Use a basis contract to market old crop corn

Use a basis contract to market old crop corn

If you are holding 2014 corn in the bin, consider using a crop marketing strategy called a "basis contract."

By Steve Johnson

Editor's Note: Steve Johnson is an Iowa State University Extension farm management specialist and regular contributor to this Farm Management Friday column. You can contact him at [email protected] or 515-957-5790.

Do you have a marketing exit strategy for old crop corn you currently have in storage? Consider using a basis contract. In other words, set the basis now while it's attractive. Be patient and wait for the July corn futures contract to rally. This could likely happen between now and July 1.

PRICING YOUR CORN: ISU's Steve Johnson suggests using July futures prices for old crop corn you have stored. Use it as the pricing mechanism and be ready to have pricing orders in place, especially if you are trying to catch the unicorn: $4 cash corn.

There is reason to be concerned that corn basis could widen by late July and August just like it did in 2014. That's the time period when the potential for large 2015 crops would typically be confirmed. Farmers are holding an extremely large number of old crop bushels this spring and summer. A large 2015 crop could confound the problem with both lower futures prices and by late summer and fall, a wider basis.

Consider pricing the basis portion of old crop bushels now
There is some concern that some farms who already have financial worries with working capital and cash flow issues, could be setting themselves up to be storing both 2014 and 2015 crops well beyond harvest this fall. This could put them in a real bind in trying to make fall and winter payments and meet family living expenses.

Farmers should at least consider pricing the basis portion of their old crop corn bushels now. You can still remain long the board price via the July 2015 corn futures contract by using a basis contract. This forces a farmer out of this "long futures" position in advance of the first notice day for the July contract, about June 29. That's just before June 30 when two important USDA reports will be released: the Quarterly Grain Stocks report and the Planted Acreage report.

What is a basis contract?
A basis contract secures the basis level and delivery period without specifying the final futures price. You are allowed to lock in a basis level you find attractive even if you're not ready to set the futures price. You'll need to confirm in the contract, the delivery period and location for those bushels being priced. The final cash price will be equal to the basis combined with the futures price once the "long" futures position is lifted.

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Basis contracts are a good choice when you think that basis levels will likely widen but you feel the futures price could improve. Basis contracts also guarantee you a delivery period to move your grain. Locking in a basis now may also be preferable to additional storage charges. You will also be able to receive a partial cash payment when you deliver your grain.

Huge U.S. corn ending stocks at end of this marketing year
The U.S. corn ending stocks are estimated at 1.85 billion bushels for the 2014-15 marketing year that ends August 31. If this projection turns out to be the case, it will be the largest U.S. ending stocks for corn in 9 years. Near ideal spring planting conditions for most the Corn Belt has led to a decline of nearly 40 cents per bushel in the July 2015 contract since early April.

Without a major weather concern to spur speculative buying, most market analysts believe the July corn contract will likely trade in a sideways trading range between $3.60 and $3.75 per bushel. Perhaps fund buying could lift the July contract price to the $3.80 per bushel level, with strong resistance above this price.

During the spring months is when risk premium typically increases futures prices. That's when uncertainty grows for producing another large global corn crop. Many farmers are currently holding large amounts of old crop corn bushels. By mid-July, with confirmation of another large U.S. corn crop, many farmers will be forced to make decisions about moving old crop bushels. Do you hang onto those bushels into the 2015 harvest, hoping that futures prices rally and/or the basis narrows? Managing both futures price and basis risk will be critical in the next few months.

Corn basis trends, cash market has been supported
Fortunately, the basis (cash minus futures price) has narrowed nicely this spring despite the drop in futures prices. That's not unusual with lower futures prices, as grain merchandisers narrow the basis to obtain delivery of bushels.

The basis chart below indicates that the 2014-15 crop corn basis for Iowa remains strong (red line) as compared to last year (blue line) and the 10-year average corn basis (green line). Despite the sub-par performance of futures prices, the cash market price has been supported by a stronger or less negative basis. Note on the chart that basis suddenly widened (green line) by mid-July 2014 as the potential crop size was realized.

Use a basis contract to market old crop corn

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During the spring months is when risk premium typically increases futures prices. That’s when uncertainty grows for producing another large global corn crop. Many farmers are currently holding large amounts of old crop corn bushels. By mid-July, with confirmation of another large U.S. corn crop, many farmers will be forced to make decisions about moving old crop bushels. Do you hang onto those bushels into the 2015 harvest, hoping that futures prices rally and/or the basis narrows? Managing both futures price and basis risk will be critical in the next few months.

Corn basis trends, cash market has been supported
Fortunately, the basis (cash minus futures price) has narrowed nicely this spring despite the drop in futures prices. That’s not unusual with lower futures prices, as grain merchandisers narrow the basis to obtain delivery of bushels.

The basis chart below indicates that the 2014-15 crop corn basis for Iowa remains strong (red line) as compared to last year (blue line) and the 10-year average corn basis (green line). Despite the sub-par performance of futures prices, the cash market price has been supported by a stronger or less negative basis. Note on the chart that basis suddenly widened (green line) by mid-July 2014 as the potential crop size was realized.

Use a basis contract to market old crop corn

By the summer months, most all the old crop corn bushels will be owned by farmers, not the processors or elevators. Farmers were not as aggressive in selling ahead their 2014 crop in the spring and summer months this past year. Looking ahead, storage could be in short supply by September, as the old crop bushels are in the way of the 2015 crop storage needs for both corn and soybeans.

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The concern is for not only lower futures prices by late summer, but also wider basis. Remember, for the 2014-15 marketing year, the U.S. corn ending stocks are estimated at 1.85 billion bushels, the largest in over 9 years.

Why you should consider use of a basis contract
With an attractive basis now, the need to empty on-farm grain storage and generate cash may be the main drivers for farmers to move these stored bushels. In addition, some corn stored in on-farm storage is reported to be at levels above 16% moisture and subject to being docked or rejected at delivery.

A basis contract could encourage farmer movement of cash corn now. This is especially true for commercially stored bushels with higher fixed costs and less chance to benefit from attractive processor basis bids.

Locking in the basis, but staying “long” futures
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.

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 he/she wish to have this “long” futures position lifted on their behalf. Consider being “long” the July 2015 corn futures contract to increase the chance from benefitting from a late spring rally. This is the typical timeframe when corn futures prices rally in most years with the uncertainty for feed grain production in the northern hemisphere occurring.

Conclusion: recognize the risks of storing old crop corn into late summer
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, removal of basis risk, minimizing the concern for on-farm stored corn quality and freeing up storage space for the 2015 crop.

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Storing the 2014 corn crop, whether commercially or on-farm has been common. Many farmers have waited patiently since harvest for a rally and time is running out. An attractive basis, the need to empty on-farm grain storage as well as the need to generate cash are factors as to when farmers will move stored bushels this spring and summer.

A farmer might want to use a scale-up selling strategy for using basis contracts now and move stored bushels incrementally in the next few weeks. While most basis contracts are offered in 5,000 bushel increments, some merchandisers might offer contracts in truckload quantities (1,000 bushels). This idea of selling smaller increments more often might fit well with a scale-up selling strategy and spreading the basis risk.

The first step for a farmer might be to recognize the risks of storing old crop corn into the late summer months. Make sure you spend some time with your grain merchandiser so you fully understand the implications of a basis contract and the risk of being “long” corn futures via the July ’15 contract.

For farm management information and analysis visit ISU's Ag Decision Maker site at extension.iastate.edu/agdm; ISU farm management specialist Steve Johnson's site is at extension.iastate.edu/polk/farm-management.

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