The Dynamics of Commodity Spot and Futures Markets: A Primer

Abstract

I discuss the short-run dynamics of commodity prices, production, and inventories, as well as the sources and effects of market volatility. I explain how prices, rates of production, and inventory levels are interrelated, and are determined via equilibrium in two interconnected markets: a cash market for spot purchases and sales of the commodity, and a market for storage. I show how equilibrium in these markets affects and is affected by changes in the level of price volatility. I also explain the role and behavior of commodity futures markets, and the relationship between spot prices futures prices, and inventory behavior. I illustrate these ideas with data for the petroleum complex - crude oil, heating oil, and gasoline - over the past two decades.