash price series for the state of Indiana. But again, basis is a local concept. And so, having local cash price data that would allow us to then calculate basis for local regions – there was no data. We needed a private source of data that we could purchase. And so again, we got the funding and we were able to secure the data from a private source and then built a tool. The tool is just a website. So again, it’s available on the Center for Commercial Agriculture’s homepage. And the way that it works is we have corn and soybean data in the tool. It’s got historical data going all the way back to the 2004-2005 crop year (we’re really pushing 20 years of data at this point, which is kind of interesting). Again, a lot of that historical data is not something you’re going to use every day in your forecast, but it’s nice to have there. We found several instances in recent years where it’s like, you know what, let’s go back and pull out some years that were, for example, carryover years. And how did basis perform or how did it act in those particular years.

But again, when you’re forecasting, typically we’re looking at those most recent 3 to 5 years depending on what we’re looking at. But again, lots of historical data, they’re available to you to kind of look at and evaluate the way that it’s built. It’s using weekly data. So again, we’re using Wednesday’s close. We’ve done research. Does it make a difference if we use a weekly average versus Wednesday? But Wednesdays is kind of where we settled. It really is not that much of a difference if you look at it differently. The data is updated weekly. So obviously, like we’ve mentioned, there’s the historical data that’s in the tool that’s useful for building the forecast. But we also have what’s happening in the current crop marketing year as a separate kind of visualization.

So, your evaluating not only that historical average, but you’re also evaluating where the current year’s basis is relative to that, which can be very helpful for some particular situations. And then we’re averaging to the crop reporting district level. So again, we’ve mentioned several times, basis is a local concept. And so, the tradeoff that we made was, you know, obviously having an index of corn basis for the state of Indiana would be one place to start. That’s not very local. You could drill down to the individual elevator that would give us lots of data and maybe make it hard to sort through. So what we landed on was averaging out on a crop reporting district level. We’re taking all the elevators in that crop reporting district and reporting what is essentially a regional average basis. It’s not representing any particular location or end user, but it’s giving you a sense of what the pattern and what the current basis levels are in that region. And then obviously you’d need to kind of call around and evaluate what basis bids were at any particular location based on that. And again, one piece, you know, when you go to the website, you’re going to select a county that you want to view and that’s going to automatic select your crop reporting district. We did that for ease of use. But it’s important to distinguish, you know, for example, if we were looking here in west-central Indiana, we would select Tippecanoe County. That’s where we’re located. It’s going to automatically revert you back to west-central Indiana. You’re not getting Tippecanoe County specifically. And I just want to make that distinction because that’s just the way the tool was built. But you know, you’re getting a regional average basis for a particular crop reporting.

James Mintert:
Yeah, we built the tool so you select the county because most of us, myself included, don’t know what crop reporting district I live in or what we farm in. And as a result, it was easier to simply make the menu driven off those counties and then push you into the correct location. We cover Michigan, Ohio, Illinois and Indiana. And you know, one of the things that I think is interesting to do sometimes is to look at those other locations, other than just my home area. Right. And see what’s going on around the Eastern Corn Belt, because that can be kind of insightful, particularly as you think about what takes place along the river.

Nathanael Thompson:
Yeah, the river is a really big one where, you know, you can look at kind of inland basis relative to what’s going on along those southern regions of Indiana and Illinois and how those are acting or behaving differently. You know, a lot of times you can kind of glean some insights maybe what’s going on with exports. Another time we saw that kind of stick out was back in 2019 when we had planting condition issues. We saw really obvious strength in basis in north-eastern Indiana, as that was a place that was particularly hard hit by a wet spring and inability to plant. And again, just this idea that corn or soybeans were moving kind of west to east, you could see that in the basis patterns. So, again, looking at those different regions can be really insightful when you’re kind of trying to figure out what’s going on in any given year.

13:39 – How to Use the Tool

James Mintert:
So again, the tool is available at the Purdue Center for Commercial Agriculture website, https:purdue.edu/commercialag (which is pretty easy to use). It’s right off the main menu there on the top of the screen, you’ll see a series of things listed, and one of those is called Decision Tools. And in that Tools menu, one of the options is just pick off this crop basis tool and when you go to the tool, you’ll be faced with some choices.

It’s going to default to Indiana, it’s going to default to the west-central Indiana (it actually defaults to Tippecanoe County). But that just is an indication that we’re in the west-central crop reporting district. It defaults to corn and then it defaults to the nearby futures contract. But those are all individual boxes that the user can change.

If you want to look at a different state, pick either Illinois, Michigan or Ohio. If you want to look at a different part of any of those states, you pick a different county for that region. The crops listed are limited right now to corn and soybeans. We don’t have a wheat basis out here yet, but we do have corn and soybeans. So pick your crop. If you want soybeans, just change it from corn to soybeans. And then on the futures contract, you’ve got some choices. The default, as I indicated, is nearby, which rolls forward throughout the marketing year to whatever the futures contract is, which is closest to expiration at that particular point in time. But you can choose to compute basis of a deferred futures contract. And for my usage, I actually prefer that to looking at the nearby basis.

Now, in both cases you’re going to see a blue line, which is an average of several years of data and you’re going to see a black line. The black line is going to indicate what’s taking place this year. So it doesn’t matter. You’re going to see the current basis, but the difference is going to be which futures contract it’s computed off of. But for example, just for clarity, even if it’s I want to look at the nearby basis, for example, the nearby at the moment is March, I’ll actually pick that March contract. And that does change the way the chart looks in terms of the length of the series that you’re looking at. I find that a little easier to use, but that kind of depends on the individual user.

Nathanael Thompson:
I tend to do the same thing, especially as you move throughout the crop year and we get lots of rolls to new futures contracts in that nearby chart. It can get a little jumpy depending on what’s going on on the future side of things. In terms of the spreads between futures contract months, that impacts, you know, as we shift from one contract month to the next, basis might jump one way or the other because of that. Again, I tend to start with a nearby chart and then I’ll zone in on kind of the deferred future start, because what it tends to do is, number one, it gives you kind of a consistent comparison to one contract throughout the entire crop marketing year, kind of smoothing out those jumps. But it also gives you a better view of appreciation or strengthening in basis throughout the crop marketing year that you don’t always see on that deferred chart. You see this much more smooth appreciation and it kind of gives you a better visualization of what’s going on there.

James Mintert:
The other thing we didn’t mention is on the menus is there’s a box for crop year, and over there is where you get to choose which years you want to use for your average computations. On the corn side, it’s going to default to a three-year average, but you don’t have to stick with that. And in fact, you mentioned this earlier, but one of the things I like to do is occasionally, if I think this year is shaping up like some prior year, the classic example is if we happen to have a drought scenario unfold. I want to go back and see what happened the last time we had a big drought. You know, for example, here in the Eastern Corn Belt, that might be 2012. I want to go see what basis did in 2012 compared to this year. So that’s an opportunity to do that. Another example here in Indiana (in a good bit of Indiana), had a very wet spring in 2015, which had a big impact on basis subsequently. If we have a repeat of that scenario going forward, I might want to go back and see what happened in that 2015, 2016 crop year. So there’s opportunities to do that and kind of play around it. Then look at various things in the menus you do need once you make your choices, you do need to hit the submit button! So it’ll actually re-compute and you can see it redraw on the screen pretty straightforwardly. And of course everything’s pretty much labeled. One thing I want to emphasize, though, is that you have an update every week, as you mentioned earlier, that you’re using closing prices for the futures on Wednesday afternoon, as well as the closing cash prices that are posted by the various elevators that afternoon. Then you do the update in between then and Friday morning. And those updates are out pretty early on Friday morning (because you’re kind of an early riser). The key is you get a good chance to get that weekly update.

And I maybe I should just elaborate on why we chose Wednesday – It’s a kind of a standard in the grain industry to use Wednesdays if you’re going to look at weekly basis. And it’s largely because you avoid most of the holidays that way. So, it gives you a more consistent data series. And there’s a lot of people in the industry that do use that Wednesday basis as kind of a standard. And then, as you kind of mentioned a minute ago, you can choose to compute basis throughout the course of the marketing year or a deferred futures contract. For example, going back to harvest time, you might choose a futures contract that’s going to expire, for example, at the end of your personal storage season. Let’s say you typically store some corn into the May or maybe early June period. You might pick a futures contract like the July futures contract and just see how basis tracked during the course of the stored season. And you’ve looked at that pretty in-depth, I think.

Nathanael Thompson:
Yeah. I mean, really when we were initially looking at building the tool, one of the motivations for this was we were going around doing workshops on marketing and we were teaching storage hedging. And people were telling us, well, basis doesn’t change throughout the crop marketing year. And we were like, Yes, it does! And we didn’t have any data to show them, right? So again, that was the advent of really building the tool. That was something that was important when building it, we wanted to be able to look at these deferred futures contracts. Because in a storage hedge scenario, you’re gross return to storage, you’re locking in futures, is just the appreciation in basis. And when you look at a basis chart that’s computed off in the deferred futures, that’s whatever the month that you’re planning to sell the grain in the future, then you’re essentially looking at what your gross return is from that bottom in. Whenever you place the hedge in the fall, to wherever you’re going to sell in the future, you’re going to use that forecast and that improvement in basis between when you place the hedge in the fall and when you plan to sell the cash grain at some point in the future. That difference is your gross returns to storage. So again, you’re using that chart to basically build your forecast of what you think basis is going to be at the end of your particular storage season and what your returns are going to be. You then obviously calculate what your costs are going to be, and you can figure out at least an expected return to that storage scenario. That deferred futures contract component was really one of the things we really wanted in there because that was one of the big things we were trying to teach people in doing this. And we just didn’t have the data to be able to do it.

James Mintert:
And if you look at any of those deferred charts like that, you typically see what you would expect to see in the Eastern Corn Belt, that is basis tends to be at its low point either in the middle of harvest or some years it might be just a little bit after harvest, it wrapped up and then tends to become more positive as you move through the course of the storage season. Providing that potential return to storage that that you were talking about earlier. I find that very handy. And of course, this is a topic I cover in depth when I teach commodity futures here at Purdue University. So it’s a good thing to think about.

21:23 – Takeaways

James Mintert:
Let’s think about some takeaways here, Nathan. You know, I think regardless of what crop marketing tool you choose to use, whether you’re using in spot sales, if you’re using forward contracts, whether you’re using hedging with futures, maybe you’re using hedging by option contracts, basis is going to be an important component.

Nathanael Thompson:
You need to have some information on basis if you’re evaluating those different opportunities in order to make a marketing plan.

James Mintert:
And one of the things the tool really helps demonstrate is the seasonality of basis, and that’s what makes differentiating between that cash price and the futures, and the basis components of that cash price. And whether it’s a current cash price or a deferred contract price, either one, differentiating between those two really is valuable because of that seasonal component of basis and the fact that there is some predictability there.

The Purdue Crop Basis Tool gives you access to historical corn and soybean bases for the various crop reporting districts in Indiana, Illinois, Ohio and Michigan. And I’d encourage you to just check it out and kind of play around with the tool a little bit and get familiar with it.

On the next podcast in this crop marketing series, we’ll discuss some rules of thumb that we’ve been able to generate based on some research here at Purdue that can help you forecast basis using the Purdue Crop Basis Tool. On behalf of the Center for Commercial Agriculture, I want to thank Nathan for joining us today. If you want to check out the tool, just remember the address is purdue.edu/commercialag. On behalf of the Center for Commercial Agriculture, I’m Jim. Thanks for joining us.