How does seasonality in commodity markets affect futures pricing and the shape of the forward curve?
I understand contango and backwardation in theory, but I'm struggling with how seasonal supply-demand patterns in commodities like natural gas or agricultural products create predictable shapes in the futures term structure. Can someone walk through a concrete example?
Seasonality is one of the most tangible drivers of commodity forward curve shape because physical supply and demand follow predictable calendar patterns.
The Theory of Storage Connection
Recall the cost-of-carry model for commodity futures:
> F(T) = S x exp[(r + u - y) x T]
Where r is the risk-free rate, u is storage cost, and y is the convenience yield. Seasonality directly affects convenience yield: when a commodity is expected to become scarce (high demand or low supply season), the convenience yield on spot holdings rises, pulling near-term futures above distant ones (backwardation).
Example: Northwind Energy and Natural Gas
Northwind Energy is analyzing Henry Hub natural gas futures in September. Winter heating demand peaks December through February, while production is relatively stable. The forward curve shows:
| Contract Month | Price ($/MMBtu) | Implied Conv. Yield |
|---|---|---|
| October | 2.85 | 1.2% |
| December | 3.45 | 6.8% |
| February | 3.60 | 7.3% |
| April | 2.95 | 1.8% |
| July | 2.70 | -0.5% |
The curve rises steeply into winter (seasonal backwardation relative to summer months) and then falls back. Storage facilities fill during summer when prices are low, and inventories draw down in winter.
Seasonal Roll Yield Implications
A commodity index fund that rolls monthly from the front contract to the next will experience:
- Negative roll yield when the curve is in contango (selling low, buying high)
- Positive roll yield when the curve is in backwardation (selling high, buying low)
This means seasonal contango/backwardation cycles create systematic gains or losses for passive commodity investors, which is a heavily tested concept on the FRM.
FRM exam tip: When a question describes a commodity with strong seasonal demand, expect the forward curve to show backwardation heading into the high-demand season and contango during the off-season. Always connect convenience yield to physical scarcity.
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