Backwardation

If you ask for a price for forward delivery of a commodity as a buyer, it is usually higher than today’s ‘cash’ price. That’s because any seller, who has to look after the asset prior to the agreed delivery date, has to cover insurance, storage and finance costs (their money could be earning interest in the bank instead). When a forward, or future, price is above today’s market price for the same asset, the situation is described as ‘contango’.

However, it is possible for the cash price for an asset to slip above the price for forward delivery – that’s known as ‘backwardation’. The reasons can vary – perhaps there is a sudden short-term supply squeeze so the market puts a premium on assets available now. Typically, backwardations don’t last long before a contango relationship is restored.

• See Tim Bennett’s video tutorial: What are ‘contango’ and ‘backwardation’?

Merryn

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