When Oil Is Worth More Later, Someone Fills a Tank and Waits
When futures prices are higher than todays price, storing a commodity and selling it forward locks in a profit. This physical storage trade links the futures curve to the cost of a warehouse.
The Shape of the Curve
A commodity does not have one price. It has a price for delivery today and a series of prices for delivery in future months, the futures curve. When future prices are higher than the current price, the market is in contango. When they are lower, it is in backwardation.
These are not just descriptions. Contango creates a specific opportunity: buy the physical commodity now, store it, and simultaneously sell a futures contract for later delivery at the higher price. If the gap exceeds the cost of storing the commodity, the trade locks in a profit.
Contango is the market paying you to hold the commodity. Whether the payment covers the cost of holding it is what determines whether the storage trade works.
The Cash and Carry Trade
The physical storage trade, sometimes called cash and carry, works like this. A trader buys the commodity at today price, pays to store it, and sells a futures contract locking in the future sale price. At delivery, the trader hands over the stored commodity and collects the futures price.
The profit is the futures price minus the purchase price minus the cost of carrying, which includes storage, insurance and the financing cost of the money tied up in the commodity.
| Component | Effect on the trade |
|---|---|
| Contango (future above spot) | The gross profit |
| Storage cost | Reduces the profit |
| Financing cost | Reduces the profit |
| Insurance and handling | Reduces the profit |
The trade is close to arbitrage, because the sale price is locked in by the futures contract, so the trader is not betting on where prices go. The main risks are that storage costs more than expected, or that the trader cannot find storage at all.
Why the Curve Is Shaped the Way It Is
Contango and backwardation are not random. They reflect the supply and demand balance and the cost of storage.
A market in contango typically has ample or excess current supply. There is more of the commodity available now than the market wants, so the current price is depressed relative to the future, and the market effectively pays to store the surplus until it is needed. Backwardation typically signals current scarcity: buyers want the commodity now and are willing to pay more for immediate delivery than for future delivery, which happens during shortages.
The storage trade is the mechanism that connects the two. When contango is wide, storage fills as traders capture the spread, which supports the current price and pulls the curve back toward balance.
When Storage Runs Out
The trade has a physical limit: there is only so much storage. When contango is extreme and traders rush to store the commodity, storage fills up. Once it is full, the trade cannot continue, and the current price can fall dramatically because the surplus has nowhere to go.
The most striking illustration came in oil, when a collapse in demand left far more crude than storage could hold. With tanks full and nowhere to put more oil, holders of expiring futures faced having to take physical delivery they could not store, and the price of that expiring contract briefly went negative, meaning sellers paid buyers to take the oil. It was the storage constraint, not a view on oil demand, that produced the negative price.
Floating Storage
When land storage fills, traders turn to ships. Hiring a tanker to hold oil at sea, floating storage, becomes economic when contango is wide enough to cover the high cost of chartering a vessel. Waves of floating storage appear precisely when the curve is steeply in contango and land storage is scarce, and they disappear when the curve flattens.
This links the commodity curve to the shipping market, since demand for tankers as storage removes them from transport, tightening freight rates at the same time.
The Bottom Line
Contango, when future prices exceed the current price, lets a trader buy the physical commodity, store it, and sell it forward at a locked in profit if the spread exceeds the cost of carry. The trade connects the futures curve to physical storage, filling tanks when contango is wide and emptying them when it narrows. Its limit is physical: when storage fills, the trade stops and prices can collapse, as oil demonstrated when the price of an expiring contract fell below zero because there was nowhere left to put the barrels.