Backwardation in a futures market in commodities or foreign exchange, exists when the prices for contracts with nearer maturity dates are higher than those with later maturities.
Contango exists in a futures market when future prices increase progressively with longer maturities. This is the most common situation, since many commodities, which are traded with futures contracts, have carrying costs, including storage, insurance, and financing plus there must be some compensation for the risk of holding a long position. A contango market encourages investors to buy the near contracts and take delivery to sell in the later months, and for companies to increase stockpiles of the commodity.
For instance, during the credit crisis in December, 2008, the demand for oil was dropping rapidly. Most of the oil traded in futures contracts on the New York Mercantile Exchange is stored in Cushing, Oklahoma, which was becoming full due to the lack of demand. With nowhere to store more oil, the price for oil dropped to its lowest level in years. The price for a barrel of oil dropped to below $34 on December 19, 2008, the expiration day for the January contract—even as OPEC earlier agreed to cut production significantly—while the price for the February contract rose to almost $42 per barrel, the largest spread between the 2 most active contract months since 1986, according to Bloomberg.