What are contango and backwardation, and why were they important to MGRM's situation? Why is there often backwardation in the oil markets?
What will be an ideal response?
Contango occurs when the spot price is less than the forward price. Backwardation occurs when the spot price is greater than the forward price.
Contango and backwardation were important to MGRM because the company's stack-and-roll hedge exposed the company to basis risk, rather than spot price risk. Therefore, a movement from backwardation to Contango had a major effect on MGRM's profits and cash flows.
Backwardation often occurs in the oil and gas markets as a result of political and economic turmoil, which raises the convenience value of owning oil.
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