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Backwardation definition
Backwardation is a market condition in which the futures price of a commodity is lower than its current spot price, so contracts for nearer delivery cost more than those for later delivery. The forward curve slopes downward when a market is in backwardation.
This pattern often appears when there is strong demand for the commodity right now, or tight near-term supply, which lifts the price of immediate delivery. Traders who roll futures forward can gain from backwardation, because they sell pricier near-term contracts and buy cheaper later-dated ones.
Backwardation is the opposite of contango, where later-dated prices are higher than near-term ones and the forward curve slopes upward. Crude oil markets shift between the two depending on supply, demand, and storage conditions.
Backwardation Example
Suppose the near-month crude contract trades at 80.00 per barrel while the contract six months out trades at 76.00 per barrel.
Since the nearer price is higher, the market is in backwardation.
80.00 (near) minus 76.00 (later) = 4.00 premium for the nearer contract
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