The one thing that will quickly cause a strong basis is a Kansas wheat crop failure. Contracted farmers with a crop failure will be forced to buy wheat at a higher futures price with a strong basis to deliver on forward contract with a lower futures price and a weak basis.
Contracted farmers could lose up to a $1/contracted bu. on just the basis plus the loss on the higher futures prices under a short crop scenario. Under current conditions, we would suggest that farmers go ahead and forward price wheat, but that they do not lock in basis. Farmers with on-farm storage might want to consider a storage hedge to take advantage of the carry in the market, and may also gain from an improved basis in the future.
Capturing an improved basis requires one to hold or keep ownership of the physical grain. In theory, one might be able to use the Minnesota Grain Exchange (MGEX) wheat index contract to capture an improved basis, but liquidity could be an issue. Farmers may have to buy puts or sell the board if they wish to forward price next year’s crop, because of the lack of convergence is causing lenders to reduce their credit lines to elevators.
A reduction in credit line limits elevators’ ability to meet margin calls. It is also likely to cause elevators to widen the basis on their cash prices for immediate delivery. Basis was about $1 under at Wichita, KS, where it normally has been about 25-50¢ under or even stronger.
Crop Revenue Coverage (CRC) was designed as a complement, not as a replacement for the Kansas City Board of Trade (KCBT) and marketing. Because margin calls and/or forward contract cancellation penalties are tied to futures prices, this is the reason futures prices were selected for price discovery in CRC.
The worst outcome is to be forward-priced, with market prices increasing, and suffer a crop failure. If futures markets increase then the price used to replace insured farmers’ lost production is the futures price that is necessary for farmers to maintain their hedge. A crop insurance payment at the lower cash price would not fully maintain the hedge.
Farmers who sell their crop on the board and futures prices increase $1 (farmers would receive margin calls) would also want their crop insurance to increase $1 and it will as long as revenue insurance uses futures for price discovery.