How contracts work: The hidden cost of time

When you invest in oil or wheat, you almost never buy barrels or sacks. You buy futures contracts.

And these contracts have one feature: the price for delivery in a month is not the same as today's price.

Today's price is called the spot price. Say fifty dollars a barrel. Next month's contract is worth fifty-two.

When the future costs more than spot, it is called contango. It is the most common situation.

It makes sense: someone has to store the oil meanwhile, insure it, tie up their money. That cost ends up in the price.

Sometimes it is the opposite: the future is cheaper than spot. That is called backwardation.

It is often a sign of shortage. Everyone wants the barrel now, and pays more so as not to wait.

Now, the trap. A fund that tracks oil cannot hold its contracts to the end: it does not want barrels.

Before expiry, it sells the expiring contract and buys a later one. That is called rolling.

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For the example: ten thousand dollars, a contract at fifty-two. The fund holds about one hundred and ninety-two barrels.

A month later, the contract expires at the spot price: fifty dollars. Its barrels are now worth only nine thousand six hundred and fifteen.

The price of oil has not moved. And yet the fund has lost almost four per cent.

Repeat this roll twelve months in a row, with the same gap. Six thousand two hundred and forty-six dollars are left.

More than a third lost, while the barrel has not moved a cent. That is the invisible cost of rolling.

In backwardation, it is the opposite: you buy at forty-eight, it ends at fifty. Rolling pays.

That is why a commodity fund can do very differently from the price you read in the paper.

Contango even creates a strange business: floating storage. Tankers waiting offshore, full.

For the example: you buy a barrel at twenty dollars today, and sell it forward at thirty dollars in six months.

Renting a tanker and paying the costs comes to six dollars a barrel. Four dollars of margin remain, with no price risk.

In spring two thousand twenty, when the world stopped, dozens of tankers served as floating warehouses.

Remember this: in commodities, time has a price. You read it in the gap between today and tomorrow.

Before buying a commodity fund, ask whether it rolls contracts. And which way the roll costs you.