How Does “Contango” and “Backwardation” Relate to Basis Risk in Futures?

Contango is a market state where the futures price is higher than the spot price, and backwardation is where the futures price is lower than the spot price. These conditions create a non-zero basis.

If a hedger is short a futures contract in contango, they face a negative cost of carry as the futures price converges down to the spot price, which is a form of basis risk.