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Using a basis contract to market corn
Despite a late start, the 2013 harvest progressed rapidly, and yield prospects increased across most of the Corn Belt. The U.S. corn yield average rose by 5.1 bushels per acre from September to November, according to USDA’s latest estimate. Farmers are expected to harvest a record 13.989 billion bushels in 2013. Final USDA estimates will be released on January 10.
From mid-June to mid-November, the December 2013 corn futures contract declined by more than $1.50 per bushel. The nearby futures market ﬁnally found support around $4.15 per bushel. A large movement upward in price isn’t likely anytime soon without a global change to supply and demand fundamentals.
Farmers who have unpriced corn should consider using a basis contract to market at least a portion of those bushels, especially if these are stored commercially.
An attractive basis and need for cash will be the main drivers for farmers to move stored bushels. With high 2013 farm income levels, farmers may wait to sell bushels until after the ﬁrst of the year or defer additional income. I expect corn basis to remain attractive through year-end. Basis contracts encourage farmer movement of cash corn and should be considered. Commercially stored bushels will likely have higher ﬁxed costs than on-farm stored bushels. However, some on-farm bushels may need to be moved by late winter for cash ﬂow purposes or because of corn quality concerns.
Seasonal futures price trends indicate corn futures prices don’t typically rally in the fall and winter months. That’s because 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.
The chart below compares the cost 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: 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.
The chart indicates how much cash corn prices need to improve over three, six, and nine months to justify storage. 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 facility when sold.
Using these assumptions, storing bushels until April means cash prices need to improve from 44 cents to 56 cents per bushel to break even. Odds are, cash prices offered this coming spring may never reach breakeven. Also, higher moisture levels for on-farm stored corn may widen the basis in late-winter months as larger volumes of bushels are delivered to avoid moisture discounts.
Most of the cash price movement in late fall and during winter months may come from better basis being offered. This will encourage farmers and elevators to move stored bushels. Iowa will become a net importer of corn from surrounding states during this marketing year, as Iowa will use more corn than it produced in 2013.
Merchandisers tend to offer basis contracts in 5,000-bushel increments to match the futures contract that underlies the transaction. 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 settled.
Upon delivery of the cash bushels, a farmer can collect 70% to 80% of the corn’s value. The merchandiser holds the remaining 20% to 30% balance of the cash value 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 settling the basis contract.
The farmer needs to convey to the merchandiser a date and price at which he or she wishes to have this long futures position lifted. Consider being “long” the May 2014 or July 2014 corn futures contracts when using a basis contract to increase the chance of beneﬁting from a spring rally. This is the typical time frame when corn futures prices rally each year.
Discuss risks and rewards with your merchandiser when you’re initiating the cash sale and basis contract. Be sure you understand the risk of being “long” futures and the ﬂow of cash funds. Advantages of the basis contract may include elimination of storage costs, removing basis risk, and minimizing the concern for on-farm stored corn quality.
The farmer isn’t 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 have greater advantages than just the loss of capturing futures price carry.
With large amounts of corn in commercial and on-farm storage, many farmers will wait impatiently for a sell signal in the December futures contract then the March futures contract. However, attractive basis and the need to generate cash may be the primary drivers as to when farmers will move their stored bushels onto the market this winter.
Consider using a scale-up selling strategy for using basis contracts, and sell 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.
The ﬁrst step for a farmer is to determine the cost of storing corn and when cash will be needed to pay debts and generate funds for 2014. This winter a farmer might avoid delivery of spot cash sale bushels during the last half of February. That’s when income taxes are due along with other large payables in early March. Expect that basis may weaken during this time frame.