What causes a commodity futures curve to go into backwardation?

Question

AcadiFi · Accepted Answer

Backwardation occurs when near-dated futures trade above longer-dated futures, producing a downward-sloping curve. The immediate cause is always the same: convenience yield exceeds the sum of financing cost and storage cost (y > r + u).

Mechanisms driving backwardation: physical inventory tightness is the dominant driver. When working stockpiles at hubs like Cushing (for WTI crude) fall below 30-day operating thresholds, holders of physical barrels demand premium pricing to part with them. A refiner like Meridian Refining running at 92% utilization would pay nearly anything to avoid an unplanned shutdown, so the spot-to-near-month spread widens.

Other drivers include expected future supply increases (OPEC announcing production hikes pushes back-month prices down), geopolitical supply fears spiking spot prices, and hedging pressure from producers who sell forward supply, dragging long-dated futures down relative to spot (Keynes's normal backwardation theory).

```mermaid
flowchart TD
  A[Tight Inventory] --> B[High Convenience Yield]
  B --> C{y > r + u?}
  C -->|Yes| D[Backwardation]
  C -->|No| E[Contango]
```

Implications for risk managers: long-only commodity index investors earn positive roll yield during backwardation because they sell expiring contracts at higher prices and buy deferred contracts at lower prices. Historically, backwardation periods have produced the bulk of commodity index alpha. Conversely, a producer rolling short hedges loses money in backwardation. Understanding the curve regime is essential for calculating expected returns and VaR on any long-horizon commodity position — the shape, not just the level, drives P&L.

What causes a commodity futures curve to go into backwardation?

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