Why does arbitrage cap the curve from above but never from below?

You have the asymmetry from the last lesson: cash-and-carry is executable, reverse cash-and-carry usually is not. Now push on the executable side, because the cap it imposes is not fixed. It moves — and it moves in exactly the direction that makes stressed markets look extreme.

Storage is a price, not a constant

Treating storage as "$0.40 a barrel a month" is a modelling convenience. In reality storage is a scarce physical resource with a spot market of its own, and its price behaves like any other scarce thing: cheap when there is plenty, violent when there is not.

Watch the ceiling move as tanks fill. Same spot price of $78.00, same 5% financing ($1.95 over six months), same 0.5% insurance ($0.20):

• Tanks around half full. Storage $0.35 a barrel a month → 6 × 0.35 = $2.10. Full carry $4.25 → ceiling $82.25, a contango of 5.4% over six months.
• Tanks around 85% full. Available tankage is being bid for; storage $0.90 a month → $5.40. Full carry $7.55 → ceiling $85.55, a contango of 9.7%.
• Tanks effectively full; floating storage in play. Chartering a very large crude carrier as a floating tank is the marginal option. A 2-million-barrel vessel at roughly $120,000 a day is about $0.06 a barrel a day, near $1.80 a barrel a month → $10.80. Full carry $12.95 → ceiling $90.95, a contango of 16.6%.

Nothing in that table is a mood. Each line is a rental quote turned into a price relationship. When commentators call the third line super-contango and reach for adjectives about panic, the honest description is narrower and more useful: the marginal unit of storage has become extremely expensive, and the curve is reporting its price.

The feedback loop that makes it self-reinforcing

The mechanism is circular, and the circle is the point.

1. Supply exceeds demand, so inventories build.
2. Storage gets scarcer, so the marginal storage rate rises.
3. Full carry widens, so the ceiling on the curve rises.
4. A wider contango makes the cash-and-carry trade profitable at a wider spread, so more storage gets hired and more barrels go into tanks.
5. Which makes storage scarcer still.

The loop runs until either the surplus stops or the tanks stop. What it does not do is stabilise gently.

When the ceiling stops existing

Now take the loop to its endpoint. Cash-and-carry requires one physical input: somewhere to put the barrel. If there is genuinely no available tankage at any price — not expensive, unobtainable — then the trade that enforces the ceiling cannot be executed by anyone, and the ceiling is not high. It is absent.

At that moment the storage term stops being a rate and becomes a hard constraint, and the arithmetic that produced an upper bound on the curve has no solution at all. The front of the curve is then set by whatever the people who must not take delivery are willing to pay to get out of the obligation.

That is not a hypothetical. It is the precise mechanism behind April 2020, which Unit 4 walks through with the real numbers.

The summary worth keeping

• Contango is capped — by full carry, enforced by anyone who can store.
• That cap floats upward as inventories build and storage gets dear.
• The cap vanishes when storage capacity is exhausted.
• Backwardation has no cap at all, because the reverse trade needs borrowable physical that mostly does not exist.

A commodity curve is therefore an asymmetric object by construction. Symmetric intuitions imported from equity or index futures will mislead you here, reliably.

Try it now

1. Two markets with opposite storage economics are below: gold, where storage is cheap and effectively unlimited, and natural gas, where it is expensive and physically capped. Measure the widest twelve-month range you can find on each and write the two percentages down.

2. That difference is the ceiling doing its work. Where storage is abundant, carry pins the curve and the price with it; where storage runs out, nothing pins anything. For each, write down how much of the curve's typical shape you would expect carry alone to explain — and say why the answers differ.
3. Now put today's numbers through the crude table above. Keep its two storage rates, $0.35 a barrel a month with tanks half full and $0.90 with tanks 85% full, but replace the $78.00 spot and the 5% financing with the two values below. Compute the six-month ceiling at each storage rate. The distance between those two ceilings is the range the curve can travel without anything unusual happening.