Two shapes of the futures curve
A futures curve lists the price of a commodity for delivery in different months. In contango, later months cost more than the nearest month. In backwardation, later months cost less.
Why contango happens
Holding a physical commodity has costs such as storage, insurance and financing. When supply is ample and storage is filling up, later delivery is priced higher to cover those costs.
Why backwardation happens
When a commodity is scarce right now, buyers pay a premium for immediate supply. The nearest contract is then priced above later ones. Strong demand or supply disruptions often produce backwardation.
The effect on funds and rolling
Futures expire, so funds that track oil must sell the expiring contract and buy the next one. In contango they sell cheap and buy dear, which costs money each roll and can make a fund lag the spot price. In backwardation the roll tends to add return.
An extreme case
In April 2020 storage was nearly full and the front-month WTI futures contract briefly traded below zero. It was an example of how strong contango and short-term pressure can distort the nearest contract.
Related:Live oil pricesHow oil prices are setWays to invest in oil
Educational content, not investment advice.