Voiceover: What I've
drawn right here is an inverted oil futures curve. So if the futures curve looks
like this, it just means that it's more expensive to buy oil
today than to agree to buy oil at some future date,
two months from now, four months from now or
eight months from now. There's a couple of reasons
why this might happen. The most common reason
might just be there might be some type of shortage
right now for whatever reason, maybe ... maybe there's
a war going on and all of a sudden we need a lot more
fuel to support all of the crazy machinery and all of
that or maybe some oil got destroyed, maybe some oil
wells are burning. Who knows? There might be some type
of shortage, so people are willing to pay a premium
for oil right now. The other reason why you
might have an inverted oils future curve and this will
actually gel a little bit more with kind of what we're going
to talk about in this video is that people expect the price
of oil in the future to not be that different than the
price of oil today. If you were to go out there and survey
everyone who might be a seller or buyer of oil in the
world, which is obviously not possible, but if you were to ask them, "What is the expected price
of oil in eight months?", they might say, "Hey, okay we
might even have a little shortage "right now, but we expect
the price of oil to be $100." and so you might say, "Wait.
If everyone expects ... "If everyone expects the
price of oil to be $100," "why are there some people
in the futures markets today" "who are agreeing to
sell the oil for $50?" "They're agreeing to sell it
below the expected price." And the reason why they
might be willing to, maybe their oil producers and oil
is such a volatile price and because they are dependent
on oil revenues to support the people who live in that
country or whatever else. They're essentially, in order
to guarantee the price and and not be susceptible to the
volatility, they're willing to sell it at a discount, to this
theoretical expected price. So either way, this could lead
to an inverted futures curve. Now, in kind of common lingo
when people see an inverted futures curve like this,
they'll often use the word "backwardation", backwardation.
They'll say that the future ... that this futures
market is in backwardation, so backwardation and what I
want to be clear is, is that that's what most people
are talking about, inverted futures curve but that's not
exactly right if you we want to give the precise academic
definition. The precise definition is not just an
inverted curve, the precise definition is and this is
actually the theory of normal backwardation. It came from
Keynes and that is, is that the sellers are willing to sell
in the future at a discount to the expected price because
of the volatility, so that they could lock in their
price. So the theory of normal backwardation is actually
this phenomenon right here. But this is actually not
observable because you can't go and survey everyone
and figure out what the actual expected price is
and you can see that they're often one and the same. The
expectant price was here. You had an inverted futures
curve. That's why they called this curve that or this
market in backwardation. The one way that you can
kind of observe it, is if you see, so over here, this is our
spot price. This is our spot price and now we're moving
over time and you can see the spot price isn't changing
much and because it's not changing much, this cheaper
futures price, as we move closer and closer to its
delivery date, it has to converge with the spot price.
As this one right over here it starts at $75, as you go
further and further in time, it has to converge to the
spot price and so when you see the futures price moving
up towards the spot price, over as it gets closer and
closer to its delivery date, that's maybe the most
observable way that you could say that the market is
experiencing ... is experiencing backwardation.