Contango, backwardation and the curve

Because a commodity has many contracts expiring on different dates, you can plot price against expiry month — the futures curve (or term structure). Its shape has a name and real consequences.

The two shapes

• Contango — longer-dated contracts cost more than nearer ones. The curve slopes upward. This is the common state for storable commodities, because the further-out price includes the cost of storing and financing the commodity until then.
• Backwardation — longer-dated contracts cost less than nearer ones. The curve slopes downward. This typically signals a supply shortage now: buyers pay a premium for immediate delivery, often during a crisis or tight market.

Why the shape matters for returns

This is the single most important concept for anyone holding a commodity through futures over time, because of roll (next lesson):

• In contango, each time you roll from a cheaper expiring contract into a more expensive later one, you effectively sell low and buy high — a negative roll yield that bleeds returns even if the spot price never moves.
• In backwardation, rolling sells high and buys low — a positive roll yield that adds to returns.

A concrete example

If front-month coffee is at 180 cents and the next month is at 184 cents (contango), an investor rolling forward pays up 4 cents each cycle. Over a year of monthly rolls that drag can erase a large slice of any spot gain. This is exactly why some commodity ETFs underperform the headline spot price they track — and why curve shape, not just price direction, belongs in your analysis.