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In our analysis last Thursday, the three main components of pricing were briefly discussed. One of the important factors is the basis. In this analysis, I look at whether basis is the most important factor and whether we are disconnected from overseas markets.

The basis level is largely driven by domestic factors. When we have a large crop the basis level drops, conversely a small crop leads to higher basis levels. It is important to be monitoring basis levels as they provide an indicator of when it is best to sell.

During this drought, we have seen basis level rise to extraordinary levels, with the highest levels clearly being in the areas where the supply was diminished, and demand remained strong (figure 1). At points during the drought basis levels in Port Kembla achieved +A$215 over spot futures.

This has made many believe both producers and consumers that there is no need to consider the overseas price. This is not the case, in order to protect from adverse price risk, the futures market needs to continue to be considered.

In figure 2 basis is displayed as a percentage of the overall price. At the height of the drought pricing basis levels approached on average 40% on the east coast, however, they have since declined. In recent times, for instance, Geelong, Adelaide, and Kwinana have reverted close to their long term averages.

At present, the overwhelming majority of the price is comprised of the futures pricing component, which can be easily hedged on long horizons.

Remember to listen to the  Commodity Conversation podcast by Mecardo

What does it mean/next week?:

Basis is an important factor when pricing grain. As a producer, when the basis is high it is better to sell basis and maintain exposure to futures.

As a country that typically exports wheat, overseas futures are the biggest driver of prices in Australia. Although drought can cause large swings in pricing at a local level, it is important to still consider overseas futures in your marketing strategy.