Contango and Backwardation

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Futures contracts have unique expiration dates. In the case of energy contracts, they expire on a monthly basis. Contango and backwardation are terms used to describe the price difference between two individual monthly contracts. How the contracts are traded further out the curve (months away from present time) determine whether the commodity is in a state of backwardation or contango.

What Is Backwardation?

Backwardation occurs when a given contract month is trading at a premium to a later contract month. For instance, if a commodity’s month A is trading at price x, then the price of month B (a later month) will be trading at a price less than x.

The difference in prices determines the degree of backwardation. If the difference is a few cents, backwardation is much less extreme than if there is a few dollars’ difference.

What Is Contango?

Contango is the exact inverse of the aforementioned scenario. Month A is trading at price x, but month B is trading at a premium to month A (price greater than x). Again, the determining factor between contango and backwardation is whether the future value for a commodity is valued at a premium or a discount compared to a month closer to the spot price (the market price for the month a contract is currently in).

What This Means

The degree of backwardation or contango is relative. Certain commodities do not fluctuate in price as much, so if they widen in either direction by a few cents it is drastic. For others widening a dollar or two is an ordinary event.

How Matrix Storage Assists Operators

The Matrix Storage contract has a direct relationship to the relative contango or backwardation of the curve.

The Matrix model at LOOP is designed to attract new participants who can access storage via short-term to intermediate-term contracts. Because it allows storage operators to leverage the optionality inherent in storage contracts, a standardized storage futures contract provides the storage operator an opportunity to capture the value of a steeper contango. When coupled with other aspects of the program, it is an excellent adjunct to a storage operator’s risk profile.

Contact us to learn more about how Matrix Storage can assist you.

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