How Does the Concept of “Convenience Yield” Explain Backwardation in Commodities?

Convenience yield is a non-monetary benefit or premium that accrues to the holder of the physical commodity, such as the ability to profit from a sudden local supply shortage or to use the asset in a production process. This yield effectively lowers the cost of carry.

When the convenience yield is high enough to outweigh the financing cost, the cost of carry becomes negative, leading to a futures price lower than the spot price, which is backwardation.