Convenience Yield

In the energy markets, oil and natural gas consumers are characterized by relatively inelastic demand. End users, refiners, and distribution companies cannot do business without a supply of oil and gas. Because they cannot afford to be without oil and gas, these firms hold energy inventories. The financial benefit that accrues to holders of inventories is called convenience yield.

The value of the convenience yield influences the term structure of energy prices. One theory of backwardation holds that when excess supplies are available, inventories increase and convenience yield declines. Low convenience yields push the market toward full carry — forward prices in steep contango. When gas and oil supplies are short, inventories are drained from the market and end-users are willing to pay more today for an uninterrupted supply of energy. As convenience yield increases, the market can swing into backwardation.