Abstract: Despite their widespread use as predictors of the spot price of oil, oil futures prices
tend to be less accurate in the mean-squared prediction error (MSPE) sense than no-change
forecasts. This result is driven by the variability of the futures price about the spot price, as
captured by the oil futures spread. This variability can be explained by the marginal convenience
yield of oil inventories. Using a two-country, multi-period general equilibrium model of the spot
and futures markets for crude oil we show that increased uncertainty about future oil supply
shortfalls under plausible assumptions causes the spread to decline. Increased uncertainty also
causes precautionary demand for oil to increase, resulting in an immediate increase in the real
spot price. Thus the negative of the oil futures spread may be viewed as an indicator of
fluctuations in the price of crude oil driven by precautionary demand. An empirical analysis of
this indicator provides independent evidence of how shifts in the uncertainty about future oil
supply shortfalls affect the spot price of crude oil and how they undermine the forecast accuracy
of oil futures prices. Our model is consistent with a number of empirical regularities and results
obtained by alternative methodologies.