The 3 Components of Grain Marketing Price Risk: Futures, Basis & Foreign Exchange
No matter what your grain marketing strategy is, there are a few basic components of price risk that every participant in grain markets should be knowledgeable on: futures, basis, and foreign exchange.
Each component impacts on price – a higher futures and basis and a lower exchange rate will create a higher Australian price. Movements in the futures market have the main impact on price, followed by foreign exchange, then basis.
Each of these can have major implications on how you price your grain and set your sales strategy. Here’s a breakdown of how they work:
Futures
A futures contract can be defined as a legal agreement to buy or sell a particular commodity asset, or security at a predetermined price at a specified time in the future. Futures contracts are standardised for quality and quantity to facilitate trading on a futures exchange.
The Chicago Board of Trade (CBOT) is the main agricultural futures exchange in the world and is used by buyers and sellers around the world to hedge their price risk.
The CBOT is the mechanism around which many of the products offered to Australian growers are priced upon. Therefore, it is critical that those marketing grain to keep a close eye on the US futures market.
Global commodity futures markets are made up of a range of market participants; from hedge funds who are speculating on price movements, through to end users of large corporations and farmers hedging price risk.
Futures allow growers, traders or buyers to close down price risk to the difference between the underlying futures and the price of the physical commodity – the basis.
Basis
Basis is used in the grain industry to discuss the difference between two price points, most often the difference between physical prices and futures market prices.
In Australia, the basis usually compares the current physical price with the CBOT wheat futures price, calculated in AUD/metric tonne terms. Alternatively, wheat basis could be calculated relative to French wheat (MATIF) futures or Kansas Chicago Board of Trade (KCBT) Hard Red Winter wheat futures. For canola, this could be against Canada’s ICE Canola contract or the French MATIF Rapeseed futures contract.
The basis level can be either positive (premium) or negative (discount) to international futures markets.
Basis is typically driven by the local supply of grain. During periods of drought, Australian basis can be at significant premiums (positive basis) to international markets. When Australian supply is plentiful, basis is pressured and can trade at a discount to international futures markets.
As an approximate estimate, basis levels contribute to roughly 15-20% of the price paid to the farmer.
Foreign Exchange
Since the majority of Australian wheat is exported, foreign exchange rates are a critical component of pricing. The international grain market is most commonly centered around the U.S. dollar, and the change in the Australian dollar relative to other international currencies can impact how competitive Australian commodities are in the international export market.
For example, if the AUD is weakening vs other currencies, it increases the purchasing power for the importing country. The opposite is true if the AUD is strengthening, whereby the Australian wheat becomes more expensive in USD terms vs other exporters of wheat in the international market and can soften demand.
FX rates are determined by a range of economic and geopolitical factors. These can be differences between inflation rates, interest rates set by central banks, current account deficits, public debt, terms of trade and economic performance.
The Decision Making Matrix - The Yarta Quadrant
The international futures market and local basis levels (the difference between international futures market and local prices) are the two major drivers of price risk. Understanding both of these can go a long way to improving the price that you receive for your commodity and increasing your bottom line.
Once you get a handle on these two influences, the next step is knowing what to do.
The decision matrix shown below is designed for producers who have a strong opinion on where futures and basis are going to go. It can be a helpful tool for setting a high level framework on decision making. For those without a strong conviction, it is best to consult an advisor or enroll in a managed pricing program.
