Since 'Burning Oil' has been since 1st edition, 'Greek Fire' (now Alchemists Fire, since 'Greek' is setting specific), I would agree with the DM that putting water on it is not sufficient to put it out.
I would not agree that it would spread. Lamp oil might, but then again, I'd give you a chance to put burning lamp oil out with water.
I also think that the 'purify food and water' was just creative enough to be worth having work, even if it might ruin my plans by keeping the building intact (for now). However, on the fly, with a player attempting to use a spell for something other than it obvious and intended use, I might well have hastily ruled conservatively that it didn't work to avoid unintended consequences that a more liberal ruling might have latter in the game.
The question is really: using the more liberal interpretation, that the spell turns collodial mixtures and other composites into pure water - is there anything broken that this spell might get regularly used to do? At what point does this spell start working like a poor man's disentegrate, and where do you draw the line? How big of a piece of garbage gets disentigrated to make the water 'pure'?
With some time to think, I probably would have ruled that the spell turned the Alchemist's Fire into burning 'pure' animal fat or similar edible oil and therefore made it easier to extinguish. Though still not easy to extinguish. It remains a 'grease fire'.