Publications: Notes at the Margin

Oil and the "Law of One Price" (May 8, 2023)


Crude oil and petroleum products are among the rare commodities like gold that follow the law of one price (LOP). With a few exceptions, the prices of these commodities vary little across geographically dispersed markets. While Russia’s actions after the G7 imposed a price cap on its crude and product exports temporarily broke the LOP for oil, markets are moving back toward equilibrium.


Individuals like Shell’s new CEO Wael Sawan, who recently described the physical market as tight and inferred that prices should rise, ignore the economic reality that the short-run market equilibrium in commodity markets with very low price elasticities swings over a wide range. Although many who follow oil believe balance can only occur with triple-digit crude, prices could fall below $40 per barrel if Russia keeps discounting its production.


Oil ministers, oil company executives, journalists, and even some oil economists seem unfamiliar with the law of one price, which we describe in more detail in this report.


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