When contango is the main trend in the futures markets

Contango is a condition in the futures market where the price of a contract for future delivery exceeds its current spot price. Sounds complicated? The essence is simple: the market expects prices to rise and incorporates costs for storage, insurance, and logistics into the future price. For commodity markets — oil, gas, metals — this phenomenon occurs frequently and significantly influences trading strategies.

How it works in reality

Imagine: crude oil today costs $75 per barrel, and in six months — $80 per barrel. This is contango. The difference of $5 consists of storage, insurance, and financing costs. The market essentially says: “We expect stable demand, so we’re willing to pay more for deferred delivery.”

Who benefits, who loses

Producers and traders are happy with contango — they can buy cheaper now and sell at higher prices later. Profit is guaranteed by the market scheme.

Consumers and industry are cautious — rising future prices mean higher costs. They need to recalculate budgets and adjust pricing strategies.

A particular pain point is commodity ETFs and index funds. They constantly reopen positions, buying expensive contracts for distant months instead of cheap nearby ones. This “rollover collapse” gradually eats into the fund’s returns.

Contango as a market indicator

Long periods of contango signal that the market expects stable or increasing supply. It may reflect inflation expectations or interest rate changes. When contango shifts into backwardation — ( future prices below current ) — it hints at a shortage or a spike in demand. Transitions between these regimes often coincide with turning points in the market.

COVID-19 case: when contango became extreme

In early 2020, the oil market experienced an extreme example of contango. Lockdowns killed demand, flights stopped, cars were parked. Storage facilities filled to capacity. Spot oil prices fell into negative territory for the first time, but future contracts still traded in positive territory — due to high storage costs and lack of space. It was a perfect storm revealing how distorted the market can become during a crisis.

Trader tactics

Understanding contango is critical for developing trading algorithms and strategies. Experienced traders monitor futures curves, the history of contango-backwardation cycles, and other indicators. It’s essential to recognize when market structure favors arbitrage and when it risks losses.

Summary

Contango is not just an abstract term from textbooks. It’s a living mechanism that influences how much you pay for energy, what producers earn, and how investment funds operate every day. Recognizing and analyzing contango helps make informed trading decisions and avoid common mistakes when working with commodity futures.