Gold & Commodities · Pro · 4 min

Contango and backwardation

You can read a futures curve, tell contango from backwardation, and explain what each shape says about supply, storage and demand.

Many prices, one story

Ask for the price of oil, and the honest answer is a question: for which month? Oil, gas, grains and metals trade with futures contracts for many delivery months, often years ahead, and each month has its own price.

Line those prices up, and their shape tells a story about the market: whether there is too much of the commodity or too little, and what it costs to wait. This lesson explains the two shapes every commodity trader knows.

Contango: later costs more

Plotting futures prices by delivery month gives the futures curve, much like the yield curve for bonds.

The CFTC defines the two shapes:

Contango: prices in later delivery months are progressively higher than in the nearest month.
Backwardation: prices in later delivery months are progressively lower.

Why does contango happen? Holding a physical commodity costs money: storage, insurance and the interest on the money tied up in it. When supply is plentiful and inventories are high, sellers of later delivery want to be paid for carrying the commodity until then. Later months trade higher. For many commodities that can be stored, contango is the usual state.

Backwardation usually signals scarcity now. When buyers need the commodity immediately, for example because of a supply disruption, they pay a premium for near delivery, and near months trade above later ones. Holders of physical stock earn a benefit from having it available right now, which economists call the convenience yield.

The shape can change quickly. A sudden supply shock can flip a market from contango into backwardation within weeks, and a glut can push it deep into contango.

Backwardation: now costs more

A fictional oil market is calm and well supplied. December futures trade at 70, September of next year at 74. The curve is in contango.

Then a major supply disruption hits. Refiners need oil now.

December futures jump to 82.
September futures rise only to 76.50, because the market expects supply to recover.

The curve has flipped into backwardation. The shape now tells you that the shortage is seen as temporary.

Common mistakes

Reading the front-month price as the only price. Each delivery month has its own.
Treating later prices as forecasts. They reflect storage and financing, not only expectations.
Ignoring the shape when holding futures products. It decides the cost of rolling.
Assuming the shape stays the same. It can flip quickly.

The takeaway

In contango, later futures cost more than near ones. In backwardation, they cost less. The shape tells you about storage, scarcity and demand.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the curve that is in backwardation.

Tap the chart.

Curve A falls with later delivery dates. The CFTC defines backwardation as futures prices that are progressively lower in distant months.
2What is contango?

That is the CFTC's definition. Storage and financing costs are a common reason.
3Oil is suddenly scarce and needed right now. Which curve shape is more likely?

When buyers pay up for immediate delivery, near-term prices rise above later ones.
4Why does contango often appear when inventories are high?

With plenty of supply now, the market pays a premium for later delivery to cover the cost of carrying it.

of 4 correct.