Commodity Carry and the Shape of the Curve

Own a barrel of oil in a vault and it earns you nothing while you wait, and it costs money to store. Own an oil futures contract instead, and something odd can happen: if the market is short of oil right now relative to the future, holding the contract and rolling it forward every month can be a source of steady profit even if the spot price of oil never changes at all.

Why commodity curves slope at all

Unlike a bond or a stock, a commodity futures curve is shaped by the physical world: storage costs, financing costs, and the convenience of having the physical good on hand right now (the convenience yield). When supply is tight — refiners need oil today more than they need a promise of oil in six months — near-term contracts trade above far-dated ones, a shape called backwardation. When storage is abundant and there is no urgency, far-dated contracts trade above near ones to compensate whoever is willing to store the physical good, a shape called contango. A long futures position that rolls from an expiring contract into the next one earns the difference between the two prices every time it rolls, which is exactly the definition of roll yield.

Adjust the curve above and think of it as the futures price plotted against months to delivery: a downward-sloping shape (like a negative-exponent curve) means each successive contract is cheaper, so rolling long from the cheap far contract up to the more expensive near contract each month is what pays; an upward-sloping shape works in reverse and taxes the roll.

Worked example

An oil futures curve is in backwardation: the front-month contract trades at $82.00 and the second-month contract trades at $80.50. A long position holds the front month, and as it approaches expiry, sells it and buys the second month to stay invested — but by the time of the roll, what was the second month has itself become the new front month at (roughly) the old front-month price. Approximated simply, the monthly roll yield is:

$$\frac{82.00 - 80.50}{80.50} = 0.0186$$

About 1.86% captured on the roll that month, roughly 22% annualized if the curve's shape persists — with zero change in the spot price of oil. Reverse the curve into contango, with the front month at $80.50 and the second month at $82.00, and the same roll costs the position about -1.83% that month instead.

What this means in practice

Systematic commodity strategies size long or short exposure based on curve shape as much as on any price forecast, and passive commodity index products (which must roll on a fixed schedule) can see their returns diverge sharply from the spot price of the commodities they track, purely from years spent rolling through contango. Curve shape also carries information: persistent backwardation across a commodity complex often reflects genuine physical tightness, while broad contango often reflects oversupply or a glut in storage.