Commodity Future
Also known as: Oil futures, Grain futures
Standardised contracts on oil, gold, wheat and power — where the physical world sets its prices.
1 · SnapshotThe one idea to remember
2 · BeginnerWhat is it, really?
Commodity futures are how the world puts a price on physical things. Each contract is an agreement to buy or sell a fixed amount of a raw material, of a fixed quality, on a fixed date. A thousand barrels of WTI crude oil. Five thousand bushels of wheat. A hundred ounces of gold. The terms are standard, so the contracts are interchangeable and easy to trade.
They were invented so that farmers and millers could agree a price before the harvest came in — in Chicago in the 1800s, and in Osaka for rice long before that. That is still what they are for. Producers sell futures to fix what they will earn. Users buy them to fix what they will pay. Speculators stand in the middle and carry the risk, in the hope of being paid for it.
Most of these contracts can end in actual delivery, at named warehouses, ports or pipelines. Hardly any of them do. But the fact that they could is what keeps the price honest: on the last day the contract has to be worth the same as the real barrel or the real bushel, or traders make free money until it is. April 2020 showed this at its most dramatic, when the oil price went below zero — buyers were paying to get out of taking delivery, because there was nowhere left to put the oil.
Point at a line to pick it out from the others.
a paymentonly if a condition is metnot a payment
A producer fixes next year's price today. What the contract does not fix is how much cash it will demand along the way.
At the trade
- The producer → The consumer Not a date: a grade, a place and a month. Change any of the three and it is a different contract at a different price.
Every day until then
- The producer → The consumer If the price rises, the short pays it out now — even though the physical crop that will benefit has not been sold yet. Funding that gap is what destroyed Metallgesellschaft in 1993.
At the end
- The consumer → The producer Between the daily settlements and the physical sale at the market price, the producer ends up with the price it fixed. The hedge worked; the cash flow was the hard part.
Notice periods, warrants and the delivery nobody usesafter the trade
something deliveredonly if a condition is met
Most positions never reach this. The fact that they could is what ties the paper price to the physical one.
Before the notice period
- The buyer → Clearing house Position limits tighten into the delivery month because the deliverable supply is finite and the paper position need not be.
If delivery does happen
- The seller → Clearing house Not a lorry: a document of title to metal in a named warehouse, grain in a named elevator, or a nomination on a pipeline.
- Clearing house → The buyer The commodity itself may not move at all.
- Asset class
- Commodities
- Instrument type
- Exchange-traded future
- Traded
- Exchange (CME, ICE, LME)
- Typical users
- Producers, consumers, merchants, funds
Which risks decide the outcome
Not how risky this is, and not a rating — there is deliberately no total. It says which of five failure modes drives what happens here, in the same order on all 129 products so they can be compared. This publication's own reading; see the notice below.
- Marketdecides it
- Creditbarely applies
- Liquiditymatters
- Fundingdecides it
- Operationalmatters
What decides it here. The hedge is funded every day for a year before the physical sale settles it. Metallgesellschaft in 1993 was right about the price and ran out of cash anyway.
3 · IntermediateHow it works in practice
The forward curve tells the story
- Contango: later months pricier — the market pays for storage; typical when supply is ample.
- Backwardation: later months cheaper — immediate scarcity; owning physical now has value (the "convenience yield").
- Curve shape, not spot level, is the professionals' read on physical tightness.
Roll yield
Futures investors must roll expiring contracts. In contango, each roll buys dear and sells cheap — a systematic drag (why oil ETFs long underperform spot oil); in backwardation, rolling earns. Long-run commodity index returns are dominated by this, not by spot moves.
Hedgers vs. speculators
Commitments-of-Traders data shows the ecology: producers net short, index money net long. The normal backwardation hypothesis (Keynes): hedgers pay speculators an insurance premium, visible as positive expected roll returns in producer-hedged markets.
4 · AdvancedPricing & valuation
Pricing: storage arbitrage with a twist
What the symbols mean
- Fthe forward or futures price
- Tmaturity, in years
- Sthe price of the underlying today
- rthe interest rate, per year
- ythe yield to maturity
with storage cost \(u\) and convenience yield \(y\) — the option-like value of holding physical inventory (keep the refinery running, meet a delivery). Unlike equities, \(y\) is unobservable and volatile: it's backed out of the curve and spikes with scarcity. Cash-and-carry arbitrage bounds only the contango side (storage is real and finite); backwardation has no arbitrage ceiling — scarcity can price anything.
Term-structure models
Two-factor models (Gibson–Schwartz: spot + mean-reverting convenience yield; Schwartz–Smith: short-term deviations + long-term equilibrium) capture the curve's dynamics for real-asset valuation and hedging. Seasonality (gas, power, agriculture) adds deterministic curve shape; power markets push further — non-storability breaks the arbitrage link entirely, making expectations + risk premia the whole price.
Spreads as the real market
- Calendar spreads: storage economics distilled (the "cash-and-carry" trade at full tanks = April 2020).
- Crack/crush/spark spreads: refinery, soybean and power-plant margins as tradable objects — processors hedge the spread, not the legs.
- Location/quality bases: WTI–Brent, hub differentials; pipeline shocks trade here.
Financialisation debates
Index-fund flows, position limits, and the empirical question of whether paper money moves physical prices — the literature says: levels rarely, curve shape and correlations measurably.
The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.
5 · Desk notesHow practitioners think about it
Now say it back
Close the page and give Commodity Future in four sentences. It takes a minute and it is the only way to find out whether reading it was enough.
- Who wants what — two parties wanted opposite things badly enough to write it down.
- What the contract obliges, and when — not the payoff; the obligation.
- Where the money comes from — name the source, or you have described a hope.
- What makes it lose — the ordinary way, not the dramatic one.
Put Commodity Future beside any other instrument →
Where this instrument shows up elsewhere
- EasyWhat is a derivative?QuestionsA contract whose value is read off something else
- MediumAmaranth, 2006Case Studies$6.6bn lost in a single month on natural gas spreads
- MediumHow to Read a Futures Contract SpecPlaybooksOne page on an exchange's website decides how much you are exposed to, when you stop being able to change your mind,…
- MediumMetallgesellschaft, 1993Case StudiesA hedge that was economically sound and financially fatal
- MediumNegative Oil, April 2020Case StudiesFor one afternoon a barrel of oil was worth minus thirty-seven dollars — not because demand vanished, but because…
- MediumThe Nickel Squeeze, 2022Case StudiesA price that rose 250% in two days, and an exchange that cancelled the trades
- MediumWhat Time Does to a PositionAnalysisEvery instrument has a clock in it
- MediumWhich Desk Trades WhatPrepEleven trading seats and six that sit next to them: what each one actually touches, the single number it lives by,…