Farmers need to be asking tough questions about how our grain is priced, and we must not be satisfied without full answers.
Farmers continue to be confounded by “basis.” Their complaints include the volatility in basis as well as a lack of transparency in how basis is calculated. As well, many farmers believe that the positive effects of the falling Canadian dollar are not being returned to farmers through a better basis.
In short, many growers feel they are being underpaid for their commodities because of a corrupted basis.
But do we actually have a basis problem? Or is the current dysfunctional basis simply a symptom of a much larger problem; namely, a broken price discovery system?
What is basis?
By textbook definition, basis is the result of a simple calculation: Cash Price – Futures Price = Basis.
In the working world, basis is the difference between the local cash price and the futures price to reflect the real costs of storage, handling, transportation and interest incurred. Basis also includes, in the case of a grain company or broker, a profit margin.
More importantly, from a seller’s viewpoint, basis also reflects demand for delivery of the commodity. If a buyer needs delivery of the commodity, the basis will strengthen, thereby resulting in a higher cash price for delivery of that commodity.
Lack of information
How many of you can tell me with certainty what the actual local cash price is in your area for a specific grain and grade? Likely, most of you can tell me, or quickly find out, what the basis is for your delivery point as well as the futures price. But most of you will not be able to tell me what the local cash price is for your area because no one is tracking cash bids.
Many of you will argue that the cash price would be the future price minus the quoted basis. While this may be the cash price you receive for a sale, it may have little relationship to the real value for that commodity in your area. The price you received reflects a single transaction between two parties at a particular time. It may be well above or below the local average price.
Worse, if cash price is determined by the basis (rather than the basis being determined from the cash price) it is giving all pricing power to the buyer.
The biggest problem facing farmers is not basis. It is a lack of a local price. While some of that is due to a lack of buyers and competition, the bigger problem is that no one in Canada is tracking grain sales and reporting pricing information.
South of the border, the USDA Agricultural Marketing Service (AMS) has been tracking and publishing unbiased price and sales information of farm commodities since 1915. AMS employs over 4,000 people and has a budget of US$965 million for 2015.
AMS reports local cash prices as well as sales volumes and quality of commodities sold and in storage. It collects data from both domestic sales and international sales, and this regularly updated information is available within hours of collection via the Internet, by telephone, and through printed media.
This information allows farmers to evaluate current market conditions, identify market trends, plan sales, and plan for next year’s cropping. The portion of the current AMS budget for this collection and dissemination of price and sales data is US$35 million for 2015 alone.
Since the privatization of the CWB, we have had no organization reporting on price and sales of Canadian crops. This may be changing. On January 28, 2015 the Alberta Wheat Commission (AWC) announced it was spearheading a pilot project of publishing regional cash prices for a number of agricultural commodities. A model of its Price and Data Quote (PDQ) website is already up and running to give farmers and industry the opportunity to provide feedback as to what price and data information is needed, what can be collected, and what they would like to see available. This test site can be viewed at www.pdqinfo.ca.
Russ Crawford, one of the individuals tasked with developing the price and data report concept, urges farmers to check out the site and provide feedback as to what information they feel they need and would like to see included on the site. He hopes this site will become the standard for local cash pricing just as ICI is for futures pricing and Quorum is for grain transportation and movement information.
Will this solve the problem we have with the lack of an established local pricing system? Unfortunately, at this time, there are only a few companies providing cash bids to PDQ. Crawford and his partners are trying to encourage more companies to provide pricing information through direct contact with grain companies, traders, processors, and end-users.
Unlike in the U.S., where companies are mandated to provide sales and price information to AMS, participation in providing price and data information on commodity sales is voluntary in Canada. It is unknown how many companies will participate. If the information on the PDQ site reflects only a small percentage of commodity sales, it will not be of much value.
The second problem is that the funding for this program is unclear. The federal government provided $742,725 to get this program up and running, but there has been no promise of additional or continual funding.
Crawford says there are a number of ways this could be funded in the future. The AWC, which started the program, may decide to be the sole owner of the information, although Crawford feels this may be outside its mandate. Other commodity groups and commissions may join the AWC to provide this information to all stakeholders. It may evolve into, or be sold to, a private entity and the information disseminated on a subscription basis.
Or it could be recognized, as it is in the U.S., that this information is actually for the public good and should be available to everyone, meaning it should be government funded.
Let’s assume the PDQ concept succeeds and becomes an accurate accounting of local cash prices available to everyone. If we are to be able to calculate a true basis, we must also question whether the posted futures prices are still a truly accurate reflection of supply and demand for commodities.
Today’s futures markets are much different than they were when they were first introduced. The original futures markets provided both risk management (which they still do well today) as well as a mechanism for price discovery. Futures markets used to be used primarily by the actual buyers and sellers of commodities. The settlement price accurately reflected what the buyer and seller of the commodity were willing to trade the commodity for at a future point in time. There were also a limited but necessary number of speculators in the futures market who were willing to enter into a contract when there was a lack of buyers or sellers.
But today, investor and speculator trades often overshadow actual hedges. A significant number of trades is rolled forward rather than completed. It makes us ask, is the futures price really an accurate reflection of market fundamentals?
Furthermore, except for canola, we do not have an active Canadian futures market for any agricultural commodity. Does the U.S. futures price accurately reflect the future value of Canadian crops?
A necessary function of any futures market is to provide the price structure for delivering against a contract. Are the U.S. future market delivery points a feasible option for Canadian farmers, especially given our congested transportation system?
And what impact has the privatization of the futures markets had on the accuracy of price discovery? When quantity of trades becomes the driving factor in the profitability of a futures market, are we putting at risk the regulatory role which used to be the primary goal of the futures market?
If the futures markets are not an accurate reflection of the future supply and demand for commodities, then basis again becomes meaningless.
Disparity between international and futures prices
Farmers are also angered over the apparent disparity between Vancouver port prices, futures prices and the price paid at the elevator pit. While this difference should be reflected as the basis, all too often the rumoured price at port is well above the money the farmer receives plus the basis. Farmers want to know why the futures price is not an accurate reflection of the port price, given they are the ones paying for delivery of that grain to port.
Of course, an even more important question is, what are the actual prices being paid for our grains at port?
Farmers are also questioning why we are not seeing the arbitrage of prices between Canada and the U.S. now that the CWB is gone. Is it truly just a transportation problem, or are there other factors at play as well?
Is the abnormal basis level the problem, or is it simply the tip of the price discovery iceberg? Are we, as producers, being distracted by basis from a much more serious problem — that of a lack of price discovery? Have we allowed buyers to corrupt the meaning of basis so that it is no longer a valid delivery signal for growers but rather a way for buyers to manipulate price?
I have no answers, just a lot of questions, including the ones you have just read. These are the questions every farmer must be asking of their commodity organizations, farm groups, and governments. We need answers to these questions now or the problem will simply get worse as consolidation in our industry continues.
Price discovery – Gibson Capital Inc.
Iebeling Kaastra, research director with Gibson Capital Inc. at Calgary is concerned with the lack of price discovery in Canadian crops and livestock.
“There is very poor price discovery in agriculture in Canada,” Kaastra says. “I fear that over time, it is getting worse due to global trends, increasing concentration of grain-handling businesses, vertical integration, the inability to launch new futures contracts, and the lack of government funding for price collection and dissemination.
“Farmers should be concerned.” Kaastra argues.
Kaastra warns that poor price discovery can lead to price manipulation. And, he points out, risk management is not possible if prices are unknown.
Kaastra has written a short online article entitled Price Discovery in Canadian Crops and Livestock which should be read and considered by every farmer.
Some key points in that article include:
- “… true price discovery is the result of a competitive market in which many buyers and sellers are transacting within well-defined rules.”
- “Price discovery in Canadian cereals, pulses, oilseeds, and livestock markets have unfortunately lagged the developments in the U.S.”
- “For over 90 years the USDA has embraced the ‘public good’ role of price collection and dissemination.”
- “It is highly unlikely Canada will have a new agricultural futures contract any time soon.”