Last week, I wrote that the Price Cap is dead. This week, we begin to contemplate its reincarnation.
As expected, Urals broke through the $70 barrier this week, briefly touching $72 intraday before closing at $71.64 on Friday. This is a hefty $11.64 / barrel above the $60 cap.
The Urals discount -- the difference between Urals and Brent -- has continued to narrow, closing the week at $15.59 ($16.11 on a weekly basis), the lowest since the start of the war, that is, even before the implementation of the Embargo and Price Cap. We might expect the Urals discount to continue to shrink to the $8-12 / barrel range, but probably not much less, as that would make Russian oil uncompetitive in India, an indispensable customer for Russian crude. This provides little comfort, alas, because Urals will simply follow Brent up, as it has since May.
The situation is even more unfavorable to the east. Russia's ESPO (Eastern Siberia - Pacific Ocean pipeline) oil price closed the week above $81, just $2 / barrel below the US benchmark WTI oil price. We can expect Russia's eastern oil prices to all but close the gap on Brent in the coming weeks to months.
If we look at the Urals oil price in the longer context, the situation is even more disturbing. The Urals oil price today is actually higher than it was one year ago -- by $6 / barrel -- and, again, that was before the Price Cap was implemented. In fact, the Urals price today is about the highest it has been for the week since 2015.
I had said that the Price Cap would prove a liability for the Biden administration come Labor Day, but we may not have to wait that long. Here's Friday's headline from the Kyiv Independent:
Bloomberg: Russian oil breaks price cap, revenue soars in July
The article notes that Russia's July oil revenues were up 20% from the prior month. August will be even more dramatic.
How will the Biden administration respond? With Brent heading towards $90, western leaders may prove reluctant to crack down on shippers violating the Price Cap. The alternative is an insistence from the administration that, despite its flaws, the Price Cap still holds the Urals price below Brent by $10-15 / barrel. This will likely remain true, but my Ukrainian readers may nevertheless despair, and with good cause. Every incremental $10 / barrel equates to $25 bn in annual revenue to the Russian government. If Urals marches up to $80, Putin may have little difficulty doubling Russia's defense spending.
Such an outcome is, of course, entirely avoidable. The Price Cap and Embargo were poorly designed. They can be modified to fit Ukraine's needs. But don't expect the Biden administration, the US Treasury or the Federal Reserve to make the necessary adjustments. When faced with a violation of prohibitions, governments' responses historically have been misguided and counterproductive.