Backwardation describes a price curve on which later delivery is cheaper than earlier delivery. For commodity traders, it is a statement about the prices available at one quotation time: it helps identify delivery premiums and compare hedge maturities. It does not tell a futures holder what profit they will realise.
The word also appears in a spot-versus-futures comparison: a specified futures contract is backwardated relative to spot when its current quote is below the current spot price. Always state the two prices being compared. A single future below spot does not establish that every successive futures maturity is cheaper. CME’s introduction uses the spot-versus-futures convention.
Read across delivery dates
Suppose a fictional commodity has these simultaneous quotes, all in USD per unit, with matching grade, location and quote basis:
| Delivery | Price |
|---|---|
| Spot | 100 |
| One month | 98 |
| Three months | 95 |
Both futures are below spot, and the futures segment slopes downward from 98 to 95. Defining the calendar spread as nearby minus deferred, its value is USD per unit. Reversing the quotation order reverses that sign.
Original synthetic snapshot. The horizontal axis is delivery date relative to today; all three quotes are observed at the same fictional instant. The connecting line guides the eye between the stated quotes.
The comparison matters. With spot still 100 but the two futures at 98 and 99, both futures would be below spot while the futures segment slopes upward. A real curve can also change direction across seasons. Use the named maturity pair or segment when describing backwardation or its opposite, contango.
Why availability now can command a premium
Physical inventory can keep a production process running when replacement supplies are delayed. That operational benefit is convenience yield. It can outweigh financing and storage costs, supporting a premium for prompt availability. A contract promising later delivery cannot run a factory today. This is the mechanism described by CME.
Backwardation may therefore accompany tight near-term supply, but the curve alone does not identify its cause or measure a shortage. Seasonality, delivery terms and changing supply and demand also matter; the EIA’s natural-gas explanation illustrates these influences.
The Commodities lesson, available in full with a free signed-in account, connects these physical specifications and carrying benefits to a producer’s futures hedge.
“Normal backwardation” asks a different question
In the Keynes–Hicks usage, normal backwardation means that today’s futures price is below the expected spot price at that contract’s maturity:
Here denotes real-world expectations. This is an expected-risk-premium comparison, rather than an observable curve-slope comparison. The hypothesis links net commercial selling to compensation for speculators willing to hold the other side. It is not a universal property of commodity markets. Hull discusses the distinction in Chapter 5, §5.14.
Return to the three-month quote of 95. A hypothetical expected maturity spot price of 105 satisfies normal backwardation; an expectation of 90 does not. Either expectation is logically compatible with the displayed spot and futures quotes. The curve alone does not supply the expectation. A subsequently realised spot price is an outcome, not a direct observation of what the market previously expected.
A lower entry quote is not money received
Buying the deferred future at 95 does not pay the trader the USD 5 per unit gap to today’s spot price of 100. Nor does closing a nearby future at 98 and opening the deferred future at 95 create an immediate USD 3 per unit trading profit. The old position’s profit depends on its own entry price; the new position’s profit depends on subsequent changes in its own quote.
For a fictional linear future that finally cash-settles exactly to the stated spot benchmark, the cumulative long trading P&L per underlying unit is . Assume the position survives all margin calls and ignore fees and interest on settlement cash flows:
| Realised spot at maturity | Cumulative long futures P&L per unit |
|---|---|
| 90 USD | −5 USD |
| 105 USD | +10 USD |
Daily settlement transfers those gains and losses along the way; it does not defer every cash flow until expiry. CME’s mark-to-market explanation describes that mechanism. Deposited collateral is separate from trading profit.
A backwardated curve can contribute positively to a long investor’s roll yield under a stated return decomposition and subsequent curve path. To calculate a realised strategy return, specify the contracts held, roll dates, exposure sizing, price evolution, collateral income and costs. Today’s downward slope alone guarantees none of those outcomes.
Sources
- CME Group — What is Contango and Backwardation: spot comparison, convenience yield and convergence.
- U.S. Energy Information Administration — What is the natural gas futures market?, 29 July 2024: delivery-curve interpretation and physical drivers; historical market observations on that page are dated.
- CME Group — Mark-to-Market: settlement cash flows and funding requirements.
- John C. Hull, Options, Futures, and Other Derivatives, ninth Global Edition, Pearson, 2018, Chapter 5, §§5.11–5.14, pp. 143–148: storage, convenience yield and normal backwardation.