NC State Extension Publications

North Carolina farmers plant soybeans in all 100 counties in the state from the mountains to the sea. At 1.6 million acres in an average year, soybeans have the biggest footprint of any crop in the state. In a good year, the crop is worth as much as $800 million to farmers. Because soybeans work well in rotation with other crops like tobacco, and can be planted in the same field in the same year following the winter wheat crop, it is a very popular crop with farmers. Most soybean acres in North Carolina are in the eastern part of the state in the coastal plain. Leading soybean counties include Robeson, Beaufort, Pitt, Sampson, Pasquotank, Wayne, Duplin, and Johnston counties. # US Soybean Situation and Outlook There are two highlights with respect to the current demand and supply of US soybeans when studying Table 2-1. The first highlight is the massive level of ending stocks for the 2016 / 2017 marketing year of 345 million bushels, an increase of 75.1 percent from the previous year. Last year’s record US production of soybeans of 4.307 billion bushels from 82.7 million acres harvested averaging 52.1 bushels per acre, combined with a modest total use of 4.183 billion bushels, explains these sizable ending stocks. These large ending stocks carry forward to this year’s supply so beginning stocks are 345 million bushels. These sizeable beginning stocks, which combined with production to create the total supply available, serve as a curtailment to the upside price potential for the 2017 / 2018 marketing year.  15 / 16 16 / 17 17 / 18 % Change Millions of Acres Acres Planted 82.7 83.4 89.5 7.3% Acres Harvested 81.7 82.7 88.7 7.3% Yield (bu/a) 48 52.1 49.9 -4.2% Millions of Bushels Beginning Stocks 191 197 345 75.1% Production 3,926 4,307 4,431 2.9% Total Supply 4,140 4,528 4,801 6.0% Use: Crushing 1,886 1,895 1,940 2.4% Exports 1,942 2,170 2,250 3.7% Seed & Residuals 115 118 136 15.3% Total Use (Demand) 3,944 4,183 4,326 3.4% Ending Stocks 197 345 475 37.7% Ending Stocks, % of Use 4.99 8.25 10.98 33.1 US Season Average Farm Price ($/bu) $8.95$9.50 $9.20 -3.2% Source: WASDE, USDA, Sept 2017 Despite this massive stockpile of soybeans on hand, US soybean producers surprisingly opted to once again increase planted acres for the 2017 / 18 season by 7.3 percent to 89.5 million acres. With a projected yield of 49.9 bushels per acre on 88.7 million harvested acres, combined with 345 million bushels beginning stocks, the US is projected to have a record soybean supply of 4.801 billion bushels in 2017 / 18, an increase of 6.0 percent from the previous year. With projected total use of 4.326 billion, a modest increase of 3.4 percent from the previous year, the ending stocks of soybeans will be even larger at the end of the 2017 / 18 marketing season—475 million bushels and an increase of 37.7 percent from the previous year. With supply outstripping demand in 2017 / 18, there is significant downward pressure on soybean prices. The WASDE median price of the projected range of$8.35 to $10.05, which is$9.20, represents a modest decline in average farm price of $0.30 or 3.2 percent from the previous year. The second highlight, which is made clear in the historical plot of production, crush, exports, and ending stocks in Figure 2-1, is that export demand is projected to be higher than crush again. That is, a recent soybean use phenomenon has demonstrated more demand for exports than for US crush the past several years. Figure 2-1 illustrates how US soybean production has experienced a healthy upward trend over the period 1980 through 2017. However, the production years of 2014/2015 and 2015/2016 were breakout years where soybean production jumped to just below the 4-billion-bushel level and then higher in subsequent years. This phenomenon signifies that the upward trend in production might have increased. Only with the test of time will this be affirmed. To better understand the current situation, it is useful to plot the stock/use ratio (SUR) and the average farm price for a production year over time. The SUR and price have an inverse relationship, meaning when SUR is low then prices are high and vice-versa: when SUR is high the prices should lower. Figure 2-2 plots SUR and price for the period 1980 through 2017, clearly showing this inverse relationship. The period between 2010 and 2017 in particular illustrates this inverse relationship. During the first component of this timeframe, 2010 through 2014, SUR was declining and price was increasing. The SUR ranged from a record low of 2.65 percent to 6.55 percent, and prices ranged from$10.10 to $14.40. Then in 2014 and 2015, as production leaped to almost 4 billion bushels before reaching a record 4.307 billion bushels in 2016, and without offsetting increases in soybean use, ending stocks were on the rise. SUR increased from 4.95 percent to 11.21 percent over the period 2014 through 2017. The slopes of the increasing SUR and decreasing price are very similar during this 2010 through 2017 timeframe. One final point to glean from Figure 2-2 is the current projected SUR of 11.21 percent and the average farm price of$9.20 per bushel. Previously, when looking backwards in time, the last time SUR was at a similar level of 10.68 percent in 1999 to what it is currently, soybean price was $4.63 per bushel or half the prices of what soybeans are today. This observation provides some credence to the argument that soybean prices after the significant run up in prices during the period 2010 through 2014 have established a new price plateau. A price plateau means prices will likely not return the$4.00 to $6.00 a bushel range experienced in the early 2000s. Having said that, the current demand and supply situation in 2017/18 will add a projected 475 million more bushels to ending stocks in 2017/2018. This scenario leaves projected ending stocks of 475 million bushels to act as a significant lid on soybean prices for the next several years until ending stocks can be reduced to their more typical level of 175 million bushels. In short, the massive ending stocks in the current year’s soybean limits upside potential on prices in the near future. Prices will need to decline below the projected$9.20 per bushel so that the ending stocks will be attractive to purchase, all else being equal.

Another useful gauge of the current soybean outlook is to look at the futures market and see where the forward-looking soybean harvest futures contracts (November) are currently trading. For example, at the time of writing, the November 2017 soybean futures are trading at $9.99 per bushel. Looking a year further out to November 2018, soybean futures are trading at$9.95 per bushel. Given that the two forward-looking harvest contract futures are trading within 5 cents of each other, it is reasonable to assume that the current market outlook is neutral, signaling that demand and supply are not expected to change much in the 2017 / 18 and 2018 / 2019 marketing year.

Figure 2-1. US soybean supply and disappearance 1980 / 81 – 2017 / 18P.

Figure 2-2. US soybean stocks/use and average farm price 1980 / 81 – 2017 / 18.

# Managing Price Risk in North Carolina

North Carolinian soybean producers face many different risks, ranging from production, price, and financial risks to environmental, health, and legal risks. Moreover, government policy can affect the sources and levels of risk. One such risk is price risk—the possibility that the selling price of a crop will decline, perhaps to a less-than-proﬁtable level. To manage this risk, a producer must achieve a balance between the different goals of locking in a proﬁt level and preserving opportunities to beneﬁt from favorable marketing conditions.

Alternatives for managing price risk include marketing instruments (a wide range of cash grain contracts, futures markets, and options markets) and crop insurance (revenue protection). None of these alternatives alone will likely achieve the desired balance. In most situations, a balanced risk plan will require using a combination of marketing instruments, insurance products, and the farm programs offered by the government. The performance of such a risk-management plan will depend upon market conditions at planting and at harvest in a given location.

Within that context, a producer must decide what to plant, whether to purchase crop insurance or to self-insure, and how and when to sell the expected harvest. All of these decisions will jointly inﬂuence the level of production, price-risk exposure, and profits. The uncertainties involved in production and prices mean that “no one size fits all.” Each individual’s risk tolerance and financial situation affect the best price-risk management alternatives for a specific situation. Because effective price-risk management depends on the situation, this chapter focuses on the topic of price-risk management for soybean marketing in North Carolina taking into account the current economic situation for soybeans. It is critical to understand that North Carolina has unique characteristics that distinguish it from the Midwest and the Corn Belt, and they affect risk-management choices. To manage price risk effectively, producers in North Carolina need to understand these distinctions, the current market situation and outlook, and the available marketing alternatives. This chapter attempts to outline some of the basics involved. With this information, a producer can develop a number of different strategies to use. This chapter focuses only on some basic and simple strategies that can serve as a foundation for more sophisticated approaches.

Price Risk

A producer plants a crop making the basic assumption that at harvest, or sometime thereafter, he or she will be able to deliver the crop to a buyer for a profit. Between planting and harvest, or that “sometime thereafter,” there is substantial probability for the price to either increase or decrease. A price increase is typically viewed as an opportunity or good fortune. A price decrease is typically viewed as risk or bad fortune. Price-risk management strategies seek to accomplish one of two alternatives: either to lock in a price level or to establish a price floor. Locking in a price level entails establishing a price that is as high as possible given the current situation and outlook with all of the price uncertainty being removed. That is, by locking in the price, both price risk (bad fortune) and price opportunity (good fortune) are eliminated. A forward contract is one way to lock in a price level because the producer promises to deliver a product at a specific time for a set price. Setting a price floor involves the producer eliminating price risk (bad fortune where prices decline) but the potential for price good fortune remains. A hedge using a put option where a producer purchases a put option at a particular strike price is one way to establish a price floor and still have the possibility of benefiting from a price rally. The cost of purchasing the put option can be likened to an insurance premium on price.

Basis

Basis can be thought of as the economics of where and when. More concretely, basis can be defined as the difference between local cash prices and futures prices for commodities at a given point in time. This difference can be expressed in a simple formula:

Basis = Local Cash Price - Future Price

Using this definition of basis, we can also express local cash price as a simple formula, the sum of futures price plus basis:

Local Cash Price = Futures Price + Basis

It is important to note that basis refers to a local product with identical specifications to the futures contract specifications. If a product differs in quality from the specifications, its selling price will be affected. The formula for local cash price being the sum of futures price and basis is fundamental to price formation and price risk management. Breaking down this formula into its components is helpful in understating the concept. Nearby futures price (the futures contract closest to expiration) reflects the current world expected demand and supply situation. A soybean futures contract is an agreement to buy or sell a predetermined amount of soybeans at a specific price on a specific date in the future. Buyers of soybeans use such contracts to avoid the risks associated with the price increases and sellers use such contracts to avoid the risks associated with price declines. The soybean futures price is traded and determined at the CME group located in Chicago. There is a significant volume of contracts traded such that no one trader can impact price and so the nearby futures price is considered to be the best unbiased estimate at any particular time. Any significant changes in the world demand and supply are reflected very quickly as buyers and sellers react to the new information. Because soybean futures prices are determined by world supply and demand of soybeans, futures prices have more volatility than basis. This relationship that basis is much less volatile than futures is fundamental to price risk management and in particular hedging.

Understanding and making effective risk-management decisions to manage local cash price risk requires understanding and managing futures price risk and basis risk. Fortunately, the futures markets allow producers to gather significant amounts of information concerning the riskiness of futures price levels. These markets also offer opportunities to hedge or offset this risk by using futures or options contract as a temporary substitute for a cash transaction that will occur later.

Information concerning the local basis is less readily available. Understanding what the basis looks like will enhance a producer’s ability to make effective risk-management decisions and to evaluate current bids and offers. It has already been noted that basis can be thought of as the economics of where and when. It reveals the difference between two prices—cash price and nearby futures contract price—for a commodity at a given time and place. Using basis as a measure, we can track the difference between these two prices for a crop across locations and seasons. We can also see how these prices for a crop will probably behave in the future based on their relative differences in the past. Many factors affect basis levels within a given region, including supply and demand within the market area; availability of storage, handling, and processing facilities; the volume of imports; and the cost of transportation to the area. Some rules of thumb can be helpful concerning basis. Local end use demand is a strong influence on basis within any given market area. When local end use demand is high relative to supply, the basis tends to be relatively strong. When local end use demand is low relative to supply, the basis tends to be weak. Basis will be stronger at the end user-processor location than at an intermediary handler location. Intermediary handlers must reduce their bids below the final use price level to cover operating costs, including a profit and transportation costs from the buying points to the end users. Transportation costs from the production areas to the end user can be a significant factor in determining basis.

A compilation of historical basis data can be immensely helpful to put current local price levels into perspective. Sellers can use these data to see how current price levels compare to those in previous years and to detect seasonal trends in price levels. Because basis levels tend to be more predictable than general price levels, historical basis data are especially informative. Knowing the historical basis and its typical patterns throughout a marketing year can help producers determine when and where to sell their crops and, in particular, it can help them to evaluate different marketing alternatives such as cash contracts, forward contracts, basis contracts, and hedging.

Futures market prices provide measures of the expected levels of supply and demand for a product at different times in the future. Most of the major grain players in the world markets pay significant attention to the CME and also utilize this market to manage price risk. The higher the futures price, the more expected demand there is for the product relative to expected supply. Conversely, when futures prices are low, expected supply is greater relative to expected demand. The futures contract closest to expiration is often referred to as the nearby futures contract. We can think of the nearby contract as a measure of the current demand and supply situation in US and world markets. Similarly, the basis serves that same function for local cash markets compared to the national market. When current basis is relatively strong, it implies that current local demand is high relative to supply. Likewise, when current basis is weak, it implies local demand is low compared to supply. The terms weak and strong, when used to describe basis levels, are relative terms: a weak basis is one that is below typical historical levels, and a strong basis is one that is above typical historical levels.

Table 2-2 provides a historical monthly average for nearby soybean basis for Fayetteville, North Carolina for the period 2000 through 2016. The monthly summary statistics for the 17 years of basis data, and in particular the mean, illustrate the local demand and supply situation at Fayetteville throughout the marketing year.

 Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec $/bu 2000 0.04 0.05 0.01 0.05 -0 02 0.08 0.13 0.21 0.14 0.04 -0.14 -0.15 2001 -0.12 -0.04 0.05 0.10 0.15 0.15 0.15 0.18 0.20 0.02 -0.06 -0.02 2002 0.05 0.05 0.00 0.00 0.04 0.05 0.11 0.07 0.25 0.20 0.12 0.10 2003 0.10 0.15 0.15 0.19 0.18 0.20 0.28 0.33 0.19 0.02 -0.10 -0.06 2004 -0.04 0.01 0.14 0.20 0.32 0.02 0.74 0.83 0.26 0.00 -0.05 -0.05 2005 0.09 0.15 0.07 0.10 0.11 0.20 0.20 0.21 0.10 3.00 -0.08 -0.02 2006 0.04 0.09 0.07 0.15 0.05 0.11 0.18 0.11 0.12 0.11 -0.06 -0.04 2007 -0.06 0.00 -0.10 0.01 -0.06 -0.05 -0.11 -0 03 -0.10 -0.08 -0 09 -0.02 2008 -0.11 -0.12 -0.17 -0.06 0.13 0.23 0.42 0.65 0.48 -0.10 -0.19 -0.01 2009 -0.19 -0.17 0.49 0.50 0.54 0.24 0.71 0.79 1.27 0.19 -0.17 -0.14 2010 -0.09 0.02 0.11 0.19 0.21 0.41 0.76 1.07 0.60 0.06 0.02 0.15 2011 0.09 0.20 0.27 0.38 0.46 0.58 0.75 0.61 0.04 0.00 0.02 0.11 2012 0.19 0.28 0.34 0.40 0.39 0.38 0.45 0.58 0.68 0.19 -0.14 -0.24 2013 0.00 0.09 0.31 0.31 0.99 0.59 0.44 0.63 0.20 0.38 0.34 -0.04 2014 0.43 0.26 0.33 0.54 0.50 0.61 1.13 1.96 2.10 0.75 0.11 0.04 2015 0.18 0.13 0.26 0.33 0.43 0.49 0.57 0.83 0.95 0.25 -0.07 -0.12 2016 -0.08 -0.05 0.00 0.02 0.10 0.14 0.42 0.60 0.38 0.01 -0.03 -0.04 MIN -0.19 -0.17 -0.17 -0.06 -0.06 -0.05 -0.11 -0.03 -0.10 -0.10 -0.19 -0.24 MAX 0.43 0.28 0.49 0.54 0.99 0.61 1.13 1.96 2.10 0.75 0.34 0.15 MEAN 0.03 0.06 0.14 0.20 0.27 0.26 0.43 0.57 0.46 0.12 -0.03 -0.03 Table 2-2 illustrates that soybean basis in Fayetteville is typically weakest at 3 cents under (or -$0.03) in the months of November and December. These months correspond to the harvesting window of soybeans in North Carolina and so local supplies are plentiful (assuming an average to good season occurs) and therefore high relative to demand and so basis is weak. Starting in January, soybean basis in Fayetteville begins to strengthen as local supplies become less plentiful than demand. This strengthening in basis continues until August when basis is on average 57 cents over (or $0.57)—the highest for the year. In September, basis slightly declines to 46 cents over (or$0.46) before October, when basis significantly declines to 12 cents over (or $0.12) as the local market enters the harvesting window. In short, examining basis throughout the calendar year depicts the annual changes in local demand and supply. It can also be helpful to compare basis at different locations to gauge whether there are important differences or any potential arbitrage opportunities. We expect the difference in basis between two locations to reflect approximate transportation costs. If the difference is higher than transportation costs, it represents an opportunity for an arbitrage when growers might contract to sell their soybeans to the location with the stronger basis and extract the premium being offered over transportation costs. Figure 2-3 plots historical monthly average nearby soybean basis for Fayetteville, Cofield, and Norwood for 2000 through 2016. Fayetteville is located in the central part of the state and is a significant crusher of soybeans, Cofield is located in the eastern part of the state, and Norwood is located in the western part of the state. This figure illustrates that the monthly basis in each location mimics the others in terms of when soybean basis weakens and strengths and there is constant differential between each location reflecting transportation costs. The average difference between Fayetteville-Cofield is$0.15 per bushel, Fayetteville-Norwood is $0.50 per bushel, and Cofield-Norwood is$0.35 per bushel. These average differences approximately reflect the costs of transportation of soybeans between the two locations.

Historical Basis to Manage Price Risk

Historical basis at a given location can be used as a measuring stick: you only need the current basis being bid to compare with historical levels to decide if the current basis is stronger or weaker than usual at any time. This comparison is especially useful in evaluating different marketing decisions.

Comparing basis over time at the same location can help gauge whether there has been some fundamental or structural change in the local market. We would naturally expect that basis to have some volatility year-to-year to reflect the local demand and supply conditions. In the absence of no fundamental or structural change, however, we would expect average monthly basis to be similar between two time periods, say 10 years apart. Recall, basis levels tend to be more predictable than general price levels for year-to year, and it is this characteristic that is fundamental to hedging.

Figure 2-4 provides a comparison of historical monthly average nearby soybean basis for Fayetteville over the periods 2000 through 2004 and 2012 through 2016. This comparison shows that basis around harvest in November or December periods has not changed significantly. Starting in January, however, we find a significant change in basis between the two periods. Basis has strengthened in the first quarter around 10 to 18 cents, before further strengthening by 32 to 35 cents for May through July, and strengthening even more to 60 to 65 cents in August and September.

This significant strengthening over the January-October timeframe signifies that the local demand and supply situation at Fayetteville has changed since 2000 through 2004 with an increased demand for soybeans and hence the higher basis to attract new sellers. This increase in soybean basis over this timeframe is likely to be present in other local soybean markets around the state. It is a result, in part, of the grain initiative that has been underway in the state for more than five years. The grain initiative has placed an emphasis on increasing grain acres and on local buyers buying more grains locally in an effort to reduce the feed deficit to support the significant livestock production and demand for feed.

Using Basis to Evaluate Cash Bids

Basis can be used to decide whether it is beneficial to accept an offered cash price at any time. If the cash bid includes a basis amount that is strong relative to history, then the bid is attractive and indicates a strong desire by the purchaser to buy and a good opportunity for the seller to sell. The converse is also true. By knowing what the basis has been in the past, the seller can decide with greater confidence whether an offer is reasonable.

Using Basis to Evaluate Forward Contracts for Harvest Delivery

Historical basis can be used to evaluate forward price contract offers. A stronger-than-expected basis in conjunction with an acceptable price level may signal an opportunity to eliminate price and basis risk by agreeing to a forward price contract. This strategy is advantageous in that it provides protection from any declines in price levels or weakening in basis. The primary disadvantage of this strategy is that it prevents benefiting from price rallies or strengthening in basis after the contract is made. There are production risks as well: the producer is under contract to deliver the amount of grain specified.

Using Basis in Deciding Whether to Hedge

Basis can be used to decide whether it is beneficial to hedge or to accept a forward contract. A weaker-than-expected basis (compared with historical levels at the same time), in conjunction with an acceptable price level (determined by the harvest time futures), may signal an opportunity to eliminate price risk by hedging and retaining only basis risk. This strategy lets the seller lock in the current price level but not the basis. Locking in the price level eliminates the more risky component (price), leaving the less risky and more predictable component (basis) to strengthen to its typical level. A stronger basis makes hedging less attractive (a weakening of basis is detrimental to a producer who has hedged) and signals that a forward contract may be more appropriate.

The Marketing Cross

Most of what has been described above can be characterized in Table 2-3 and Figure 2-5, which display the merits of risk management under alternative scenarios of basis and futures prices. Table 2-3 also shows the risks associated with different marketing strategies. Figure 2-5 illustrates alternative strategies for different futures price and basis situations.

 Marketing Strategy Futures Price Risk Basis Risk Cash Sale at Harvest Yes Yes Cash Forward Contract No No Basis Contract Yes No Futures Hedge No Yes Put Options Hedge No Yes

Each of the strategies takes advantage of potential changes in either futures price or basis and protects the seller against adverse movements in those elements. The suggested strategies are the least risky marketing alternatives for each situation. For example, when the basis is strong and current futures prices are high, the best strategy with the least risk would be to enter into a forward contract. That contract locks in both the favorable basis and attractive futures price. It protects against a weakening of the basis and against futures prices falling.

Figure 2-3. Historical monthly average nearby basis for Fayetteville, Cofield, and Norwood for 2000 - 2016.

Figure 2-4. Comparison of historical monthly average nearby soybean basis for Fayetteville over the periods 2000–2004 and 2012 - 2016.

Figure 2-5. Alternative marketing strategies for different futures price and basis situations.

# Authors

Professor, Grain Marketing and Risk Management
Agricultural & Resource Economics
Extension Associate - Farm Management
Agricultural & Resource Economics
Professor and Extension Soybean Specialist
Crop and Soil Sciences
Extension Weed Specialist and Associate Professor
Crop and Soil Sciences
NC Farm School Associate
Agricultural & Resource Economics

Publication date: Nov. 21, 2017
AG-835

## Other Publications in North Carolina Soybean Production Guide

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