Consider Use Of A Basis Contract To Market Corn

Consider Use Of A Basis Contract To Market Corn

Have prices for 2013 corn crop already reached their peak?

Despite a late start, the 2013 harvest progressed rapidly and yield prospects increased across most of the Corn Belt states. As shown in USDA's November Crop Production and WASDE reports corn yields increased by an average of 5.1 bushels per acre from September to November USDA and is forecasting a record 13.989 billion bushels of corn being produced in the U.S. this year.

VALUABLE MARKETING TOOL: Why use a basis contract to market your corn? A farmer who sells cash bushels and replaces them by buying a futures contract is doing the same as a grain merchandiser providing a basis contract for the farmer, notes ISU Extension farm management specialist Steve Johnson.

"The December 2013 corn futures contract has declined by $1.40 per bushel since late June," pointed out Iowa State University Extension farm management specialist Steve Johnson on November 5. "Strong support is likely at the $4.25 per bushel level. Most could reason that a large movement upward in price isn't likely to occur in the near future."

In this week's Farm Management Friday report, Johnson encourages farmers who have unpriced corn to consider using a basis contract to market that grain. Following are his observations and recommendations.

Have prices for 2013 corn crop already reached their peak?

Seasonal futures price trends indicate that corn prices don't typically rally in the fall and winter months. Most everything is known about northern hemisphere feed grain crops where nearly 85% of the world production takes place. However, most farmers will be reluctant to give up ownership of bushels at sub $4.50 per-bushel cash corn prices. The memory of $7 per bushel cash corn just a year ago still lingers.

Consider your storage costs. The chart below compares the costs of storing corn at a commercial elevator to on-farm storage. Accruing costs per bushel are reported every three months or until nine months following harvest. The assumptions are as follows:

* Cash corn is valued at $4.20 per bushel

* Interest rate of 4.5% on borrowed funds

* Handling charge of 20 cents per bushel paid up-front

* On-farm storage at 2 cents per bushel per month

* Commercial storage at 4 cents per bushel per month

  

Consider Use Of A Basis Contract To Market Corn

The chart indicates the improvement in cash corn prices needed to justify storage and are listed at three, six and nine month periods. Commercial storage will be higher than on-farm costs. The cash price received for commercially stored bushels will also reflect the basis offered at that particular facility when sold.~~~PAGE_BREAK_HERE~~~

Using these assumptions, storing bushels until April means that cash prices will need to improve from 44 to 56 cents per bushel to break even. Odds are that the cash prices offered in the spring may never reach breakeven. Also, higher moisture levels for on-farm stored corn may widen the basis in the late winter months as larger volumes of bushels are delivered to avoid discounts due to moisture.

Good reasons why you should consider using a basis contract

Most of the cash price movement this late in the fall and during winter months may come from better basis being offered. This will be to encourage farms and commercial elevators to move stored bushels. Iowa will become a net importer of corn from surrounding states during this marketing year, as Iowa uses more corn than it produced in 2013.

An attractive basis and the need for cash will be the main drivers for farmers to move stored bushels. With high 2013 farm income levels, farmers will likely wait to sell bushels until January or defer the income. Expect corn basis to remain attractive through November and continue until year-end.

A basis contract to encourage farmer movement of cash corn might be considered. This is especially true for commercially stored bushels with higher fixed costs and on-farm stored bushels that need to move in the late winter for cash flow or because of corn quality concerns.

Locking the basis but staying "long" futures; here's how the basis contract works

A basis contract is offered by most grain merchandisers. These contracts tend to be offered in 5,000 bushel increments to match the futures contract that underlies the transaction. So a farmer delivers cash corn, the merchandiser buys or goes "long" futures on behalf of the farmer. The merchandiser will likely charge a small service fee of 1 to 2 cents per bushel subtracted when the basis contract is terminated.~~~PAGE_BREAK_HERE~~~

Upon delivery of the bushels, a farmer can collect 70% to 80% of the value of the cash corn. The 20% to 30% balance of the cash sale is held by the merchandiser to make potential margin calls should futures prices decline. Any excess funds minus the 1 to 2 cent service fee are returned to the farmer upon termination of the basis contract.

The farmer needs to initiate with the merchandiser a date and price at which they wish to have this "long" futures position lifted on their behalf. Consider being "long" the May 2014 or July 2014 corn futures contracts to increase the chance of benefitting from a spring rally. This is the typical timeframe when corn futures prices rally each year.

Understand the risks and rewards when using a basis contract

A farmer should discuss with the merchandiser at the time of initiating the cash sale and basis contract their understanding of the risk of being "long" futures and the flow of cash funds. Advantages of the basis contract might include: elimination of storage costs, removes basis risk and minimizes the concern for on-farm stored corn quality.

The farmer is not able to take advantage of the carry offered in the futures markets with a basis contract. Hopefully eliminating storage costs, basis risk and corn quality concerns will be a greater advantage than the loss of any carry that could be captured in the futures market.

Conclusion: You want to use a scale-up selling strategy if using basis contracts and move your stored bushels incrementally

Storing the 2013 corn crop, whether commercially or on-farm, will be common this fall. That's already evident by the number of farmers who have put their corn in storage. Many farmers will wait impatiently for a "sell" signal in the December futures contract and in the March futures contract. However, attractive basis and the need to generate cash may actually be the primary drivers as to when farmers will move their stored bushels onto the market this fall and winter.~~~PAGE_BREAK_HERE~~~

A farmer might want to use a scale-up selling strategy for using basis contracts and move stored bushels incrementally. While most basis contracts are offered in 5,000 bushel increments, some merchandisers might be offering them in truckload quantities (1,000 bushels). This fits well with a scale-up selling strategy and spreads the basis risk.

First step for a farmer is to know the cost of storing corn and when cash will be needed to pay debts in 2014

The first step for a farmer might be to recognize the cost of storing corn and when cash will be needed to pay debts and generate funds for 2014. Consider avoiding delivery of bushels during the last half of February. That's when income taxes are due along with other large payables in early March. Spend some time with your grain merchandiser so you fully understand the implications of using a basis contract.

The delivery of cash bushels via a basis contract can be tied to the May 2014 or July 2014 corn futures prices. The odds do favor those corn futures prices will rally during the spring months.

For farm management information and analysis visit Ag Decision Maker; ISU farm management specialist Steve Johnson's site is available here.

TAGS: USDA
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