Overview
Contango is a market condition where the futures price of a commodity is higher than its current spot price, creating an upward-sloping forward curve. This is the 'normal' state for most commodity markets because futures prices must compensate for the cost of carry โ storage costs, insurance, financing, and opportunity cost of capital.
Cost of Carry Model
Theoretical futures price = Spot Price ร (1 + r + s โ y), where r = risk-free rate, s = storage cost, y = convenience yield. In contango, the cost of carry exceeds the convenience yield.
Why Contango Occurs
- Storage costs: Physical commodities like oil require tank farms. Cushing, Oklahoma's storage capacity (~76 million barrels) becomes critical during oversupply
- Financing costs: Holding physical inventory ties up capital at the prevailing interest rate
- Ample supply: When current supply is abundant, spot prices are low relative to future expectations
Historic Contango Events
- April 2020 Oil Crash: WTI May 2020 futures fell to โ$37.63/barrel (first-ever negative crude price) on April 20, 2020, while June futures stayed around $20 โ an extreme contango driven by COVID-19 demand collapse and Cushing storage filling to 80%+ capacity
- 2008โ2009 Super Contango: Oil contango reached $8โ10/barrel spread, making floating storage (storing crude in tankers) profitable. An estimated 100+ million barrels were stored at sea
Impact on Investors
- ETF Roll Cost: Contango creates a 'negative roll yield' for futures-based ETFs like USO (United States Oil Fund). When rolling from expiring contracts to more expensive next-month contracts, investors lose value โ USO lost ~80% of its value from 2009 to 2023 despite oil prices recovering
- Contango Bleed: Persistent contango systematically erodes returns for long-only futures investors