New on FinoLib · Volume I: Global Economy
I have added a new article to FinoLib, my finance education website: Contango vs Backwardation: Commodity Futures Curves Explained, part of Volume I: Global Economy. This page gives you the core of the topic in expert but plain language; the full article goes much deeper.
The idea in plain words
Commodities trade along futures curves. Contango, when later prices are higher, signals ample supply and is capped by the cost of carry. Backwardation, when later prices are lower, signals scarcity and has no cap. Negative oil prices in April 2020 came from storage running out.
Key points
■In April 2020 the front-month WTI contract averaged $16.70 a barrel against $29.17 four months out, a contango of $12.47; in March 2022 the front month averaged $108.26 against $99.42, a backwardation of $8.84.
■A fund holding futures in contango sells low and buys high when it rolls: moving from a $60 contract into a $62 one costs 2 ÷ 60 = 3.3% of the position.
■On April 20, 2020, the day before the May contract expired, Cushing storage was 76% full.
■About 20% of the world’s oil supply normally passes through the Strait of Hormuz, and its 2026 closure sent Brent to a $117 monthly average in April.
A closer look
Section 1.6 told the political story of oil, and Section 6.2: The 11 Sectors — Deep Dive introduces the energy companies and the two crude benchmarks, WTI and Brent. This chapter is about how commodity markets work as markets. Producers, refiners, airlines, utilities, trading houses, banks and investment funds all trade them, mostly through futures: exchange-traded contracts to buy or sell a set quantity at a set price on a future date. Physical goods differ from shares in one way that drives everything else: a barrel has to be stored somewhere, insured and moved, and those costs show up in prices.
A worked example
Trace the Chain — Part 1 Thought Experiments
1. Global oil prices double. Trace the chain for India: import bill → trade deficit → rupee → imported inflation → RBI response → your EMI. 2. A country’s central bank holds most reserves in dollars and its exports are sanctioned. Which chapters explain its predicament, and what were its realistic options beforehand? 3. Two economies each grow 6%: one’s median age is 27, the other’s is 47. Whose growth is more durable, and why? 4. The US imposes a 30% tariff on Indian textiles. Trace effects on a Tiruppur exporter, a US retailer, an American shopper, and a Vietnamese competitor. 5.
Under the hood
Under the Hood: Why Contango Has a Ceiling and Backwardation Does Not
A trader can buy oil today, store it and sell it forward. That trade, called cash-and-carry, caps how far a later price can rise above today’s. Illustrative numbers: spot oil at $60 a barrel, storage at $0.50 a barrel a month, money borrowed at 5% a year, six months ahead. Step Formula and substitution Result Financing cost $60 × 5% × 6 ÷ 12 $1.50 Storage cost $0.50 × 6 $3.00 Full cost of carry $60 + $1.50 + $3.00 $64.50 If the 6-month future trades at $67 Buy spot, store, sell the future: $67 − $64.50 $2.50 locked-in profit Traders doing this push spot up and the future down…
The Simple Version
Oil, gas, metals and even the right to emit carbon are traded like financial assets, with prices for delivery today and for every month ahead. Because these goods have to be stored and shipped, the shape of those prices tells you whether the world has too much or too little. When a chokepoint closes, the shock travels from a tanker lane to a gasoline pump to a central bank’s inflation forecast in weeks.
When This Breaks: Oil Below Zero
A WTI futures contract ends in physical delivery at Cushing, Oklahoma. On April 20, 2020, the day before the May contract expired, Cushing storage was 76% full and the remaining space was expensive or already committed. Holders who could not take delivery had to find someone to take the contract off their hands, and the May contract traded as low as −$40.32 a barrel: sellers paid buyers to accept oil.
Recap
Commodities trade along futures curves: contango signals ample supply and is capped by the cost of carry, while backwardation signals scarcity and has no cap, and negative oil prices in April 2020 came from storage running out.
What the full article covers
The full article includes worked examples, a look under the hood at the mechanics, a recap, a reveal-on-click quiz and the official sources behind every figure.
Volume I: Global Economy
Read the full article on FinoLib
The complete article, Contango vs Backwardation: Commodity Futures Curves Explained, with every worked example, diagram, quiz and source, is free to read in Volume I, Global Economy on finolib.com.
Explore the Finance Education Series: Vol. II — Capital Markets · Vol. I — Global Economy · Vol. III — Finance Encyclopedia · Vol. IV — Finance Careers · Vol. V — Personal Finance