jonathan

Crude Oil Dances the Contango

For Due Diligence...
No, you are not understanding it correctly. The difference just reflects time value of money. Something delivered in the future has less value than something delivered today. With a future you are paying now for something that you will not receive for a month...so the price would be a little lower than what you would pay for an immediate delivery (the spot).

Said another way...the product supplier is asking to be paid a month in advance. He will have use of your money for an extra month before he has to deliver the goods. So he would expect to discount his price a little bit (by something close to the risk-free rate).

Contango might mean that there is enough demand for futures that the supplier can get his money without having to discount the price. A little of that is probably ok but if that diverges much from the "get it today" spot price for the commodity then you can bet that a speculator is going to lose money.

I'm not sure what that means for the market direction. If it lasts for a while it might mean a market top, since actual oil consumers (companies buying oil to use, not for speculation) would just buy at spot and pay the storage cost (when that becomes cheaper than the future) leaving the futures market to speculators with no buyers. Certainly indicates some frothy demand at least, IMHO.