Backwardation and Contango

Backwardation and contango are two terms that describe the shape of a futures price curve — how the price of a futures contract compares with the current (spot) price of the underlying asset. They are essential concepts for anyone trading or investing in commodities and other futures markets, because they affect the returns and costs of holding such positions. This guide explains what backwardation and contango mean, what causes them, and why they matter — in plain language. It connects to the wider world of derivatives and is a relevant topic in qualifications like the FRM.

First, a quick word on futures

A futures contract is an agreement to buy or sell an asset at a set price on a future date. For a given commodity — oil, gold, wheat — there are contracts expiring at various dates, and each has its own price. Plotting these prices against their delivery dates produces the futures curve. Backwardation and contango are simply the two basic shapes that curve can take, depending on whether longer-dated futures are cheaper or more expensive than the spot price.

What is contango?

Contango is when futures prices are higher than the current spot price, and longer-dated contracts cost progressively more — an upward-sloping curve. This is often the "normal" state for many commodities, because holding a physical commodity until a future date involves carrying costs: storage, insurance and the financing tied up in it. Futures prices reflect those costs, so a barrel of oil for delivery in six months typically costs more than one today. In contango, the market is effectively charging for the convenience of locking in future delivery.

What is backwardation?

Backwardation is the opposite: futures prices are lower than the spot price, and longer-dated contracts are cheaper — a downward-sloping curve. This usually signals strong demand for the commodity right now, or concern about near-term supply. When buyers are willing to pay a premium to have the asset immediately rather than wait, the spot price is pushed above future prices. The benefit of holding the physical asset in tight conditions — known as the convenience yield — outweighs the carrying costs, tipping the curve into backwardation.

A simple way to picture it

Imagine oil trades at £80 a barrel today. If the contract for delivery in six months is £84, the market is in contango — the extra £4 broadly reflects the cost of storing and financing the oil until then. If instead that six-month contract is only £77, the market is in backwardation — buyers are paying a premium for oil now, perhaps because supply is tight, and are unwilling to pay as much for delivery later. The same curve can flip between the two states as supply and demand conditions change.

Why backwardation and contango matter

These curve shapes have real consequences, especially for investors who hold commodity positions through futures (as many funds do):

• The "roll". Because futures expire, an investor wanting continuous exposure must repeatedly sell the expiring contract and buy a later-dated one — "rolling" the position. In contango, they sell low (the cheaper expiring contract) and buy high (the pricier next one), creating a negative roll yield that drags on returns over time. In backwardation, the reverse happens, producing a positive roll yield.
• Market signals. The shape of the curve conveys information — backwardation often points to tight current supply and strong demand, while steep contango can signal oversupply.
• Trading and hedging decisions. Producers, consumers and traders all factor the curve into when and how they hedge or take positions.

Why it matters for finance professionals

For anyone involved in commodities, derivatives or investment, understanding backwardation and contango is essential. They explain why a commodity investment can lose money even when spot prices rise (thanks to a negative roll yield in contango), and they offer a window into supply and demand conditions. Grasping these concepts is fundamental to working with futures markets and a relevant topic in professional finance and risk qualifications.

Frequently asked questions

What is the difference between backwardation and contango?

Contango is when futures prices are higher than the spot price (an upward-sloping curve); backwardation is when they are lower (a downward-sloping curve). They describe the two basic shapes of the futures curve.

What causes contango?

Mainly the carrying costs of holding a commodity — storage, insurance and financing — which make future delivery more expensive than buying today. It's often the normal state for storable commodities.

What causes backwardation?

Strong demand for the asset now, or near-term supply concerns, which push the spot price above future prices. The benefit of holding the physical asset (the convenience yield) outweighs carrying costs.

Why do these matter for investors?

Investors holding futures must "roll" expiring contracts. Contango creates a negative roll yield that erodes returns over time, while backwardation creates a positive one — so the curve's shape directly affects performance.

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Backwardation and contango are key to understanding futures and commodity markets. Learnsignal's tutor-led courses, including the FRM, develop the derivatives and markets understanding that topics like this build on — with clear teaching that makes the concepts genuinely click.