In Contango Versus Backwardation, the Truth May Not be in Convenience: Disequilibrium States and the Spot-Forward Balance in Commodity Markets

The notion of a stochastic ‘convenience yield’ to explain variations and reversals in the spot -forward premium is a common rationalisation in commodity market research. However, such variations may arise from causes more intrinsically related to the structure and cash flows of the extended commodity markets. An instance is where the market can be subject to disequilibrium phases, characterised by rationing or clearing impediments that interfere with arbitrage. Th ese are likely to arise when market inventory is in short supply, so that disequilibrium switches can be based on the inventory/sales ratio.