Backwardation can occur when there is now more demand for an asset than there are contracts expiring in the futures market. A shortfall of the commodity on the spot market is the major cause of backwardation in the commodities futures market. In the crude oil market, supply manipulation is prevalent. Some countries, for example, try to maintain oil prices high in order to increase their revenue. Traders who lose money as a result of this manipulation may suffer large losses.
What is the cause of crude oil’s backwardation?
When commodity markets are undersupplied, backwardation is more likely to occur. There has never been such an extraordinary premium of the front contract over longer-dated contracts in the history of the Brent futures contract. The first contract is currently selling around USD 8-9/bbl higher than the sixth contract. This super-backwardation is supported by falling oil inventories and diminishing spare capacity as a result of oil demand reaching a new record high this year.
Another possible driver of the backwardation structure is refineries seeking alternatives to Russian crude in the face of sanctions, as evidenced by the significant discount of Urals vs Brent. We maintain our bullish outlook for crude and continue to encourage risk-takers to add long positions in Brent’s longer-dated oil contracts or sell Brent’s downside price risks.
Read the original article here. Brent crude oil is in “hyper backwardation” as of February 24, 2022.
Is there a backwardation in oil futures?
Backwardation occurs when oil futures trade at a lower level than spot prices and near-term futures. According to UBS strategists, Brent crude, the international benchmark oil price, is currently trading at its most severe backwardation since futures prices have been recorded. In fact, it’s referred to be “Wonderful backwardation.”
“There has never been such an enormous premium of the front contract over longer-dated contracts in the history of the Brent futures contract,” stated strategist Giovanni Staunovo.
Brent futures for April delivery were trading at $98.55 per barrel on Friday. Futures for October delivery were trading at $87.41 per barrel.
Are oil futures generally in backwardation or contango?
The oil futures curve, on the other hand, is currently in “backwardation,” which occurs when spot prices and the front month futures price (CL1:COM) surpass futures prices for delivery in months further out. In other words, buying oil on the spot market for immediate delivery is currently more expensive than buying oil for delivery many months down the road. When the futures curve is not in backwardation, however, it is in “contango,” which means that prices for delivery contracts further out in time rise.
Some analysts interpret the backwardation of the futures curve as a sign that the market expects the spot oil price to fall in the coming months. The standard explanation is that the high spot price represents temporary production constraints, whereas the lower futures prices indicate that the market anticipates output to increase and the market to be balanced. As a result, buyers who require oil immediately are willing to pay a higher spot price than buyers who will require oil in four months.
The NYMEX March contract is around $4 below the December (front month) contract at the time of writing this article; the front month contract is about a dollar below the spot price.
What causes a futures market to transition from contango to backwardation?
As market participants’ perceptions of the future projected spot price alter over time, the forward curve shifts from contango to backwardation.
Why are futures prices higher than spot prices?
The futures market exists because producers seek the security of locking in a fair price in advance, while futures buyers hope that the market value of their purchase will improve in the time between now and delivery. Contango occurs when the futures price is higher than the spot price.
Is backwardation a negative or bullish sign?
Backwardation is a bullish indication for oil since it suggests traders no longer have an incentive to keep oil and sell it later. Instead, they should sell oil now rather than later because future prices may be lower.
How does backwardation assist you?
Traders can profit from backwardation by purchasing a gold futures contract that is trading below the expected spot price and profiting as the futures price converges with the spot price over time.
A forward contract and a futures contract differ in which of the following ways?
- Forward and futures contracts involve two parties agreeing to buy and sell an asset at a specific price on a specific date.
- A forward contract is a private, customisable agreement that is exchanged over the counter and settles at the end of the term.
- A futures contract has fixed terms and is traded on an exchange, with prices settled daily until the contract’s expiry.
- Forward contracts are unregulated, whereas futures are controlled by the Commodity Futures Trading Commission.
- Forwards have a higher counterparty risk than futures, which are less dangerous because there is nearly no likelihood of default.
What is the contango market for oil futures?
When immediate crude oil prices fall below those further out in the future, the market is said to be in contango. There are futures contracts for each month that are set to expire in a number of years. These values reflect the market’s current and future oil price estimates.
These points form the oil price ‘curve’ when plotted in a chart with time on the x-axis and oil prices on the y-axis.
A simple plot of current oil prices by month (including the recent bounce) yields the following curve:
Contango is common for non-perishable commodities with a cost of carry, such as crude oil and merchandise.
Storage fees and interest on money held in inventory are examples of such expenses.
What is the best way to tell if a future is in backwardation or contango?
- When the futures price is higher than the predicted future spot price, it is called contango. A normal futures curve is frequently confused with a contango market.
- When the futures price is below the predicted future spot price, this is known as normal backwardation. An inverted futures curve is frequently confused with a typical backwardation market.
- If futures prices are higher at longer maturities, the market is normal; if futures prices are lower at longer maturities, the market is inverted.