What's the difference between contango and backwardation in commodity futures?

Contango and backwardation describe the relationship between the futures price and the expected future spot price of a commodity. Understanding them is crucial for commodity investing.

Contango:

• Futures price > Expected spot price (upward-sloping futures curve)
• Each successive futures contract is more expensive
• Investors who roll futures contracts face a negative roll yield (buy high, sell low)

Backwardation:

• Futures price < Expected spot price (downward-sloping futures curve)
• Each successive futures contract is cheaper
• Investors who roll futures contracts earn a positive roll yield (buy low, sell high)

Why do they occur?

Condition	Drives Toward
High storage costs (oil, natural gas)	Contango
Abundant supply, low near-term demand	Contango
Convenience yield > storage costs	Backwardation
Supply disruptions, high near-term demand	Backwardation
Heavy hedging by producers (selling futures)	Backwardation

The convenience yield is the benefit of physically holding the commodity — a refinery holding crude oil can keep operating during a supply disruption. This benefit only accrues to physical holders, not futures investors.

Impact on futures investors:

Total return on commodity futures = Spot return + Roll yield + Collateral yield

Example: Suppose West Texas crude oil spot is $75/barrel.

Contango scenario: The 1-month future is $76, 2-month is$77. When you roll from the expiring 1-month to the next contract, you sell at $76 and buy at$77 — losing $1/barrel in roll yield.

Backwardation scenario: The 1-month future is $74, 2-month is$73. When you roll, you sell at $74 and buy at$73 — earning $1/barrel in positive roll yield.

Practical implication: In prolonged contango (common in oil markets with ample supply), simply holding a long futures position bleeds money through negative roll yield — even if the spot price doesn't change. This is why many commodity ETFs underperformed the spot price during periods of high contango.

Exam tip: The CFA exam frequently tests the sign of roll yield in contango vs. backwardation and asks about the impact on total return.

Practice commodity questions in our CFA Level I question bank.