Legal Definitions - backadation

Backwardation describes a specific market condition where the current price of an asset (known as the spot price) is higher than the price for its future delivery. This is the opposite of the more common market situation, where future prices are typically higher than spot prices to account for costs like storage, insurance, and interest over time. Backwardation often indicates a current shortage or exceptionally high immediate demand for the asset.

• Example 1: Energy Market Disruption

  Imagine a major hurricane unexpectedly hits the Gulf Coast, causing several oil refineries to shut down temporarily. Oil distributors and airlines need jet fuel and gasoline *immediately* to meet current demand. This sudden, urgent need for immediate delivery drives up the price of a barrel of crude oil available today (the spot price) significantly higher than the price of a barrel of oil that can be delivered in six months, when the refineries are expected to be fully operational again and supply normalized. This scenario illustrates backwardation because the immediate price for oil is greater than its price for future delivery.

• Example 2: Agricultural Commodity Shortage

  Consider a severe and unexpected drought impacting a major wheat-producing region just before harvest. Bread manufacturers and food companies need wheat to fulfill existing orders and keep their production lines running. The immediate scarcity caused by the drought makes the current price of wheat (spot price) jump dramatically. Meanwhile, the price for wheat to be delivered in a year's time (future price) might not rise as sharply, as traders anticipate new harvests will eventually alleviate the shortage. This creates a backwardation market, where today's wheat is more expensive than wheat delivered far in the future.