Backwardation

Backwardation often occurs when there is strong demand for a commodity right now, or a shortage of current supply. Buyers are willing to pay a premium to receive the commodity immediately rather than later.

For example, if crude oil trades at 70 per barrel in the spot market and a futures contract for delivery in six months trades at 66, the market is in backwardation.

Backwardation can benefit investors who hold commodity exposure through futures. When they sell expiring contracts and buy later ones, they buy at lower prices, earning a positive roll yield, even if spot prices stay the same.

Economists sometimes explain backwardation through the convenience yield: the benefit of physically holding a commodity, for example to keep a refinery running during a shortage, which can outweigh storage and financing costs. Backwardation is the opposite of contango, and markets can switch between the two as supply and demand conditions change.