The Cost of Rome burning - Canola Basis
Blog entries from early May ("Just Fiddlin...?" and "Just Fiddlin...? (Part 2)") painted a picture of the extent of unresolved policy issues in Canadian agriculture. As we indicated in those earlier entries we would post follow-up blog entries to estimate the costs of having improperly aligned policy. This entry is the second follow-up entry. In this entry we provide a rough cost estimate of the widened canola basis in the commodity market. The estimates that we provide are by no means a complete costing of the issues; in fact we encourage comments on our assumptions and alternative ways to valuate the policy issues.
Preliminary estimates show
that the costs of an erratic canola basis could be in the range of $100 in a
one-time loss to an annual $400 million loss (see Table 1). This cost is one
that is borne entirely by farmers (as the entry from two weeks ago indicated
(link), the costs associated with transportation problems are split between
farmers and other system players).
The basis represents the difference between the futures market price and the local cash (or street) price. The basis is influenced by two factors: (1) the cost of getting grain from point of production to point of use; and (2) local supply-demand conditions. Throughout the 2007-08 crop year the basis has not followed historical patterns. The basis in Saskatchewan generally ranges between $20 and $30 under during the crop year (see Informa Economics and Manitoba Canola Growers Association) (the basis is negative or under when the cash price is less than the futures price). Since February 2008, however, the basis has ranged between $40 and $60 per tonne under (see Quick Market Updates for examples of the ranges); at one point it was as high as $138 per tonne under (WP March 27, 2008). With values in this new range, the basis clearly exceeds the freight and carrying costs.
This crop year the basis widened in February when half the canola crop (approximately 5 million tonnes) had still not been priced. The result was a lost of revenue to farmers - had the basis remained at historical levels, farmers would have received approximately $20 per tonne more for their canola. The result is that farmers lost approximately $100 million during the current crop year. If this wider basis becomes a prolonged condition, extending into future crop years, the loss will be on all the canola production (approximately 10 million tonnes per year). Using an upper estimate of $40 per tonne as the amount by which the basis could increase, the annual cost to farmers would be $400 million.
Table 1. Lower and Upper
Bound Widening Canola Basis Costs, 2008
Lower
Bound |
Upper
Bound |
|
|
Tonnes involved (million) |
5 |
10 |
|
Cost per tonne ($) |
20 |
40 |
|
Total cost ($ M) |
100 |
400 |
|
Assumption |
Widened
basis temporary |
Current conditions persist |
Informa Economics. 2007. Canola Weekly. March 12, 2007. Available
online at: http://www.informaecon.com/CW03-12-07.pdf
Manitoba Canola Growers
Association. No Date. Understanding Canola Basis. Available online at:
http://www.mcgacanola.org/market/canola_basis_fact.pdf
Pratt, Sean. 2008. "Futures
market suffering from disconnection with cash price" March 27. Western Producer http://www.producer.com/free/editorial/markets.php?iss=2008-03-27&sec=markets&sto=0012
Statistics Canada. Table 25. Cash Grain Prices, Canada. Cereals and Oilseeds Review. Available online at: http://www.statcan.ca:80/bsolc/english/bsolc?catno=22-007-XIB
We need to be a little bit careful here. If farmers get too focused on the basis, they are going to miss a tremendous opportunity to price canola at good levels. If we assume that the market for canola is competitive (and I would argue it is), then the basis is not an issue. That is, if the basis was forced lower, the futures price would need to also decline as end users are going to be unwilling to pay more than they currently are for canola. We need to remember that there are substitutes for canola, like soybeans etc.
If the above is the case, then the $100 million loss is not real. In fact, I would argue that the opposite has happened and the industry has subsidized canola growers. Many company's went long the basis at harvest (purchased canola at $20-30 under the futures) in the anticipation of the basis narrowing. In hindsight, this was a bad decision as the basis did not behave "normally" and actually widened over the year. The result of this would be a direct cost to grain companies and a direct gain for canola growers.
I have a pdf document that I would like to submit - who can I send it to?
Daniel
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To view Daniel's comment to this blog entry, go to this link: http://www.kis.usask.ca/Blog/Canola_Basis_Rebuttal.pdf