1.4.2.2. The Components of Basis
Basis is calculated by grain handlers who continually monitor local supply and demand conditions and compete for grain. They price their product based on expected storage and transportation costs and price bids from potential buyers. Grain handlers also keep an eye on competition with other grain handlers and adjust their basis to increase or decrease the flow of grain.
Basis patterns are predictable because local carrying and transportation costs, and local supply and demand conditions are predictable. When the cash and futures prices diverge by more or less than this basis cost, arbitrageurs will keep the near-term cash and futures markets in line by exploiting that difference, simultaneously buying and selling that product and forcing prices to converge.
- • Cost of carry. Most commodities have a cost of carry. In grains, for example, the cost of carry is composed of storage costs and shrinkage and drying costs. A farmer who stores her product at her local grain elevator incurs a daily or monthly storage fee. The fee is usually fixed for the first few months of storage, before it increases with each additional month. For example, if the current month is January, a March contract will have a lower cost of carry than a September contract.
- • Transportation. The cost of transportation varies depending on the circumstances. The cost of transportation to a shipping point from a grain elevator in Western Kansas will be different from one on the Ohio River. Shipping by barge from a remote location to the Gulf of Mexico may be cheaper than by rail or truck. The type of transportation used may also vary seasonally at some locations.
- • Local supply and demand. Local prices are lower at harvest time, when supplies are at their maximum, and higher at planting time when supplies are scarce. Basis strengthens where local demand is high and weakens where it is low. Where local demand is temporarily low and storage space