Contango (as defined at http://www.investorwords.com)is "a condition in which distant delivery prices for futures exceed spot prices, often due to the costs of storing and insuring the underlying commodity. opposite of backwardation." The potential, substantial economic and worldwide significance of contango came to light after an investigative reporter did a review of contango's effect on world oil prices. That analysis can be found on NPR's "All Things Considered" dated August 24, 2006 entitled "Analyst: Blame Investors for High Gas Prices".
"Contango" might be one cause for up to 20% of the past run up in prices of oil around the world. Major investors such as hedge funds, brokerage houses, banks, pension funds, etc. are making large guaranteed profits whenever unusual levels of contango develop in oil commodity prices. Contango is the opposite of "backwardation" (where the reverse price level differences occur in the futures market). Contango lets investors lock in guaranteed significant profits by buying oil at "low" current prices and selling the same oil to others at guaranteed higher prices in the future i.e. through the futures market. When the price of storage and insurance to hold the commodities for future delivery (plus the initial purchase price) is less than the total future price received, then guaranteed profits result by utilizing and understanding contango.
by Ubunto August 29, 2006
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