17 June 2011

5 minute read

North America

Basis Changes

Lower supply or higher demand for a commodity in a local cash market relative to the overall price level represented by the futures market is reflected in higher (i.e., stronger, or more positive) basis values. Conversely, higher supply or lower demand results in lower (i.e., weaker, or more negative) basis values. The past several weeks have resulted in favorable basis changes for cattle feeders, despite price levels generally becoming less favorable.

The basis for slaughter cattle has generally been more positive than normal for this time of year, both in the Northern and Southern Plains. In Nebraska, the slaughter cattle basis was +$4.55/cwt last week (i.e., weekly weighted average cash prices were $4.55/cwt higher than the weekly average nearby Live Cattle futures price), compared to the previous three-year average of +$1.59/cwt for that week. Since the beginning of May, slaughter cattle basis has averaged $2/cwt higher than the previous three-year average in Nebraska for the comparable time period. Texas-Oklahoma prices have averaged about $0.50/cwt higher than the three-year average for that market during this time period. Last week, it was +$1.55/cwt compared to the previous three-year average of +$1.85/cwt.

These slaughter cattle basis figures illustrate two interesting points. First, basis in both the Northern and Southern Plains has generally been stronger than average in the last several weeks. This has been beneficial for cattle feeders, particularly for those who had hedged their fed cattle sales in the futures market. For cattle that have been marketed in the last several weeks that were hedged earlier in the year (with a short futures position), a substantial gain in the futures market will likely be realized given the drop in fed cattle prices. When those hedges were placed, feeders were likely expecting a lower, more average basis to add onto the futures price level at which they sold. Thus, a stronger-than-average basis now results in a higher price than expected. Further, with a gain in the futures market, it is likely that hedged marketings made money while unhedged cattle lost money. So, it is easier for feeders to “pull the trigger” and make those cash market sales despite the drop in the market price level. This eventually helps feedyards stay more current and keep cattle weights from increasing as much as they otherwise would.

The second interesting point is that the slaughter cattle basis has strengthened more in the Northern Plains than in the Southern Plains recently. Equivalently, this means that Northern prices have gained on Southern prices. Seasonally, the spread between Northern and Southern cattle increases at this time of the year (i.e., basis is stronger in the North than in the South) because cattle supplies are tighter in the North than the South at this time of year. This spread may be wider this year due to the reduction in slaughter cattle imports from Canada. Canadian fed cattle imports in May were almost 60% lower than in May last year, based on weekly trade data. Further supporting the wider-than-normal spread this year between the North and South is the notion that more fed cattle are hedged in the North than in the South. Although data aren’t available to quantitatively support this premise, anecdotal information would suggest that it is the case. To the extent it is true, it may keep fed cattle marketing more timely in the North for the reasons mentioned above.

Corn basis has also been favorable to cattle feeders in some areas. For a corn buyer, a weaker basis is preferable because it translates to lower cash prices. Significant wet conditions and flooding have resulted in sizable basis changes in the corn market in recent weeks. In areas of the country where corn plantings were late or reduced due to the cold, wet conditions, corn basis, particularly for new-crop, has been rather strong. In areas like Iowa and Nebraska where corn planted acreage will likely turn out higher than earlier planned, there is less reason for new-crop corn basis to strengthen. More interestingly, though, is the large change in old crop corn basis in the past couple of weeks in areas along the flooding Missouri River. Omaha, Nebraska corn basis has weakened by $0.16/bu in the last two weeks, from -$0.04/bu to -$0.20/bu, which has occurred throughout eastern Nebraska and surrounding areas. This is due to the flooding on the Missouri River causing some large processing plants to shut down and loss of rail transportation. Corn basis in the Texas Triangle, however, has only weakened by $0.06/bu during this time period.

So, what do these basis changes mean for feedyard managers? They generally imply that these are good times to take cash market positions (e.g., sell slaughter cattle or buy corn) if price levels have been hedged at favorable levels. Of course, prices levels for both fed cattle and corn have moved negatively against feeding margins in the past several weeks, so this isn’t to say that establishing outright price levels on fed cattle or corn necessarily is attractive at this time. Instead, for those that had previously hedged futures price levels, basis is more favorable than expected.

Last week, fed cattle traded on Wednesday at steady prices in the Southern Plains and higher prices in the Northern Plains. For the week, live prices in the 5-Area market were up $1.29/cwt compared to the previous week. Dressed prices rallied $3.30/cwt for the week. Boxed beef prices weighed on fed cattle prices last week, with the Choice averaging $174.08/cwt, $3.66/cwt lower than the previous week. Yearling steer prices were lower last week, with average prices in Montana almost $3/cwt lower, Oklahoma about $1.50/cwt lower, and Nebraska prices about steady. Steer calf prices saw bigger drops for the week, with Montana averaging about $14/cwt lower, and Oklahoma and Nebraska prices declining $2-3/cwt. For the week through Thursday, Omaha corn prices increased $0.08/bu to $7.66/bu, more than double the corn price at this time last year. Despite the stronger corn market, dry distillers grain prices dropped nearly $3/ton last week and wet distillers grain prices were about steady.