Follow the canola basis to capture better prices

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Source: Government of Alberta

“Canola producers, particularly those with canola in storage, follow canola cash prices,” says Neil Blue, provincial crops market analyst with the Alberta government. “However, not all canola producers track basis, the difference between the cash price and the futures price of canola. Following basis can give clues to what is happening in the market and provide pricing opportunity.”

The basis is found by subtracting the futures price from a cash price. For example, near the end March, one Alberta canola buyer’s bid for May delivery was $640/tonne. The May canola futures was at $636/tonne. The cash price of $640 minus the futures price of $636 equals a plus $4/tonne May basis. This is referred to as an over basis, or $4 over the May futures.

At the same time, another Alberta canola buyer had a bid of $620/tonne for May delivery canola. The basis of that buyer was $620 minus the May futures of $636, or minus $16/tonne, sometimes expressed as $16 under the May futures. In this example, both canola buyers are pricing from the May futures, but there is a significant difference in their bids for May delivery due to their individual basis levels.

“The basis for crops can include the costs of handling, cleaning, storing and transporting the crop as well as a profit for the grain company,” explains Blue. “Buyers set their basis level according to how aggressively they need to attract delivery commitments from producers, strengthening their basis relative to the futures price when they need more product, and weakening their basis when they are more comfortable with their product needs being met for a given delivery period.

“To evaluate a basis, one should have some basis history for comparison. Canola basis levels range from a weak minus $80, or cash price $80/tonne discount to a futures price, to a strong plus $80, or cash price $80/tonne premium to a futures price. Canola basis levels can even be outside of this wide range.”

Blue points out recent marketing year basis levels are also relevant to current basis analysis, and so are seasonal basis trends. Basis is a reflection of local supply and demand in a market, so canola basis levels tend to be weakest at harvest when there is usually plenty of supply relative to demand. As the marketing year progresses, supplies tend to tighten relative to demand and that situation often results in stronger basis levels into spring.

“Canola trade is a margin business, so buyers will only pay a high enough price to obtain needed supplies. Lately, as canola futures prices have risen, many buyers have weakened their basis levels for near-term delivery. That weaker basis indicates that buyers have contracted volumes closer to their near-term needs as farmer selling increased in response to the higher prices.”

For most of this crop year, canola crushers have generally had a stronger basis than elevator companies. Profitable crushing margins have been implied by the sum of canola oil and meal values being much higher than canola seed prices. Conversely, Canadian canola seed exports, mostly handled by elevator companies, have been relatively weak, down by 1.9 million tonnes or 33% from the year ago pace.

“A producer’s decision of which company to contract a canola sale with relates to the net price at the farm level and experience with individual buyers. For producers storing unpriced canola, there are some strategies to consider. For example, if one is determined that there will be further seasonal price improvement into late spring, possibly supported by continued concerns of dry conditions, it may be advantageous to just contract the best basis with a buyer, considering transportation and other factors. Then, set a futures price target with that buyer to complete the contract.”

A reason for locking in the basis is that, just like has happened since February, as the futures price rises, the basis bids could weaken. If the basis is locked in, then the futures is the only variable to complete pricing of that contract. Cautions with this strategy are ensuring that stored canola will remain in good condition for later delivery, and knowing the deadline that the buyer sets for pricing that basis contract against the futures month to which that basis contract relates.

“Following basis levels can be successfully used to capture a better price from the market or at least provide information on market conditions,” says Blue.