CONTANGO & BACKWARDATION
Plain English
Contango means futures prices are higher than the current (spot) price — the market expects the price to rise, or storage costs are being priced in. Backwardation means futures are below spot — often signals current tight supply. Both conditions have major implications for traders and commodity investors.
Going deeper
The relationship between spot prices and futures prices across different expiration months creates the 'term structure.' Contango: front-month futures < next-month futures < far-dated futures. Costs of carry (storage, financing, insurance) explain why most commodity markets are in contango under normal conditions. Backwardation: front-month futures > next-month futures > far-dated futures. Signals current physical shortage or strong near-term demand. Persistent backwardation is very bullish — it means holders of physical commodity earn a positive roll yield. ETFs that roll futures lose money in contango (they sell cheap front-month and buy more expensive next month). VIX futures are almost always in contango, destroying long VIX ETF returns over time.
Examples
Oil Contango During Glut
During COVID, demand collapsed and storage filled up. Crude oil futures were in extreme contango: April (spot) $0, May $20, June $30. Traders paid to store oil and sell forward — the contango 'carry' made physical oil storage a profitable business.
Natural Gas Backwardation
After a prolonged cold winter, storage levels are critically low. January NG trades at $4.50 while March trades at $3.80. Backwardation of $0.70 reflects the current shortage premium. Producers rush to sell spot; buyers accept the higher price for immediate delivery.