Risk Premiums and Forward Basis: Evidence from the Soybean Oil Market

Forward pricing contracts for soybean oil are important supply chain arrangements in both the biodiesel and food industries. Forward pricing is often extended to end-users by soybean oil processors where the forward price quote is a function of the Chicago Board of Trade (CBOT) futures price and the cash-futures basis. Upon entering a forward pricing agreement, the processor (seller) assumes the risk associated with basis fluctuations. This research examines if soybean oil processors extract a market premium for assuming this risk. Using forward basis quotes and subsequent realized basis values for soybean oil, it is found that soybean oil processors do not charge an embedded cost for their forward pricing services. Furthermore, the results suggest that the absence of a statistically significant embedded cost may be due to the lack of predictability in the basis or the inability of soybean oil processors to adequately forecast soybean oil basis levels.