“On average you’re taking about a $9 (a tonne) hit by delivering (canola) in the fall (unless you locked in a lower basis).
– Derek Brewin
There are times when the canola basis – the difference between canola futures contract price and the net elevator price to the western Canadian farmer – seems “wonky,” says University of Manitoba agricultural economist Derek Brewin.
But based on his research so far he can’t tell whether there’s a legitimate reason or whether buyers are engaging in “strategic behaviour” to boost profits at farmers’ expense.
“There could be reasons in the infrastructure for the anomalies I’m seeing,” Brewin said during a seminar on his research presented at the university Nov. 19.
“When I see funny things I need to look at the industry and say ‘is there a reason for this?’ before I say it’s something untoward.”
Basis normally consists of the costs, including various risks, buyers have in getting canola from a country elevator to export position. Farmers sometimes complain the basis is wider than it should be and question whether companies are truly competing. Although Brewin can’t say one way or the other, he’s confident of several things. One is, on average, between 1998 and 2006 the canola basis was $10 a tonne wider between August and November than the rest of the year.
A wider basis is expected at harvest. It’s a signal for farmers to store their canola because the system can’t handle it all at once. “But $10 (a tonne) is a big number,” he said.
Brewin was quick to note his calculat ion was based on posted elevator prices collected by Winnipeg Commodity Exchange (now ICE) and therefore doesn’t necessarily reflect the basis farmers received. Farmers could have locked in a lower basis and delivered against it.
The message for farmers?
“Really consider what you want to deliver in October and November versus January, February,” Brewin said. “On average you’re taking about a $9 (a tonne) hit by delivering (canola) in the fall (unless you locked in a lower basis). Do you really need the money that bad and how much would it cost you to borrow money for that period (to store the canola)?”
Brewin is skeptical about a fall fire sale on canola, noting that farmers would be much better off financially to borrow money and store their canola for a few extra months. (Farmers can also get interest-free loans against stored crops of all kinds.)
Although the canola basis widens dramatically in the fall, there could be years when that’s the best time for a farmer to sell, if the total return is attractive, Brewin said.
“The net price to the farmer is the most important thing,” he said. “You don’t want to ignore that factor.”
Crusher versus exports
Brewin also advises farmers close to a crushing plant to carefully consider the total net return from the crusher versus an elevator.
“The real competition from the export market (visible through canola prices offered by the elevator) gets kind of muted (where elevators and crushers compete),” he said. “It’s more chaotic and more difficult to predict. If you can make deals with the crushing plant, I think that’s actually what the system wants you to do.”
Brewin suspects that’s the case in the Yorkton area where crushers at Clavet and Nipawin, Saskatchewan and Harrowby, Manitoba are competing for canola and the elevator companies might not be all that interested in buying canola for export.
The situation could be a bit different in southern Manitoba. The crush plants at Ste. Agathe and Altona sometimes import American canola. At those times the crushers don’t need to be as competitive with the export market.
“So in that region, the elevator and the export market might be a pretty good option for you,” Brewin said.
Red flags popped up when Brewin compared the basis in the different areas where farmers can deliver canola against the futures contract.
“The farther away you were from Vancouver the lower your basis was, which really doesn’t make sense,” he said because the increased risk of delayed delivery.
Brewin also found the basis was wider in areas where there was more than one crusher in the same delivery area.
“This is actually saying competition was bad for your basis, which really doesn’t make sense,” he said.
The basis around Yorkton was wider than expected given three crushers are competing for canola in that area. Meantime, Brewin found the basis around the crushing plant at Lloydminster, Alberta was narrower than expected given there’s a big volume of canola going right by on its way to Vancouver for export. Theoretically, it should require a very small premium to attract that export-bound canola to the crusher.
Some contend the best way to keep the basis in check is by making it easier for farmers to deliver canola against the futures price. In theory that should force the futures and the cash prices together. One measure of a well-functioning futures market is the lack of delivery; the mere threat of delivery should be enough to force price convergence.
Brewin advises caution when it comes to tinkering with the current contract. It’s widely traded and therefore presumably meeting the needs of elevator companies, crushers, exporters and foreign buyers. With tampering there’s a risk the contract will be less effective as a hedge against price risk. Farmers and the whole industry might be better off sticking with what they’ve got, Brewin said. [email protected]