Introduction
The forward curve is the market's collective expectation of future commodity prices, expressed through the prices of futures contracts for delivery at successive future dates. For energy bankers, the forward curve is not an abstract concept. It is a direct input into the financial models you build every day. When you populate the commodity price assumptions in a NAV model, you typically use the current futures strip as one of your price scenarios. When you advise an E&P company on hedging strategy, the forward curve determines the prices at which the company can lock in future cash flows. When you assess the timing of a sell-side M&A process, the shape of the forward curve tells you whether the market expects prices to improve or deteriorate.
Understanding forward curve structure, specifically the concepts of contango and backwardation, is essential for both energy banking work and interview preparation. Interviewers frequently ask candidates to define these terms, explain what they signal about market fundamentals, and describe how strip pricing is used in energy financial models.
How the Forward Curve Works
A commodity forward curve plots the price of futures contracts for each delivery month extending into the future. For WTI crude oil, the NYMEX futures strip extends several years forward, with monthly contracts for the first two to three years and quarterly or annual contracts further out. For Henry Hub natural gas, the NYMEX strip similarly extends multiple years, with natural gas exhibiting pronounced seasonal patterns (winter months priced higher than summer months due to heating demand).
- Futures Strip (Strip Pricing)
The series of futures prices for each successive delivery month, taken as a snapshot at a specific date. Energy bankers use "the strip" as shorthand for the current market-implied commodity price path. For example, "the WTI strip is at $72 for 2025 and $68 for 2026" means that the market-implied average oil price (based on futures contracts) is $72 for the first year and $68 for the second. Strip pricing is one of the standard price scenarios used in energy financial models alongside consensus forecasts and stress-case assumptions.
The shape of the forward curve at any given moment reflects the market's collective assessment of supply-demand fundamentals, storage economics, interest rates, and risk premiums. Two fundamental shapes dominate energy markets: contango and backwardation.
Contango: Future Prices Higher Than Spot
- Contango
A forward curve structure where futures prices for later delivery months are higher than the current spot price (or near-month futures price). On a chart, the curve slopes upward from left to right. Contango typically signals adequate or excess current supply, with the price premium on deferred contracts reflecting storage costs, financing costs, and the market's expectation that the oversupply will be absorbed over time. The opposite structure, backwardation, occurs when near-term prices exceed deferred prices, signaling tight supply or strong immediate demand.
On a chart in contango, the forward curve slopes upward from left to right.
What contango signals:
- Adequate or excess supply. If the market has more oil or gas available than it needs in the near term, spot prices are depressed relative to expected future prices. The surplus supply weighs on current prices while the market expects the excess to be absorbed over time.
- Storage economics matter. In contango, it can be profitable to buy crude at the spot price, store it physically, and sell it at a higher futures price for later delivery. The spread between the spot and futures price must exceed the cost of storage, financing, and insurance for this trade to work. During the COVID-19 crisis in April 2020, WTI futures briefly went negative because physical storage at Cushing filled to capacity and there was literally no place to store the next barrel, creating the most extreme contango in history.
- Bearish near-term sentiment. Contango often (but not always) indicates that the market expects current conditions to be weaker than future conditions.
Backwardation: Spot Prices Higher Than Futures
A market is in backwardation when the near-month or spot price is higher than prices for later delivery months. On a chart, the forward curve slopes downward from left to right.
What backwardation signals:
- Tight supply or strong current demand. When buyers need crude or gas right now and supply is constrained, they bid up the near-term price relative to deferred contracts. This is particularly common during geopolitical disruptions, OPEC+ production cuts that tighten physical markets, or unexpected demand surges (cold winters for gas, economic booms for oil).
- Incentive to sell inventory. Backwardation discourages storage and encourages drawing down inventories, because selling today at a higher price is more attractive than selling in the future at a lower price. This dynamic helps rebalance tight markets by bringing stored barrels back to market.
- Bullish near-term, uncertain long-term. Backwardation often reflects a market that is tight today but expects supply to catch up or demand to soften over time.
In early 2024, WTI futures were in backwardation, with near-term contracts priced above deferred months, reflecting OPEC+ production cuts that tightened physical markets. By late 2024, as concerns about oversupply grew (rising non-OPEC+ production, weakening demand growth), WTI shifted into contango, with analysts forecasting the curve would remain in contango through 2025 if OPEC+ began unwinding its cuts.
How Bankers Use the Forward Curve
The forward curve is embedded in energy banking work through several channels.
Strip pricing in financial models. The most direct application is using the current futures strip as a commodity price assumption in NAV models, DCFs, and LBO analyses. A common approach is to use the strip for the first two to three years of the projection (where futures liquidity is deep and prices are relatively reliable) and then transition to a long-term consensus price or flat real-price assumption for the remaining projection period. This hybrid approach captures near-term market expectations while avoiding the false precision of using illiquid, far-dated futures for decades-long reserve projections.
Hedging advisory. When energy bankers advise E&P companies on hedging strategy, the forward curve determines the price levels at which hedges can be executed. In backwardation, producers can lock in attractive near-term prices but face declining prices for deferred hedges. In contango, producers can hedge future production at prices above the current spot, which may be appealing if they believe the contango reflects temporary oversupply rather than a permanent price reset.
Deal timing. The shape of the forward curve influences M&A advisory. When the curve is in steep backwardation, sellers may prefer to act quickly (capturing high near-term implied values), while buyers may argue for lower prices based on deferred-month pricing. When the curve is in contango, the opposite dynamic prevails: the market implies that future conditions will be better than today, which can support a buyer's willingness to pay a premium based on a forward-looking valuation.
| Forward Curve Shape | Market Signal | Modeling Implication | Deal Timing Impact |
|---|---|---|---|
| Contango | Oversupply, storage economics | Strip starts low, rises over time | Sellers may wait for higher prices |
| Backwardation | Tight supply, strong demand | Strip starts high, declines | Sellers may accelerate to capture premium |
| Flat | Balanced market | Strip near current levels | Neutral timing signal |
Sensitivity analysis. Regardless of the current curve shape, energy bankers run commodity price sensitivities that show valuation outcomes across a range of price scenarios (typically strip, +/- $5-10 per barrel, and a stress case). The forward curve provides one anchor point, but the sensitivity table shows the client or buyer the full range of possible outcomes.
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