Basis is a concept that many struggle to deal with. One reason is its name. What in the world is ‘basis’? More descriptively, it is the difference between two prices for the same thing. Think of it as the gap between what the quant collective in Chicago thinks wheat is worth next month and what a buyer will actually pay for tonnage sitting in the silo in Kwinana. One price is the yardstick (the ‘basis’ for comparing other prices) and the other is the reality. And the space between them? There be dragons!
Purists – the kind that still wear suits - love the Chicago Board of Trade (CBOT). It’s big, it’s liquid, it’s denominated in USD and it’s got more supporting data than a NASA launch. It's great as futures contracts can hedge your forward pricing exposure whether a buyer or a seller. The downside is ‘basis risk’ – the possibility that your local price will wander off like a toddler in a department store – while CBOT stays put (or vice versa).
It's important to know that there is not just one basis. There are as many as there are markets to lock in pricing. CME Platts, ASX Futures, MATIF are all exchanges that offer futures. But none are as big as CBOT and, from Jakarta to Odessa, traders invariably open their morning feed to see what it did overnight.
But if CBOT prices are being yanked around by US political tantrums, is it really the best benchmark for those of us in the antipodes?
Take soybeans. China usually hoovers up half of the US export crop. But thanks to Trump’s tariff war, that trade has been frozen like last night’s leftovers. China is a fundamental market maker, importing a ridiculous 90+ million tonnes per annum, and Brazilian and Argentinian soy producers have been reaping in the premiums whilst US soy stews sullenly in storage as a result. Regardless of whether China continues with the tariff or opens the trade up suddenly, Brazil and Argentina will be on the other end of the seesaw to US CBOT soy – what is up for one is down for the other.
Accordingly, what is the best basis for basis? A futures contract in Illinois or a futures contract in the Port of Santos, Brazil?
But that’s not all, nearly half the US soy crop goes into biofuel, a figure that was zero just 25 years ago. And this whole setup hinges on government mandates – one sharpie signature away from oblivion. Add in subsidies for US growers (some of which seem to be scribbled on napkins at political fundraisers), and the US price is also whimsically underpinned by the US taxpayer.
Meanwhile, if you’re an Argentinian soy producer, you can sell to China, but you can’t access the US crush or Uncle Sam’s wallet. So why hedge in a market that doesn’t reflect your reality?
WA’s biggest crop, wheat, isn’t immune from these shenanigans. It takes its cue from corn, which is subject to many of the same issues as soy, as well as presidential soft drink preferences. (The corn syrup vs cane sugar debate in Coke has bizarrely become political.)
As entertaining as all this is, it leaves the grain trade in a pickle. CBOT is incrementally becoming more representative of the swirling melodrama that is the White House (what’s left of it that is) than it is of the value of a tonne of physical grain being poured into a ship’s hull.
It’s a touch ironic that the tool that is intended to reduce trading risk is becoming riskier itself. Tread with care.
