Backwardation: What it is, why it happens, and an example. What is Forwardation? The term "forwardation" refers to a situation in which the price of a commodity for future delivery is higher than the price for the same commodity for immediate delivery. This often occurs when there is a strong demand for the commodity in the future, relative to the present. Forwardation can also be used as a term to describe the actual act of making a forward contract.
What are contango and backwardation in futures markets? Contango and backwardation are two important terms used in the futures market that describe the relationship between the spot price and the futures price of a commodity.
The spot price is the current market price of a commodity, while the futures price is the price at which a commodity will be delivered at some future date.
If the futures price is higher than the spot price, this is known as contango. If the futures price is lower than the spot price, this is known as backwardation.
Contango and backwardation are important because they can have an impact on the price of a futures contract.
When there is contango, the price of the futures contract will be higher than the spot price. This is because the buyer of the contract is willing to pay more for the commodity than the current market price.
When there is backwardation, the price of the futures contract will be lower than the spot price. This is because the seller of the contract is willing to sell the commodity for less than the current market price.
What causes backwardation in oil markets? There are a few key reasons why oil markets may experience backwardation:
1. Production costs: It costs more to produce oil that is further away from being extracted, so oil that is closer to being extracted is typically worth more.
2. Time value of money: The closer an oil contract is to expiration, the less time there is for the price of oil to change, so oil that is closer to expiration is typically worth less.
3. Storage costs: It costs money to store oil, so oil that is closer to being delivered is typically worth more.
4. Market expectations: If the market expects the price of oil to rise in the future, then oil that is closer to being delivered is typically worth more.
Why are futures prices higher than spot prices?
The most common reason for this is due to the fact that when you buy a futures contract, you are effectively buying a contract to buy or sell an asset at a later date. The price of the futures contract is generally higher than the current spot price of the underlying asset, because the buyer of the contract is effectively paying a premium to have the asset delivered at a later date.
There are a number of factors that can influence the price of a futures contract, but the most common reason for a higher futures price is simply because the buyer is willing to pay a premium for the convenience of having the asset delivered at a later date.
Are oil markets in backwardation?
The answer to this question is both yes and no. It depends on the time frame you are looking at and the specific oil market you are considering.
In general, oil markets are in a state of contango, which means that future prices are higher than spot prices. However, there are periods of time when the market is in backwardation, which means that future prices are lower than spot prices.
Looking at the oil market over the past year, you can see that there have been periods of both contango and backwardation.
Looking at a longer time frame, you can see that the oil market has been in a state of contango for most of the past decade.
So, it really depends on the time frame you are looking at and the specific oil market you are considering.