Backwardation

What Is Backwardation?

Backwardation is a market condition in which the price of a futures contract for near-term delivery is higher than the price for later delivery. In other words, the forward curve slopes downward as the delivery date moves further into the future. It is most often discussed in commodity markets such as oil, natural gas, and metals, though the term can apply to any asset with a futures market.

Some traders use the term when the futures price for a given date sits below the spot price of the same asset. Because usage varies, it helps to check the context when you encounter it.

How It Works

Backwardation usually reflects strong demand for a commodity today relative to expected supply later. Buyers who need the physical product now may pay a premium to get it immediately. Holders of inventory may also prefer to sell now rather than store the commodity and wait, which pushes near-term prices up relative to later ones.

Economists often connect this to convenience yield, the benefit of physically holding a commodity, such as keeping a production process running without shortages. When that benefit is high, near-term prices tend to rise above prices for later delivery.

The opposite situation, where later futures prices are higher than near-term ones, is called contango.

Why It Matters to Investors

Backwardation can affect the returns of investors who hold futures contracts. Futures contracts expire, so an investor who wants to maintain a position must sell the expiring contract and buy a later one, a process called rolling. In a backwardated market, the later contract is usually cheaper, so rolling can generate a positive roll yield, all else being equal. The reverse is generally true in contango.

As a hypothetical example, suppose a near-month contract trades at 80 and the next-month contract trades at 78. An investor who rolls the position would capture the 2-point difference if prices otherwise stayed unchanged. In practice, returns also depend on how the underlying price moves, which the shape of the curve alone cannot predict.

Backwardation is also viewed as a sign of tight supply conditions, but it describes current market pricing rather than forecasting future prices. Investors often study the shape of the futures curve alongside other information to understand how a market is positioned.