Term

Contango and Backwardation: Commodity Futures Curve Structures

When commodity traders speak of the “shape of the curve,” they are referring to the relationship between prices for delivery today versus prices for delivery in future months. This relationship — the term structure of commodity futures prices — is described by two key concepts: contango and backwardation. Understanding them is fundamental to understanding how commodity markets work, how physical traders make money, and why storage economics matter.

Contango: Future Price Higher Than Spot

A market is in contango when the futures price for a commodity is higher than the current spot price — that is, when the market prices future delivery more expensively than immediate delivery.

In a contango market, the futures curve slopes upward over time. If today’s crude oil spot price is $70 per barrel, but the three-month futures price is $73 per barrel and the six-month price is $75 per barrel, the market is in contango.

Why Contango Occurs

Contango reflects the cost of carry — the economic costs of holding a physical commodity over time. For a storable commodity like crude oil, the cost of carry includes:

Storage costs: tank rental fees, terminal handling charges, insurance
Financing costs: interest on the capital tied up in the commodity inventory
Quality deterioration risk: for commodities that degrade over time

In a simplified theoretical world with no supply or demand distortions, futures prices would trade at spot price plus cost of carry — this is the “full carry” contango. If the three-month cost of carry for crude oil is $3 per barrel (storage plus financing), then a three-month futures price at $3 over spot represents a market in full carry.

Contango is typical when:

Supply is ample or oversupply is present
Near-term demand is weak relative to longer-term expectations
Storage capacity is available

The Contango Storage Trade

Contango creates a trading opportunity for operators with access to storage infrastructure. The trade is straightforward in concept:

Buy spot crude oil at $70 per barrel
Simultaneously sell six-month crude futures at $75 per barrel
Store the crude for six months (cost: approximately $2-3 per barrel)
Deliver into the futures contract at expiry at $75 per barrel
Capture the profit: $75 - $70 - $3 (storage) = $2 per barrel, risk-free

This trade — sometimes called a “cash and carry” arbitrage — is actively executed by physical commodity trading houses with storage infrastructure. It explains why, in periods of deep contango, commodity storage assets become extremely valuable and storage capacity fills rapidly.

The most dramatic recent example was the COVID-19 oil price collapse of April 2020. Global oil demand fell precipitously as lockdowns grounded aviation and idled transportation. Crude oil markets fell into extreme contango — at one point, WTI front-month futures traded briefly in negative territory (below zero) as traders with no storage capacity were forced to pay to avoid taking physical delivery. Traders with storage capacity — including the major Geneva houses — executed contango storage trades at exceptional profitability during this period.

Backwardation: Spot Price Higher Than Futures

Backwardation is the opposite condition: the spot price is higher than futures prices, meaning the market prices immediate delivery more expensively than future delivery. The futures curve slopes downward over time.

If today’s crude oil spot price is $85 per barrel, but the three-month futures price is $83 and the six-month price is $80, the market is in backwardation.

Why Backwardation Occurs

Backwardation typically reflects physical scarcity in the near term — a shortage of supply relative to immediate demand. When buyers need crude now and are willing to pay a premium to obtain it quickly, the spot price rises above forward prices. Sellers of spot crude can command a premium precisely because near-term supply is tight.

The theoretical explanation for backwardation draws on the concept of convenience yield — the implicit benefit of physically holding a commodity. When a refinery needs crude to run its operations, having crude in storage has a tangible operational value that is separate from any financial return. In tight markets, this convenience yield exceeds storage costs, causing spot prices to exceed futures prices.

Backwardation is typical when:

Supply is tight relative to near-term demand
Inventories are low
There are supply disruptions (geopolitical crises, weather events, infrastructure outages)

Backwardation and Physical Traders

Backwardation is commercially favourable for physical commodity producers and traders with access to spot supply. A trader that can lift physical crude and sell it at spot prices benefits from backwardation because their immediate-delivery sales command a premium over forward sales. For storage operators, backwardation is unfavourable — storing a commodity for future delivery earns a negative return if future prices are lower than current prices.

The 2022 European energy crisis created sharp backwardation in natural gas and LNG markets as near-term supply was drastically short relative to demand. Physical traders with LNG supply available for immediate delivery commanded extraordinary spot premiums.

Switching Between Contango and Backwardation

Commodity markets regularly switch between contango and backwardation as supply and demand conditions change. A market in deep contango during a demand slump can transition to backwardation rapidly following a supply disruption or unexpected demand surge.

For Geneva’s physical oil traders, reading the shape of the curve is a daily priority. The term structure of futures prices:

Determines whether a storage trade is profitable (contango) or loss-making (backwardation)
Affects the value of oil inventory held in tanks or on vessels
Influences decisions about whether to sell crude spot or sell it forward
Signals market participants’ collective view of near-term supply-demand balance

Spreads and Basis Trading

Sophisticated traders do not simply take views on whether the market is in contango or backwardation — they trade the spreads between specific contract months. A “calendar spread” trade involves buying one month’s futures contract and selling another month’s contract, taking a view on how the shape of the curve will change.

If a trader believes the market is transitioning from contango to backwardation — that is, that near-term supply will tighten — they might buy near-term futures (which will appreciate as backwardation develops) and sell longer-dated futures. Spread trading of this kind is a significant part of the activity of both financial and physical commodity traders.

For physical trading houses, managing the basis risk between physical cargo prices and futures hedges is an essential and continuous activity — and understanding the term structure of futures prices is central to that risk management.

The Vanderbilt Portfolio AG, Zurich. This encyclopedia entry is for informational purposes only and does not constitute trading or investment advice.

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