Basis is a term common to all futures contracts. For example the difference between the spot price of wheat and its futures price is the wheat basis.

Because markets are competitive, the wheat basis tends to equilibrated with the cost of carrying the wheat until the future delivery date. To make it worth anyones while to set aside wheat for future delivery, the futures price of wheat must be > than the spot price of wheat.

As a result, wheat basis typically is negative.Iowa corn basis tends to trade a discount to the futures but is it still true with all the new constructed Ethanol plants ? Note that all the wheat is the same (there are more or less, thirty species of wheat ), not all the oil is the same (it is worth mentioning that there are almost 250 different types of crude oils in the world ).

Basis can also be positive, its the case in ports, importing regions, regions in a state of  protein deficit. Arkansas, North Carolina have a lot of poultry farms and feeders, they use more grains than what they can grow, their basis tends to trade at a premium to the futures. In Canada, the provinces eastward of Ontario are a good example where grain is regularly priced +30% above the futures contracts. Its amazing when you have a good year and you farm for crops farmer (but not fun if youre a dairy farmer)

Basis in Energy.

The Basis is notoriously important in Natural Gas . Bakken Crude Oil is trade at a discount to the WTI causing a real headache to producers ; this is a basis.

Energy companies use generally more financial leverage.   By leverage, I mean that the energy business have a high burden of capital investment before making the first net dollar after several layers of debt with restrictive covenants. Their Net Back is correlated with their Basis so its not uncommon for them to finance and hedge their operations with OTC products draw upon a basis ex: Natural Gas Basis Swap

Bakken Wti basis assessment (realized basis)

Natural gasbasisCMENYMEXClearport data, prices for gas at theAlgonquinCitygate trading point (AGT)—this basis index (AGT- Henry Hub Natural Gas Futures) is used by many New England gas buyers—averaged about $4.25/MMbtu higher than the HenryHubNYMEX natural gas futures contract last winter.

The basis can vary to extreme levels in some markets. On the other hand, if volatility disappears in a market, the basis would be mostly flat providing no opportunities to balance physical points in a market. I will not personally seek to trade physical or financial gas markets such AGT without a VaR allocation or outside established risk parameters.

Trading the basis is not without risks .  During a rally, the short futures position(in a short futures, long cash position) will face margins calls, triggering more money to be tied-up to the futures account. If you close the losing short position in the futures, the unrealized loss will become realized.. Extreme events can blow-up the basis: Hurricane Katrina in 2005.  The Dust Bowl  In the past it has caused giga-losses and the demise of trading firms of all sizes. When albertan O&G companies enter the US Futures markets or sell cash oil  into the US they are exposed to currency risk, this  adds another dimension in trading a commodity basis.

What is in the Basis :

The starting point of  the basis is the Theory of Storage proposed by Kaldor (1939), the theory provides a link between the market structure of futures prices and the inventory of a commodity. This theory is based upon  “a cost of carry arbitrage,” in which futures prices and expected spot prices of a commodity have to rise sufficiently over time to compensate the market for the costs associated with storage. Remember its only a theory but if we keep it simple, this relationship between storage, spot and futures is a central idea behind the basis.

www.cmegroup.com/trading/agricultural/grain-and-oilseed/wheat_contract_specifications.html