Commodity Futures Curves and Roll Yield

A futures curve in contango costs a rolled long position money on every roll, independent of any move in the spot price.

A commodity futures curve plots the price of contracts on the same underlying commodity across different delivery months, and its shape, whether prices rise or fall with time to delivery, determines whether an investor holding a continuously rolled futures position earns or loses money purely from the act of rolling, independent of any change in the spot price. That effect is roll yield, and it is one of the most commonly misunderstood sources of return and loss in commodity investing.

A futures curve is in contango when longer-dated contracts trade at higher prices than nearer-dated contracts, and in backwardation when the opposite holds. Crude oil, for example, has spent extended periods in both states depending on inventory conditions and the market's expectation of near-term supply relative to storage capacity.

An investor who holds a near-dated future and, as it approaches expiry, sells it and buys the next month out, is rolling the position. In a contango market, that investor sells low and buys high on every roll, a persistent drag on returns even if the spot price of the commodity is unchanged over the same period. In backwardation, the roll works in the investor's favor, selling high and buying low.

The cost of carry model explains contango as the market's compensation to whoever holds physical inventory: the futures price for later delivery should roughly equal the spot price plus the cost of storing the commodity until that delivery date, plus the financing cost of the capital tied up in the inventory, minus any convenience yield the holder gets from having physical supply on hand. For a commodity costing $80 a barrel with storage and financing costs of $2 a barrel over three months and negligible convenience yield, the three month future should trade near $82, and that $2 gap is the contango.

When storage is scarce or demand for immediate delivery is unusually high, convenience yield rises and can exceed the storage and financing cost, flipping the curve into backwardation even though physical storage still has a nonzero cost. This is why backwardation is often read as a signal of tight near-term supply.