Iran War Brings Severe Oil Futures Backwardation

The shutdown of shipping through the Strait of Hormuz into the Persian Gulf has understandably brought a big spike in the price of the near month crude oil futures contract.  The contract for April 2026 delivery is now above $90.  But if you go out 11 months to the March 2027 contract, the price is still at $66.50.

The condition of having the near month contract price above the far month contracts is known as "backwardation".  The opposite condition is called "contango".  Financial futures like T-Bonds and SP500 futures almost always trade in contango, with the more distant contracts at a higher price, thanks to something called the "time value of money".  With the right portfolio engineering, a trader could go long the distant month and short the near month, thereby having a neutral position relative to the market, but collecting "interest" on the difference in contract premiums.

In crude oil futures, we have seen persistent backwardation ever since the 2020 Covid Crash.  Anyone with some available supply of crude oil therefore has a big incentive to sell it now and collect the higher price, versus holding onto it for future delivery.  Years ago, there were several instances when oil futures went into contango, and so oil producers had an incentive to buy storage tanks to hold their current production.  When contango has gotten really extreme, some traders have even rented crude oil tanker ships to act as floating storage in order to take advantage of the difference in pricing in the futures market. 

There are several messages to take from the current condition of backwardation.  The first is that crude oil consumers like oil refineries are desperate to secure any oil which can be delivered, so that they can keep operating.  With the unknown outcome of Iran's announced closure of the Strait of Hormuz, buyers are in a panic. 

The big spread to the distant month contract prices also tells us that crude oil futures traders do not see the current panicked condition as being permanent.  The distant month contracts have come up a little bit since the US-led invasion of Iran began, but that rise is not nearly as big as the near month. 

This creates the big spread you see in the chart above, and these episodes of very large backwardation are great markers of tops for oil prices.  Normally a spread of about $7/barrel is enough to mark a top, although it obviously can get to a much bigger spread like what we are seeing today. 

The high backwardation spread we are seeing now is a topping condition, but it is not a "signal" to say that a top is in.  Oversold or overbought conditions always have the potential get even more extended.  But this current spread is an interesting bit of history, and a sign that this big spike in near month crude oil prices should not last very long.