Pompeo Pontone

The investing style known as commodity curve carry — betting on longer-dated futures and against shorter-dated contracts — has jumped to its highest since at least 2004. Monday 20th April 2020’s unprecedented collapse in the West Texas Intermediate contract for May delivery exacerbated a state known as “contango,” where longer-dated futures trade at higher prices than near-term counterparts. The steepest slope in history fed right into the strategy’s sweet spot, as the front-end contract plunged thanks to vanishing storage capacity and the pandemic-induced demand shock! It comes amid heightened concern that the volume of oil held in U.S. storage is rising sharply, with the coronavirus crisis compounding the problem by dramatically reducing consumption. Futures contract supply and demand affect the futures price at each available expiration. In contango, investors are willing to pay more for a commodity at some point in the future. A contango market implies oil traders believe crude prices will rally in the future, encouraging them to store oil now and to sell at a later date. The premium above the current spot price for a particular expiration date is usually associated with the cost of carry. Cost of carry can include any costs the investor would need to pay to hold the asset over a period of time. With commodities, the cost of carry generally includes storage costs and cost risks associated with obsolescence.

In all futures market scenarios, the futures price will usually converge toward the spot price as the contracts approach expiration. This is because of the large number of buyers and sellers in the market which effectively make markets efficient, eliminating substantial arbitrage opportunities. As such, a market in contango will see gradual decreases in the price to meet the spot price at expiration.

Contango, sometimes referred to as forwardation, is the opposite of backwardation. In the futures markets, the forward curve can be in either contango or backwardation. A market is “in backwardation” when the futures price is below the spot price for a particular asset. In general, backwardation can be the result of current supply and demand factors or it may be signaling that investors are expecting asset prices to fall over time. A market in backwardation has a forward curve that is downward sloping.

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