Financial Markets for Commodities

4 The Storage and Term Structure of Commodity Futures Prices

The objectives of this chapter are to:

• – understand what determines the term structure of the price of futures contracts. “Term structure” refers to the relationship between the prices of contracts with different deadlines;
• – provide information to help answer the question: are futures markets a good tool for forecasting future physical prices? In other words, are they biased?
• – what is the link between physical quantities, storage and the prices of futures contracts?

The concept of term structure is also used for interest rates. In these cases, we examine market rates for various maturity dates. We will base our discussion mainly on the following three studies: [GOR 15, IRW 12, WIL 86].

4.1. Essential concepts

The following concepts will be used throughout this chapter:

• – the spread on a date t is the difference in the prices of different futures contracts; for example, the expression F_t,T2 – F_t,T1 represents the difference between two contracts whose maturity dates are, respectively, T₁ and T₂;
• – in a contango situation, at a date t, the spread is positive and thus the spot price (S_t) is lower than the price of the futures contract (the price of futures F_t,T with a maturity date T): S_t < F_t,T ;
• – backwardation is a situation where a spread is negative. In practice, the concept of backwardation is chiefly used to characterize a situation where the spot price is greater than the futures price, i.e. S_t > F_t,T