Backwardation: Meaning, Examples & Contango Explained

What Is Backwardation?

Backwardation occurs when the spot price of a commodity or asset is higher than the price of its futures contracts.

In other words, if you want to buy the commodity today, you’ll pay more than if you agreed to buy it in the future.

Think of it like this: imagine oil costs $100 a barrel today, but a contract for delivery three months from now costs $95.

That $5 gap signals backwardation. It shows that buyers place more value on having the oil immediately than on securing it for later delivery.

This situation is often a sign of tight supply in the present. Markets are willing to pay extra for immediate access.

The result is a downward-sloping futures curve, where prices get cheaper the further into the future you go.

In contrast, when futures contracts cost more than the spot price, the market is in contango. We’ll come back to that comparison shortly.

Causes of Backwardation

Backwardation doesn’t appear out of thin air. It happens for very clear economic reasons tied to supply and demand dynamics and the costs of holding physical commodities.

Here are the main causes:

Supply and Demand Imbalances

The most common driver of backwardation is a short-term shortage. If there isn’t enough of a commodity available now, buyers pay a premium for immediate delivery.

Futures prices stay lower because the shortage is expected to ease later.

Convenience Yield

The term convenience yield describes the advantage of holding a physical commodity in hand.

For example, a refinery may value crude oil today because it keeps operations running smoothly. That immediate utility makes the spot price higher than the futures price.

Storage Costs

Holding commodities is rarely free. Storing oil, natural gas, or grains involves costs for tanks, warehouses, and insurance.

These costs push futures prices down relative to spot prices, contributing to backwardation.

Market Inversion

When short-term contracts cost more than long-term ones, markets experience inversion. This reflects urgency in today’s market compared to expectations of calmer conditions later.

Backwardation vs Contango

To fully understand backwardation, we need to contrast it with contango, its opposite market condition.

The difference between backwardation and contango is essential for traders because it shapes hedging strategies, signals potential risks, and determines the costs or benefits of rolling over futures contracts.

Is Backwardation Bullish or Bearish?

This is one of the most debated questions: is backwardation bullish or bearish?

The answer depends on perspective:

• For commodities themselves: Backwardation is often bullish in the short term. The high spot price shows strong demand and limited supply.
• For futures contracts: It can be bearish because futures prices signal lower values ahead.

In essence, backwardation is bullish for today’s price environment but bearish when looking at future price expectations.

Traders need to analyze carefully where they stand, whether as buyers of the physical commodity or as speculators in futures contracts.

Real-World Examples of Backwardation

Backwardation shows up often in global markets, especially in energy and agriculture.

Crude Oil

Oil is the most famous case of backwardation. In 2020, during the early months of the global pandemic, supply chains broke down, and demand patterns shifted dramatically.

Storage facilities filled, and oil spot prices rose relative to futures. Backwardation signaled the immediate scarcity of delivery-ready oil.

Agricultural Commodities

Grains like corn and wheat often trade in backwardation during poor harvests or extreme weather.

Buyers pay extra to secure supplies now, while futures remain cheaper because production is expected to recover.

Precious Metals

Silver occasionally experiences backwardation when industrial demand spikes, particularly from electronics or solar panel manufacturing.

Buyers prize immediate delivery over waiting months.

These examples show backwardation in action across different commodity markets, underlining its role as a reflection of real-world supply pressures.

Trading in Backwardated Markets

Backwardation creates unique conditions for traders. Here are some ways it influences commodity trading strategies:

Arbitrage Opportunities

Traders who can deliver the commodity now may profit by selling it at the high spot price while buying futures contracts at a discount. This difference creates arbitrage opportunities.

Hedging Strategies

Producers and consumers often use futures to protect against volatility.

In backwardation, buyers may hedge by locking in cheaper future contracts, while sellers benefit from higher immediate sales.

Speculation

Speculators often trade backwardation by betting on how the gap between spot and futures prices will close.

For example, they might short the spot and go long on futures if they expect the shortage to ease.

Risk Management

Backwardated markets carry risks because they reflect scarcity. While opportunities exist, traders must manage exposure carefully to avoid losses when conditions shift suddenly.

Normal Backwardation: Keynes’s Theory

The idea of normal backwardation comes from economist John Maynard Keynes. His theory suggested that backwardation is not just an occasional event but a natural feature of futures markets.

Keynes argued that producers (such as farmers or oil companies) want to reduce risk by selling futures contracts.

To attract speculators willing to take the opposite side of the trade, they sell futures at a discount. That discount leads to backwardation.

In this view, backwardation is the “normal” state of markets, while contango arises mainly when storage and financing costs dominate.

Whether or not one agrees with Keynes, the concept of normal backwardation remains an important piece of economic theory in commodity trading.

Backwardation in Commodity Markets

Backwardation appears most often in commodities where immediate supply matters. Some patterns include:

• Energy markets: Oil and natural gas regularly shift between backwardation and contango depending on geopolitical events, weather, and production cycles.
• Agriculture: Seasonal production makes backwardation common when crops fail or when demand surges unexpectedly.
• Metals: Industrial metals like copper or aluminum may enter backwardation when construction or manufacturing accelerates.

In each case, backwardation reflects the urgency of today’s demand compared with expectations for tomorrow.

Backwardation Trading Strategies

To take advantage of backwardation, traders often use specific strategies:

Long the Spot, Short the Futures

Buyers purchase the physical commodity at today’s price and sell futures contracts, profiting from the higher spot value.

Calendar Spreads

Traders exploit differences between near-term and long-term futures prices.

In backwardation, short-dated contracts usually trade at a premium to long-dated ones, offering spread opportunities.

Roll Yield Advantage

In backwardated markets, rolling futures contracts (replacing expiring ones with new ones) can be profitable because traders buy cheaper long-term contracts to replace expiring higher-priced short-term ones.

Hedging for Consumers

Companies that rely on raw materials can lock in future contracts at lower prices, reducing the impact of current shortages.

These strategies highlight why understanding backwardation is not only academic—it directly shapes trading decisions and profitability.

Conclusion

Backwardation may sound like a technical term, but it tells a powerful story about markets.

When futures trade below spot prices, it signals that immediate supply is more valuable than future delivery.

That scarcity drives trading decisions, shapes hedging strategies, and influences global commodity flows.

By comparing backwardation vs contango, traders and investors can better interpret the signals hidden in the futures curve.

Whether you approach it as a producer, a hedger, or a speculator, backwardation offers lessons in economics, opportunity, and risk.

Understanding backwardation is not just about grasping a definition.

It’s about reading the market’s voice, understanding what traders value most at a given moment, and preparing strategies that respond to those realities.

In a world where commodities drive economies, backwardation remains a vital piece of the puzzle for anyone serious about navigating futures markets.