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| Price Basing |
Price basing is a method where producers, processors, merchants, or consumers of a commodity establish commercial transaction prices based on the futures price for the same or a related commodity. For example, a producer can offer to sell corn at 5 cents over the December futures price. this practice is commonly used in grain, oilseeds, natural gas, petroleum products, and metal markets.
Using futures contracts with similar underlying commodities as a pricing benchmark for commercial commodity transactions allows smaller participants in the commercial market for commodities to factor in different variables. It also permits these individuals and companies, who may or may not trade in the futures market, to reach a more informed price without the related cost of research.
The cash market transaction prices established through price basing may be either spot or forward prices. the extent to which the futures price information is used in price basing provides a relevant factor for determining the contribution of the futures market to price discovery.
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In certain circumstances, prices discovered on a futures market may be such an integral and indispensable part of the price determination process in the underlying cash market that bids, offers, or cash market transaction prices have a relatively high correlation to the prices discovered on the futures market.
For instance, many long-established organized futures markets for agricultural, metal, and energy commodities appear to perform a crucial price discovery role for the broader cash markets, as reflected by the widespread practice of price basing in many of these markets. To that end, price basing motivates timely dissemination of the price information by the futures market.
