With the increases in oil prices since late December, it’s time to look at some basic facts about oil prices and oil markets. Doing so will help us understand where the Biden administration has gone wrong and where it has gone right. Yes, you read that correctly: Biden has done one good thing, selling oil from the Strategic Petroleum Reserve (SPR). If he followed my advice, he would do two more good things: push to repeal the Jones Act and make clear that he will drop his opposition to fossil fuels. The sale from the SPR helps us consumers and reduces Russian’s oil revenues. Repealing the Jones Act also would help us consumers and allowing more domestic oil production would cause future prices to be lower than otherwise, making us consumers better off and hurting the Russians in the longer term.

This is the opening paragraph of David R. Henderson, “A Short Course in Oil Economics,” Defining Ideas, March 17, 2022. That wasn’t my original title but I liked this title, chosen by the editor, better.

Another excerpt, in which I explain contango:

In normal times, the relationship between the spot price of oil (the price you pay for delivery today) and the futures price for delivery in, say, a year, is one of “contango.” If you’re picturing people dancing in step with each other, you’re not far off. Contango means that the spot price is less than the futures price, but it also implies that the spot and futures prices move together.

And backwardation:

Every so often, though, the futures price today for delivery in, say, a year is less than the spot price. This relationship between the spot and futures price is called “backwardation.” The spot market is telling us that oil is more valuable now than it will be, say, a year from now.

In such a situation, arbitrage can’t work, for one simple reason: there is no time machine that lets us move oil from the future, when it will be less scarce, to the present, when it is scarcer.

We are in that situation today. On Monday, March 14, the spot price of oil closed at $103.01, while the June 2023 futures price closed at $81.11.

Read the whole thing.