Historically the two major reference prices for crude oil, WTI and Brent, have tracked each closely. Between 2011 and 2015 the prices have diverged materially.
a) Discuss the principles of the “law of one price” and the conditions which must hold for the law of one price to hold.
b) Discuss the economic reasons why the increase in North American production could have caused this price divergence to occur.
c) Discuss any logistical constraints that might exacerbate this divergence.
d) As a general matter, it is illegal export crude oil from the United States without a license. Discuss how, if at all, this fact would impact the price divergence between WTI and Brent.
e) If these logistical and regulatory constraints persist, how would continued increases in North American production, impact the relationship between the WTI price and the Brent price; what are the implications of this from the perspective of economic efficiency.