Contango and Backwardation: What They Mean, Why They Happen, and How Roll Yield Works

Contango is when futures prices for later delivery months are higher than prices for nearer months (and usually above spot). Backwardation is the opposite: nearer contracts cost more than later ones. Both describe the shape of the futures curve, the line you get by plotting the price of each contract month in order of expiry.

In short: contango is the “normal” shape for storable commodities with plenty of supply, because holding the physical asset costs money (financing, storage, insurance), so later delivery costs more. Backwardation appears when supplies are tight and having the commodity now is worth more than having it later. The shape matters to anyone who holds futures for long periods: in contango, rolling from an expiring contract to a pricier later one tends to cost money over time (negative roll yield); in backwardation, rolling tends to add to returns. It does not tell you whether prices will rise or fall.

The misconception: “contango means the market expects prices to rise”

An upward-sloping curve looks like a forecast of higher prices, but it is mostly a reflection of carrying costs. If spot crude oil is $70 and storing a barrel for a year costs several dollars, a futures contract a year out will trade higher even if nobody expects the spot price to change. The curve shows what it costs to defer delivery, adjusted for how scarce the commodity is right now. How futures prices are set works through the carry arithmetic.

What each looks like

Illustrative WTI crude oil curves (dollars per barrel):

Contract month	Contango curve	Backwardation curve
January	70.00	70.00
February	70.60	69.30
March	71.15	68.70
April	71.65	68.15
December	75.00	64.50

Each month in the contango curve is a little higher than the last; each month in the backwardation curve a little lower. Curves can also be mixed: backwardated at the front and in contango further out, or the reverse.

Why contango happens

Contango is driven by the cost of carry:

Financing: buying the commodity now ties up cash that could earn interest.
Storage and insurance: tanks, silos and vaults cost money.
Ample supply: when inventories are high, nobody pays a premium to have the commodity today.

The more it costs to store, and the fuller storage is, the steeper contango can get. Gold, which is cheap to store relative to its value, usually trades in a mild contango that reflects mostly interest rates. VIX futures also tend to sit in contango in calm markets, for different reasons: volatility tends to be expected to rise back toward longer-run levels when it is low.

A real extreme: April 2020

The most dramatic contango on record in WTI came in April 2020. Demand for oil had collapsed with COVID-19 lockdowns, and storage at Cushing, Oklahoma, the delivery point for NYMEX WTI futures, was filling up.

According to the CFTC’s interim staff report and the Congressional Research Service:

On April 20, 2020, the May 2020 WTI contract settled at minus $37.63 per barrel, the first negative WTI settlement since the contract was listed.
The June 2020 contract settled at $20.43 the same day.
The May-June spread, which had closed at minus $6.76 on April 17, widened to about minus $58.

The front contract was about to require physical delivery, and holders who could not take it had to pay others to take their contracts. The next month, a few weeks further from that problem, still traded above $20. The full story is in negative oil prices in April 2020.

Why backwardation happens

Backwardation appears when the commodity is more valuable now than later:

Tight supply: low inventories, supply disruptions, or a sudden jump in demand.
Convenience yield: a refinery, a food processor or a power plant that runs out of input has to stop operating. Having the physical commodity on hand is worth a premium, and the nearby futures contract captures it.
Expected supply growth: if more production is coming, later months may price in lower prices.

Crude oil curves were steeply backwardated for long stretches of 2022, after Russia’s invasion of Ukraine disrupted energy markets and inventories were already low. Agricultural markets often show backwardation in the months before a harvest, when old-crop supplies run short and new-crop contracts reflect the coming supply.

Roll yield, with real arithmetic

Anyone who wants to hold futures exposure for longer than one contract’s life has to roll: close the expiring contract and open a later one. The shape of the curve then affects returns. This is called roll yield (or roll return).

Rolling in contango

Using the illustrative contango curve, you hold one long January WTI contract (1,000 barrels; tick $0.01 = $10) and roll each month into the next. Suppose the spot price stays at $70.00 and the curve keeps the same shape, so whatever contract is the front month trades at $70.00 and the second month always trades $0.60 above it.

Roll 1: you sell January at $70.00 and buy February at $70.60.
A month later, February has become the front contract and has converged to $70.00. You have lost $0.60 per barrel on it: 60 ticks x $10 = $600.
Roll 2: you sell February at $70.00 and buy March, now the second month, at $70.60. A month later it too has converged to $70.00: another $600.

Each month, a long position buys the next contract at a premium to the front and watches that premium disappear as the contract approaches expiry. With a $0.60 slope and a flat spot price, that is $600 per contract per month, or about 0.86% of the contract’s value ($0.60 / $70.00), and $7,200 over twelve rolls. The oil itself never moved.

Rolling in backwardation

On the backwardation curve, you sell January at $70.00 and buy February at $69.30. If spot stays at $70.00 and the curve holds its shape, February rises to $70.00 as it becomes the front month: a gain of $0.70 per barrel (70 ticks x $10), or $700 per contract, with no change in spot.

Why this matters

This is why a long-only commodity fund can lose money even when the spot price of the commodity is flat, and why the same fund can make money in a flat market when the curve is backwardated. The effect on commodity ETFs is covered in futures ETFs explained, and the mechanics of switching contracts in rolling futures contracts.

A caution on the word “yield”: roll yield is not a fee or a guaranteed return. It is simply the convergence of futures prices toward spot, viewed from the point of view of someone who keeps rolling. If spot moves, it can swamp the roll effect in either direction.

Measuring the slope

To compare curves across markets, people often express the slope as an annualised percentage. Using the illustrative contango curve:

January $70.00, December $75.00, eleven months apart.
Difference: $5.00, or 5.00 / 70.00 = 7.14% over eleven months.
Annualised: 7.14% x 12/11 = about 7.8% a year.

Compare that with the cost of carry. If interest rates are 4% a year and storage costs another couple of percent, a slope near 7.8% suggests the market is pricing close to full carry: storage is ample and nobody is paying up for oil now. A much steeper contango points to storage becoming scarce. A slope well below the cost of carry, or negative, signals tightness and a meaningful convenience yield.

For the backwardation curve, January $70.00 and December $64.50 give minus $5.50, or about minus 7.9% over eleven months, roughly minus 8.6% a year.

How the curve shape shows up in the data

You can see the shape directly by comparing the settlement prices of consecutive months on the exchange’s website. A few rules of thumb:

Calendar spread: the price difference between two months, such as February minus January. Positive in contango, negative in backwardation (when quoted as later minus earlier).
Front versus 12-month: a common way to summarise the curve in one number.
Change over time: a curve moving from contango into backwardation often signals tightening supply in the physical market.

Traders who take positions on the spread itself rather than the outright price are covered in futures spread trading.

What can go wrong

Steep contango quietly erodes long positions. Holders who roll every month can underperform the spot price by a wide margin over a year.
Backwardation can flip quickly. When supply returns, a backwardated curve can move into contango, and positions built on positive roll yield can turn.
Extreme contango signals a storage problem. As April 2020 showed, the nearest contract can disconnect from the rest of the curve when physical storage runs out.
The curve is not a forecast. Neither shape tells you which way the spot price will go.

The short version

Contango means later futures months are priced above nearer ones, mostly because carrying a commodity costs money; backwardation means nearer months are priced higher, because the commodity is scarce now. For anyone who holds and rolls futures, contango tends to subtract from returns and backwardation tends to add to them, all else equal. The shape describes the economics of storage and scarcity, not the direction of the next price move.