Think global, act local: Supply and demand factors in commodity markets
Global and U.S. stocks-to-use ratios are powerful tools to understand future commodity price trends. Marketing commodities is also about anticipating volatility in prices as supply and demand factors evolve.
Trends in local grain bids can differ from patterns in U.S. reference prices due to supply and demand factors close to the point of production. The difference between the local and reference U.S. prices (for example futures prices in Chicago) is referred to as the basis. It reflects the value of the Canadian dollar, transportation costs, and scarcity buyers face when looking to purchase the commodity.
What are the tools to understand trends in local prices and basis levels?
Agricultural production can be highly variable, and weather is often the main culprit. For example, 2017 was characterized by high moisture conditions in Central Canada, yet corn production was up in Ontario and relatively flat in Quebec compared to 2016 levels. Variability in corn production meant there was a wide range of basis levels in the region.
Basis is defined as the difference between the reference price (typically the futures price) and the local cash price. The basis illustrates current local demand and supply conditions. The basis can be positive or negative, if it is negative, the local price is “under” the futures and if the basis is positive, it means the cash price is “over” the futures price. The terms “narrow” and “wide” are commonly used to describe basis levels. A narrow basis implies robust demand and/or declining supplies when we see the local price converge from below towards the futures price. A wide basis is the opposite: it implies sluggish local demand and/or abundance of supplies when the local price is below the futures price.
For instance, the November canola future contract is trading at CAD$511 per tonne and the cash price is $492, the cash price is $19 under November ($492 – $511 = -$19). The basis is -$19.
For instance, the December corn futures contract in Chicago is trading at US$3.98 per bushel, in Canadian dollars if the loonie is US$0.77, the Canadian dollar price would be $5.17. The cash price in Chatham is $4.73, the cash price is $0.44 under December, so the basis is -$0.44.
|December 2018 Chicago corn futures
|Corn futures in Canadian dollars
|Chatham Ontario cash price
In Ontario, when new corn supplies are coming off the combine the basis is typically wider and under the futures, improving as supplies decline throughout the year as corn is used domestically as well as exported. Interestingly, the basis in Ontario can also go from an negative-basis to a positive-basis as local demand later in the year exceeds local supplies.
How can we anticipate patterns in basis levels? The SU ratio in the Canadian market is a good starting point. A tight ratio would suggest that demand is robust, or supply expected to be lower than in other years. In that case, the basis should be narrow. The 2018-19 corn SU ratio is projected to remain relatively unchanged relative to 2017-18. Local prices are nevertheless projected to be higher due to a supportive Canadian dollar.
Canola futures are traded in Canadian dollars and there’s very little production south of the border. Yet, global soybean production trends in the U.S. and South America as well as the overall oilseed complex including palm oil will impact canola pricing. The local price will be set at a level that will attract the appropriate amount of farmer selling, while still allowing for canola to be competitive against other global oilseeds.
Larger than anticipated canola supplies widen the basis as more production compete for buyers’ interests. Strong regional demand narrows the basis level. Regions in western Canada with canola crush plants have narrower basis levels compared to other prairie regions as they compete for a steady supply and remain competitive with canola bids for export purposes – canola’s next best alternative market. Attractive basis levels in these regions has encouraged increased canola production.
Agriculture and Agri-Food Canada (AAFC) is currently forecasting canola ending stocks at July 31, 2018, to be 2.5 million metric tonnes (Mt) with combined total exports and domestic use at 20.3 Mt. This imply a SU ratio of 12.3% in 2017-18, slightly higher than the 5-year average of 11.1%. The market could totally turn in the 2018-19 crop year. Strong demand for canola along with Statistics Canada’s 7% projected decline in seeded acres would bring the SU ratio to 7.4%. Strong doubts subsist currently relative to the actual 2018 canola acres.
Generally, crop bids can be attractive during this time of year, yet are also somewhat volatile as seeding conditions change, crops progress and we approach the start of the new crop year. Watching your local grain bids requires lots of planning because as soon as grain buyers have sourced enough grain to get them to new crop, demand and basis levels can change fast.
Your local grain terminal may need to fill the last few hopper cars of a unit train, offering an attractive basis incentive on a limited number of tonnes. Once they’ve sourced enough grain to complete the unit train, the basis widens again.
Canadian agricultural commodities are priced in a global environment. Understanding demand and supply factors through stocks-to-use ratios illustrate trends in commodity prices in reference markets. Local demand and supply factors are especially important to develop a marketing plan and relevant risk management strategies that account for volatility.
Leigh Anderson is a Senior Economist at FCC with experience in agricultural markets and risk. He specializes in monitoring and analyzing FCC’s portfolio, industry health and providing industry risk analysis. In addition to his speaking engagements on agriculture and economics, Leigh is a regular contributor to the FCC Economics blog.
Leigh came to FCC in 2015, joining the Economics team. Prior to FCC, he worked in the policy branch of the Saskatchewan Ministry of Agriculture. He holds a master’s degree in agricultural economics from the University of Saskatchewan.