Buy low, sell high. That is always the ideal scenario. Traditionally that is what your investment advisors and accountants tell you. But, if you’re dealing with grain, things operate a little differently. In fact, in the case of grain elevators, ethanol plants, feed grinders, and more it’s not all about the purchase price. Rather, it’s about managing basis.
Many agribusiness professionals are familiar with basis. It’s what we refer to as the difference between the quoted market price on the Chicago Mercantile Exchange (Chicago) and the local market price. In taking a closer look at grain, it’s rare that you will sell grain at your local elevator for the same price quoted in Chicago. Often you will be paid less, but, possibly more. It all depends on local supply and demand. The whole process can cause some head scratching — how is it that you can buy high, sell low, and still make money? Hedging is the answer.
When grain marketers are contracting with you to buy grain at a future date, they are simultaneously contracting with brokers to sell grain at a future date at a different price. These contracts can be fulfilled by either supplying grain, or, supplying cash. Then, at a later date, when you deliver the grain to your local elevator, you hope the price has decreased and then you feel as though you got a better deal. The elevator cares less about what the price is, but rather, what the spread is between the local price and the price in Chicago.
For example, if you originally contracted in August for a December delivery at 50 cents under Chicago, and then when you delivered, the local spot price was only 30 cents under Chicago. Now the elevator owes you for the grain, but they also have contracted to sell the grain (back when your original contract was executed) to the brokers. Rather than deliver grain to the broker, they will buy a purchase contract from the broker at the current rate in Chicago. The elevator now has one contract requiring delivery and one contract requiring purchase of grain. These contracts will then offset each other in terms of bushels. In terms of dollars, however, the elevator has made 20 cents per bushel. This formula plays out because of the changes in basis at the local level, which eliminated exposure to price changes in the market as a whole.
This practice is intended to mitigate the future unknown market ups and downs in order to protect both buyers and sellers. However, knowing that an elevator makes money differently than you as the producer is an important distinction. The fact that they are paying less than the Chicago price isn’t all about greed, or the handling and shipping fees it costs them to get the grain to the next place. While these elements can factor into the overall pricing, the local supply and demand drives the price.
It can pay to keep an eye on basis across the country. If basis is rising across the board, future prices may go up as well. If basis is heading downward, futures could follow suit. Being informed helps those in the market decide when to lock in the grain they want to sell or need to purchase.
An accountant with experience in basis and hedging can help you navigate through this process. Don’t hesitate to partner with a professional that will assist you with this practice and other matters pertaining to the financial success of your operation.
William Bauder, CPA, CGMA is a Senior Accountant at Holbrook & Manter. He is a graduate of The Ohio State University and has extensive experience in the areas of audit and agribusiness. William has received detailed training in the area of market-to-market accounting for grain elevators and is skilled in helping agribusiness professionals make sound financial decisions. Farming is in William’s blood, as he grew up on a 2,500-acre farm in southern Delaware County.