Page 34 - Policy Economic Report- June'26

POLICY AND ECONOMIC REPORT
OIL & GAS MARKET

Lessons from Economics

Backwardation

Backwardation occurs when the current price, or spot price, of a commodity is higher than the prices in
the futures market. This generally reflects strong near-term demand or supply shortages that the market
expects to ease over time.

The opposite of backwardation is contango, where futures prices are higher than the current spot price,
typically reflecting ample supply, storage costs, financing costs, or expectations of higher future prices.

How Backwardation Impacts Market Dynamics

The spot price is a term that describes the current market price for an asset or investment, such as a
security, commodity, or a currency. The spot price is the price at which the asset can be bought or
sold currently and will change throughout a day or over time due to supply and demand forces.

If the futures contract price is lower than today's spot price, the market expects the current elevated spot
price to decline over time as supply conditions improve. This market structure is known as backwardation.

In backwardation, traders may exploit price differences between the spot and futures markets through
arbitrage where feasible. As the futures contract approaches maturity, the futures and spot prices
typically converge.

Pros

• Backwardation benefits speculators and short-term traders looking to profit from arbitrage.
• Backwardation can be used as a leading indicator signaling that spot prices will fall in the future.
Cons

• Investors can lose money from backwardation if futures prices continue to move lower.
• Trading backwardation due to a commodity shortage can lead to losses if new suppliers come

online to boost production.

Oil markets in Backwardation (Scenario for March 2026)

Backwardation is common in crude oil markets during periods of supply tightness, geopolitical disruptions,
or strong near-term demand. These conditions create a premium for immediate delivery relative to future
delivery.

The below figure illustrates a backwardation market structure, where futures prices decline as the
contract maturity extends. The left side of the graph represents near-term contracts, which are priced
higher due to tight supply conditions. As the contract expiry moves further into the future (towards
December), futures prices gradually decrease, indicating that the market expects supply conditions to

June 2026 Page | 33