Outlook: Expect strong cash basis through harvest
BROOKINGS, S.D. (Purdue University) – Local cash corn prices in many areas of the Corn Belt has had a stronger-than-average basis this past summer, said Dr. Darrell Mark, adjunct professor of economics at South Dakota State University
“While the expected sharp reductions in corn production have been the primary driver to the stronger basis, decent demand from the ethanol and livestock industries were supportive as well,” Mark said.
Basis is the difference between cash and futures prices. While aggregate supply and demand fundamentals are reflected in futures price levels, local supply and demand conditions are evident in local basis bids.
Areas with low corn supply and high demand tend to have stronger, or more positive, basis levels, while areas with a lot of corn supply and/or lower demand would tend to have a weaker, or more negative, basis.
“Looking ahead, it appears like corn basis will remain stronger than normal for several months, even during harvest when basis tends to be seasonally weakest due to high available local supplies,” he said.
Mark said several factors contribute to this outlook. First, corn production is expected to be short everywhere, but actual harvested acreage and yields will not be known with any certainty for about four months.
This uncertainty will likely cause corn producers to be slow to market uncontracted grain in expectations of higher prices ahead. For corn buyers, primarily livestock feeders and ethanol processors, that same uncertainty and risk for higher prices into 2013 could cause them to try to buy cash grain during harvest time during what are usually the seasonal lows.
Second, storage space will be more than adequate this year, which will enable producers to store much of their crop without delivering and selling much to elevators. In the past two years, a flurry of new grain bins have been erected on farms – several of which may go empty this year with the crop shortfall.
“Interestingly, the corn market is trading at an inverse carry right now, that is, deferred futures prices are lower than the nearby December contract,” Mark said. “There is no incentive to store corn under a storage hedge.
“Instead, the market is paying the best price for immediate delivery of corn. So, the only way to profit from storing corn is to have prices increase and not have prices locked in on the upside through a short futures hedge, cash forward contract, or short call option.
“Still, it is likely that farmers will end up storing most of their crop on farm because they physically can, it makes harvest quicker, and they are hopeful for a price increase.”
Mark said that income tax management is another factor that is likely to slow selling this fall.
“With an average crop harvested last year and higher-than-expected prices this spring and summer, many producers are facing a higher tax burden this calendar year than they planned,” he said. “With the need to build w orking capital, less favorable tax depreciation rules in 2012, and having already bought needed depreciable assets for the past two years, it is likely that farmers will not try to increase the expense side of the tax ledger this year.”
He said that crop insurance indemnities that would be collected in 2012 will add to the potential taxable income this year.
“There are tax provisions that may enable some producers to defer that income until 2013, so consult your tax advisor to determine if this benefits you,” Mark said. “Many farmers will likely want to push back crop sales until the beginning of the new year.
“Of course, grain sales could be made earlier than that and checks be deferred; however, that carries with it the risk of default by the grain buyer.”
He said that negative processing and feeding margins for corn buyers is likely the largest factor to negatively weigh on corn basis bids in the next year.
“Many livestock feeders have had to reduce herd numbers and switch away from feeding corn to other feedstuffs,” Mark said.
Ethanol processors who have shut down or reduced their grind don’t appear to be ready to resume full processing at harvest time like they have in recent years.
“Many analysts point out that nationally, there is more of this type of demand rationing yet to occur,” Mark said. “However, in localized areas where those buyers have already shut down, the effects on basis may already be noticed,” Mark said.
Usually, quality of corn and soybeans are reasonably uniform and are a fungible commodity by various end users, so basis bids typically only reflect transportation differentials. However, this year Mark said, it is possible that corn quality may be highly variable, even within small geographic areas.
“The drought stress may lead to light test weights and/or presence of aflatoxin, both of which may be discounted to a different degree by end users,” he said. “For example, ethanol plants will be less willing to purchase corn with aflatoxin than most livestock feeders, and beef cattle feeders can tolerate higher aflatoxin levels than poultry, swine or dairy producers.”
Mark said the premium/discount schedule may grow to reflect higher premiums for aflatoxin-free corn and steeper discounts for corn with high levels of aflatoxin.
“While it is still too early to know the extent to which of these types of quality issues will be realized this fall, it is a realistic possibility – a similar situation occurred in 2009,” Mark said.