Contango

Contango is a term used in the futures market to describe an upward sloping forward curve (as in the normal yield curve). One says that such a forward curve is "in contango" (or sometimes "contangoed").

Formally, it is the situation where, and the amount by which, the price of a commodity for future delivery is higher than the spot price, or a far future delivery price higher than a nearer future delivery.

The opposite market condition to contango is known as backwardation.

Occurrence
A contango is normal for a non-perishable commodity which has a cost of carry . Such costs include warehousing fees and interest forgone on money tied up, less income from leasing out the commodity if possible (e.g. gold). However, markets for non-perishable goods may also exist in a state of contango.

The contango should not exceed the cost of carry, because producers and consumers can compare the futures contract price against the spot price plus storage, and choose the better one. Arbitrageurs can sell one and buy the other for a risk-free profit too.

In 2005 and 2006 the crude oil market was in contango. This was a result of the perception of a future supply shortage. Many hedge funds took advantage of the arbitrage opportunity by buying present oil, selling a future contract and then simply storing the oil for future delivery. It was estimated that perhaps a $10-20 per barrel premium was added to spot price of oil as a result of this. The contango ended when global oil storage capacity became exhausted.[1]

For perishable commodities, price differences between near and far delivery are not a contango. Different delivery dates are like different commodities in this case, since fresh eggs today are not fresh in 6 months time, or 90-day treasury bills will mature, etc.