Backwardation or Contango?

Posted in finance by qmarks on March 7, 2011

As the future contracts approaches expiration it will trade at a higher price compared to when the contract was further away from expiration. This is said to occur due to the convenience yield being higher than the prevailing risk free rate. For commodity futures the supply and demand factor might affect the price of the commodity for different dates. i.e. a shortage in Copper in the short term might increase the future prices at the short period whereas at the longer horizon market might expect it to level off. That declining term structure of future prices are known as backwardation. The usual term structure is known as Contango. The cost of carry effect and the uncertainty of the future increases the price of the commodity.

But today March 07, 2011 the Oil Futures represents both contango and backwardation simultaneously. The source of the picture is Bloomberg. The Gaddafi effect.

So what?

The short term price hike in oil prices might be temporary as Bernanke articulates, but if Gaddafi becomes more and more stubborn, that might lead to an inflationary environment. Thus FED, ECB and China Central Bank might consider an early interest rate hike to keep the rising prices under control. Eventually that might slow down the global economic growth. Gaddafi, either leave or Big Guys will come and take you down!


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