Greetings friend! Here is a nice article on convenience yields if you are interested:
Think of convenience yield as the value gained from holding inventory. This value can come from its usable nature (such as in the oil industry as described in the article above) or because of scarcity etc. As you correctly point out, low supply generally means higher convenience yield.
The person who possesses the commodity benefits from the convenience yield. This is why it is factored to the spot price and not the futures price, because the spot buyer/seller has the commodity. If you buy a future contract, you do not get immediate delivery. Someone else is holding it. So you don’t benefit from convenience yield and are, depending on the date of your futures contract, possibly far away from receiving the benefit of possession currently.
So if there is a high convenience yield, then all other things being equal the market will be in backwardation. Future prices will be below spot prices. So let’s take a second and think about what that means. It doesn’t mean that in the future oil prices will be cheap. It means buying a long-dated future on oil is a cheaper way to buy oil if you can wait it out and don’t need it now.
What is backwardation? It is when farther out future prices get increasingly cheaper versus today’s spot price. And this allows you to get positive roll yield (you make money rolling futures). Why do you make money rolling futures? Because each month your long-dated futures are getting a month closer to the spot date. And spot prices are higher than future prices. This means, in September, your futures contract for October delivery of commodity X that you bought cheap in January is now approaching its delivery date and approaching the spot price. You can sell it now for more than you bought it for originally because due to backwardation as time passes and future delivery dates approach the spot date, the originally cheaper futures contracts are now approaching the higher spot contract price because they are no longer far away deliveries. They are close to spot deliveries. And - you are close to being the beneficiary of the convenience yield as a spot holder in such case.
So your price is gradually converging from lower far-away future delivery pricing to higher spot pricing which then conveys convenience yield to you once you buy and take delivery. The gradual price increase as your possession time approaches, in a market that’s in backwardation, is partially explained by the convenience yield becoming closer and closer to being conveyed with the contract and the implied benefit of ownership therefore is increasingly factored into the price.
Does this help?
Cheers - good luck - you got this👍