Friday, November 22, 2013

A Close Look at What's Happening to Basis

We've been talking about basis this year and indicating how we don't expect a great deal of "basis appreciation" or upward movement in basis as we move through the crop year.  I wanted to explain our thoughts in more detail.
Typically we expect to see basis levels pressed lower at harvest due to heavy deliveries.  Once the heavy deliveries are done, we often see a seasonal tendency for basis to improve through the rest of the crop year.  It's not a straight line moving higher, but the trend has been very evident with the best basis levels seen toward the end of the crop year when there is much less left on the farm to be delivered and farmers tend to be more reluctant to sell and deliver.
The key here is the reason why farmers are reluctant to sell.  For the most part, early deliveries have taken place to generate cash flow.  Additionally, storage space may be an issue.  But once those two factors are dealt with, many farmers watch the market and choose to sell and deliver when they see prices they like.  While this is going on down on the farm, buyers still need a constant supply coming up the driveway.  If prices are not terribly attractive, the buyers will sweeten the pot by raising their basis to keep grain moving.
The key to basis appreciation is delivery pressure easing.  Take last year in canola as an example.  There is evidence to indicate that a large part of the canola crop was forward priced prior to harvest.  In addition, being the first year without the CWB single desk, there was a lot of wheat that was forward sold.  In fact, I know a number of farmers who sold their entire wheat crop either on a forward basis or off the combine simply because they could.  Add extremely good prices to these sales and deliveries, and we can see that a great deal of cash flow was satisfied very early with these marketing strategies.  Harvest delivery pressure ended quite early and canola basis started to move higher.
Coupled with that was a yield surprise in canola - and therefore a total supply surprise.  So we had a situation where a larger than normal proportion of the canola crop was delivered early, leaving less on the farm than most people thought.  Canola basis shot up and even went to premiums over futures for the balance of the year.
This year is completely different.
Let's start with forward pricing.  It appears that total forward pre-harvest pricing of canola dropped this year from last year's levels.  It seems that some felt that forward pricing was a mistake last year (since the markets took off after harvest) and so decided they wouldn't make that "mistake" again.  This means there was less forward sold but also means there is more to be sold later.  Add to that a huge crop and we are led to the conclusion that there will be delivery pressure for some time after harvest.  The huge wheat crop also looking for access to elevators just puts more stress on the whole system.
Not let's look at where we are as of week 14 (ending Nov 8).
So far canola deliveries have averaged about 300,000 tonnes per week.  Given the projected production of 16 mmt, this leads us to estimate that for the rest of the crop year canola deliveries will average slightly higher at about 316,000 tonnes per week.  And this is why this year is different.  As we mentioned, the pace of canola deliveries tends to taper off after the first quarter of the year.  The chart at the bottom of this page shows what we're talking about.
Each of the last four years saw the same pattern; up to week 14 the pace of canola deliveries was higher than the pace afterward.  And remember what we said about last year; a greater proportion of deliveries occurred early and a smaller than expected crop lead to a greatly reduced pace of deliveries later on - only about 70% of what they were up to week 14.
This year the delivery profile is upside down.  In order for the market to clear to expected carry out levels, the pace of deliveries will need to INCREASE for the balance of the year.  This means more canola hitting the market later in the year - not less.  You can guess what that will do to basis later in the year.
Also - take another look at the chart below.  Not only is the pace in the later part of the year going to be higher than it has been earlier this year, it is expected to be as much or higher than the first quarters of each of the previous years. In other words, for the balance of the year, canola deliveries are expected to be as heavy as - or heavier than - the harvest "gut slot" deliveries we saw in the last four years - maybe longer.
Under these circumstances, we see no reason for canola basis to rebound any time soon.
Next time we will look at wheat - the story is pretty much the same though.

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