Contango and Backwardation are terms describing the structure of futures prices in the oil market (or other commodities) relative to the spot price and time to delivery.

• Contango: Futures prices are higher than the spot price, and prices increase with longer delivery dates. This typically occurs when oil supply is ample, storage costs are significant, or demand is expected to rise in the future. For example, if the spot price is $70 per barrel and the six-month futures contract is $75, the market is in contango. Traders may store oil now to sell at a higher price later, covering storage and financing costs.
• Backwardation: Futures prices are lower than the spot price, and prices decrease with longer delivery dates. This happens when oil is scarce, immediate demand is high, or supply disruptions are anticipated. For instance, if the spot price is $70 and the six-month futures price is $65, the market is in backwardation. This incentivizes releasing stored oil for immediate sale to profit from higher current prices.

How Global Events Influence Contango and Backwardation

Global events shift supply, demand, and market expectations, driving the oil market into contango or backwardation:

• Geopolitical Conflicts or Supply Disruptions:

  • Backwardation: Events like Middle East conflicts, sanctions on oil-producing nations (e.g., Iran or Russia), or OPEC production cuts reduce supply, pushing spot prices higher than futures prices. For example, the Russia-Ukraine conflict in 2022 tightened oil supply, leading to backwardation as markets feared short-term shortages.
  • Contango: Resolution of conflicts or restored supply (e.g., post-sanction agreements) can flood the market, lowering spot prices and creating contango.

• Economic Growth or Recession:

  • Backwardation: Strong global economic growth (e.g., post-COVID recovery in 2021) increases oil demand for industry and transport, tightening near-term supply and pushing the market into backwardation.
  • Contango: Economic slowdowns or recessions (e.g., fears of a global recession in 2023) reduce demand, leading to oversupply and contango as storage fills up.

• OPEC and Production Policies:

  • Backwardation: OPEC+ production cuts, like those in 2022-2023 to stabilize prices, reduce available oil, driving spot prices higher and creating backwardation.
  • Contango: When OPEC increases output or non-OPEC producers (e.g., U.S. shale) ramp up, oversupply can push the market into contango, as seen in 2014-2015.

• Natural Disasters or Infrastructure Issues:

  • Backwardation: Hurricanes disrupting U.S. Gulf Coast refineries or pipeline outages (e.g., Colonial Pipeline hack in 2021) create short-term supply shortages, favoring backwardation.
  • Contango: After disruptions are resolved, markets may shift to contango if supply normalizes and storage accumulates.

• Inventory Levels and Storage Dynamics:

  • Contango: High global oil inventories, like during the 2020 COVID demand collapse, lead to contango as traders store excess oil, expecting future price recovery. Negative oil prices in April 2020 exemplified extreme contango due to storage constraints.
  • Backwardation: Low inventories, often due to strong demand or supply constraints, drive backwardation, as seen in 2022 when global stocks were depleted post-COVID.

• Speculative Trading and Market Sentiment:

  • Backwardation: Bullish sentiment from traders anticipating tighter supply (e.g., due to expected sanctions or demand spikes) can amplify backwardation.
  • Contango: Bearish sentiment, such as fears of oversupply or weak demand, can deepen contango as traders bet on lower future prices.

Practical Implications

• Contango: Encourages storage, benefiting companies with access to storage facilities (e.g., tankers or terminals). However, high storage costs can erode profits.
• Backwardation: Prompts destocking, as selling oil now is more profitable. This can tighten supply further, reinforcing higher spot prices.