Contango and Backwardation Explained for Futures Traders

Contango and backwardation are the two basic shapes of a futures curve, which is the line you get when you plot a commodity’s futures prices across successive delivery months. In contango, later months cost more than the nearest month. In backwardation, later months cost less. The shape carries information about storage, supply tightness and market expectations, and it directly affects the returns of anyone who holds futures positions over time.

In brief

• Contango: prices in later delivery months are progressively higher than the nearest month.
• Backwardation: prices in later delivery months are progressively lower.
• The curve’s shape reflects storage costs, inventories and expectations, not a forecast on its own.
• Investors who roll futures from one month to the next can gain or lose from the curve’s slope.
• Neither shape is permanent. A market can flip between them within weeks.

The official definitions

The Commodity Futures Trading Commission (CFTC) glossary defines contango as a market situation in which prices in succeeding delivery months are progressively higher than in the nearest delivery month, and backwardation as a situation in which futures prices are progressively lower in the distant delivery months. Its backwardation example uses gold: if the January contract is priced above the June contract, the market is backwardated by the difference.

In practice, traders compare a few points on the curve, often the front month against the next one or the contract a year out. The EIA, in its discussion of oil inventories, refers to the spread between the 12-month and 1-month futures prices as a measure of the incentive to store oil. A wide positive spread means contango, and a negative spread means backwardation.

Why contango happens

Holding a physical commodity costs money. A buyer who purchases oil, grain or metal today and keeps it until a later date pays for storage, insurance and the financing tied up in the inventory. When supplies are ample, the later price tends to sit above the spot price by roughly enough to cover those carrying costs. This is often called a “cost of carry” market.

The EIA describes the incentive this way: companies store oil when production exceeds consumption, and a wider futures spread strengthens the reason to store. If you can buy a barrel now, sell a futures contract for later delivery at a higher price, and cover your storage costs, you lock in a return. That behavior pulls oil into storage, which absorbs surplus supply. The EIA also notes that rising crude storage can signal production running ahead of consumption, which may weigh on spot prices.

Why backwardation happens

Backwardation usually signals scarcity today. When buyers need the commodity immediately, they bid up the spot and nearby prices above the price for later delivery. Holding inventory then offers a benefit, sometimes called a convenience yield: a refinery or processor with stock on hand can keep operating when supply is tight, which is worth paying for.

The EIA describes the mechanism from the inventory side. A sudden loss of production or a jump in consumption can raise spot prices relative to futures, and that encourages firms to draw down inventories instead of building them. A backwardated curve rewards selling stored goods now rather than later.

Perishable or hard-to-store goods can sit in backwardation for structural reasons, and seasonal markets such as natural gas or heating fuels often change shape through the year as demand varies.

How to read a curve

Consider four hypothetical prices for the same commodity, quoted per unit:

Delivery month	Contango example	Backwardation example
Nearest	70.00	75.00
Second	71.00	74.00
Third	72.00	73.00
Fourth	73.00	72.00

These numbers are made up for illustration. In the first column, each month costs more than the one before: contango. In the second, each month costs less: backwardation. The steepness of the slope matters as much as the direction. A gentle contango suggests a well-supplied market with modest carrying costs. A steep one suggests inventories are filling quickly and storage is getting expensive or scarce.

Roll yield: why the shape affects returns

Futures contracts expire. Someone who wants to keep exposure to a commodity, such as a commodity index fund or an exchange-traded product that holds futures, must close the expiring contract and open a new one in a later month. This is called rolling.

• In contango, the fund sells the expiring contract at the lower nearby price and buys the next contract at a higher price. Unless prices rise, this costs money on every roll. The cost is called negative roll yield.
• In backwardation, the fund sells at the higher nearby price and buys the cheaper later contract. If the curve holds its shape, each roll adds a gain, called positive roll yield.

This is a major reason why the return on a futures-based product can differ from the change in the commodity’s spot price. A commodity can finish a year higher on the spot market while a fund that held rolling futures in a steep contango trails it. The reverse can also occur. The EIA notes that commodity index funds generally hold baskets of commodities and typically roll their contracts forward instead of taking physical delivery.

A simple hypothetical shows the arithmetic. If a fund holds a contract at 70.00 and rolls into the next month at 71.00 while the spot price does not move, the roll costs 1.00 per unit, about 1.4 percent of the position. If the curve stays the same shape and the fund repeats that every month, the drag accumulates. The actual figure for any product depends on its contracts, roll schedule and fees, which its prospectus explains.

Convergence

At expiry, the futures price converges toward the spot price. The CFTC defines convergence as the tendency for cash and futures prices to approach each other, usually during the delivery month. In contango, this means the later, higher-priced contract must drift down toward spot if spot stays flat. In backwardation, the later contract drifts up. The curve’s slope is therefore not a free gain or loss; it is part of the price path every contract follows to expiry.

Common misconceptions

“Contango means prices will rise.” A contango curve describes today’s price relationship between months. It does not promise that spot prices will climb. Spot prices usually need to rise to the futures level only if conditions change. Indeed, convergence is often achieved by the futures price falling.

“Backwardation is always bullish and contango always bearish.” The shape tells you about the balance between near-term supply and demand and the cost of storage. It is one input, and many other factors move prices.

“The curve is the same for every commodity.” Storage costs, perishability, seasonality and geography differ. Durable goods that are cheap to store tend to trade closer to a cost-of-carry relationship, while markets with tight physical supply or strong seasonal demand may spend long periods backwardated.

“A fund that tracks futures tracks the spot price.” Roll yield makes the two diverge, sometimes by a lot over long periods.

Why followers of crude oil futures watch the curve

Crude oil is the market where these terms are used most often. The EIA states that futures prices reflect expectations about future supply and demand and that inventory levels are most meaningful when compared with the same quarter of the prior year. Analysts therefore read the oil curve alongside inventory data. A curve moving toward contango while stocks build points to oversupply. A curve moving into backwardation while stocks fall points to a tightening market. The EIA also describes how the U.S. Strategic Petroleum Reserve and public stocks held by International Energy Agency members add another layer of buffer.

For details on how these prices are formed, see our guide to how commodity prices are set, and for the mechanics of the contracts themselves, how futures contracts work.

FAQ

Is contango good or bad?

Neither. It describes a price relationship. It is a cost for investors who roll long futures positions and a potential opportunity for those with storage who can sell forward, so the effect depends on your position.

Can a market switch between contango and backwardation?

Yes. Changes in inventories, production, demand or news can alter the curve’s shape quickly. The EIA notes that sudden production losses or demand jumps can lift spot prices relative to futures.

What is “normal backwardation”?

The term originated in older economic theory about hedgers paying speculators for taking risk. Today, many people use “backwardation” simply for a downward-sloping curve and do not rely on that theory. Check the context when you see it.

How do I find the futures curve for a commodity?

Exchanges such as CME Group publish settlement prices for every listed delivery month on their websites. Brokerage platforms plot the same data as a curve. Compare the nearest month against later months.

Does contango affect physical buyers?

Yes. A buyer who needs a commodity later can lock in the later price with futures or buy now and pay for storage. Contango reflects the market price of making that choice.

Where can I find official definitions?

The CFTC glossary at cftc.gov defines contango, backwardation, convergence and delivery. The EIA publishes explanations of oil inventories and financial markets at eia.gov.