Over the past few weeks, I have heard oil and gas industry folks discussing "contango" and I am not embarrassed to admit that at one point I misheard one gentleman and thought he was asking me to dance...as in, asking me if I "can tango."
To save you from finding yourself in this situation, here is a short primer on "contango," not to be confused with a dance.
- What is "contango"
According to Investopedia's definition of contango, "Contango is a situation where the futures price of a commodity is above the expected future spot price." Explained in a different way, Investopedia says that, "Contango refers to a situation where the future spot price is below the current price, and people are willing to pay more for a commodity at some point in the future than the actual expected price of the commodity."
Still a little confused and wishing you were actually asked to dance instead? Me too.
Investopedia's "Breaking Down 'Contango'" is a little more helpful – it says the following:
"When market is "in contango," it describes a situation in which the delivery price of a particular futures contract has to converge downward to meet the futures price. A market that is in contango indicates that the forward or futures curve is upward sloping."
Investopedia also gives us the following example of contango: "Assume an investor goes along with a futures contract at $100. The contract is due in one year. If the expected future spot price is $70, the market is in contango, and the futures price will have to fall (unless the future spot price changes) to converge with the expected future spot price."
Clear as mud? Here is a helpful video Contango: CNBC Explains.
- Why are we talking about "contango"
Now that we know what “contango” is, why are people talking about it? The word on the street is that the contango in the oil market is decreasing and according to media outlets such as Bloomberg, "the fading contango is the clearest sign of recovery." The recent article entitled, "Look Past OPEC Freeze Hype to Really Understand Oil's Advance" discusses and explains the current narrowing of the oil contango in detail.
However, if it is one thing that the commodity market has taught us over the past two years it is that it is unpredictable…
Stay tuned for more on the contango in the oil market – In the meantime, dust off your dancing shoes and twirl around the dance floor, knowing what a contango is!
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