US Concedes Price Cap Defeat

Despite Brent near $91 and Urals above $74 -- $14+ / barrel above the Price Cap limit -- Reuters reports that 

The G7 and allies have shelved regular reviews of the Russian oil price cap scheme...even though most Russian crude is trading above the limit because of a rally in global crude prices.

Initially, EU countries agreed to review the price cap every two months and to adjust it if necessary while the G7 would review "as appropriate" including "implementation and adherence."  The G7 has not reviewed the cap since March, however, and four people familiar with G7 policies said the group had no immediate plans to look into adjusting the scheme.

The sources said that while some EU countries were keen for a review they said that there was little appetite from the United States and G7 members to make changes.

To recap: Despite the fact that Urals has exceeded the Price Cap for nearly two months, the G7 has no plans to either review or adjust the scheme. To put it another way, the G7, and in particular the Biden administration, is substantively conceding the defeat of the Price Cap.

And why is that?  Reuters explains, from July 27th

The [Biden] administration...is set to move slowly, wary of creating ripples in a market that could send rising global oil prices higher.  The administration is in a "policy pickle" because it does not want to come down too hard with enforcement threats and risk boosting global petroleum prices by interfering with the movement of oil, the source with knowledge of administration thinking said.  "They'll spook the service providers facilitating exports, they certainly don't want to do that."  High consumer energy prices are a political risk for President Joe Biden, who is seeking reelection in 2024.

The failure of the Price Cap is not unexpected.  Indeed, I have criticized the Price Cap and the EU embargo as the wrong policy from the start -- more than a year ago now.  Prohibitions, including embargoes and price caps, virtually never work and almost always have severe side effects, by my research, up to 20 times worse than the problem itself.  This was fully evident by July 28th, when I noted that "the Price Cap can now formally be considered a failure."

Policy responses, I argued, would prove misguided, which again, a review of the historical record of prohibitions clearly indicates.  In my August 4th analysis, The Price Cap is Dead, I wrote

[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.  

I elaborated on August 29th

The Biden administration is more likely to paper over the failings of the current regime or admit defeat than to make necessary and constructive modifications to the Price Cap.

This largely brings us up to date.  Eric Van Nostrand, acting Assistant Secretary for Economic Policy, continues to gamely defend the Price Cap.  The matter is rapidly descending into farce, however, and the Biden administration had better come up with something more convincing, and soon.  A likely scenario heading into the election is both sky-high oil prices -- Goldman Sachs is forecasting $107 Brent for 2024 if Russia and Saudi Arabia hold their nerve (a fair bet) -- and a blow out of the Urals price.  Given that the G7 seems in no mood to enforce the Price Cap, we can expect the Urals discount to shrink, and a worse case scenario could put Urals as high as $100 / barrel for 2024.  This is almost twice Russia's average crude oil export price for the 2015-2021 period and sufficient to triple Russia's military budget compared to the pre-war period.  This will also add drag to the western economies and depress public support for Ukraine as unaffordable.  Both the Biden administration and Kyiv will find themselves cornered.

So what are the Ukrainians doing?  The Ukrainian embassy in Washington reads all my reports.  The ambassador has had these analyses on her desk for seventeen months.  And what have they done with it?  Absolutely nothing.   No qualification, no presentation, no advocacy.  Absolutely nothing.  I am as pro-Ukrainian as they come, but it would be helpful if the Ukrainians could take just a little, baby step towards defending their own financial interests.  The difference between the abandonment of the Price Cap and restructuring it to capture the value of the Urals discount (and then some) is absolutely huge, as much as $100 bn / year if Goldman's oil price forecast holds up.  If the Cap is abandoned, those sums will go to Russia and will be used to grind down Ukraine for years to come.  Alternatively, those funds can be redirected to Ukraine and the western alliance partners, materially funding the war, eliminating the financial considerations to Ukraine's entry into the EU and ensuring that Poland and the Baltics are kitted with all the weapons they need.  And a few Republican Congressmen will be able to breathe easier.

The Ukrainians need to step up and fight for constructive financial policy as hard as they are fighting the Russians in the field.