Oil & Gas Exploration & Production

Highlights US crude oil output will continue its sharp recovery before leveling off by mid-2022, in our latest forecast (Chart of the Week). The recovery in US production is led by higher Permian shale-oil production, which is quietly pushing toward pre-COVID-19 highs while other basins languish. Permian output in July was ~ 143k b/d below the basin's peak in Mar20, and likely will surpass its all-time high output in 4Q21. Overall US shale-oil output remains ~ 1.1mm b/d below Nov19's peak of 9.04mm b/d, but we expect it to end the year at 7.90mm b/d and to average 8.10mm b/d for 2022. We do not expect US crude oil production to surpass its all-time high of 12.9mm b/d of Jan20 by the end of 2023. Instead, exploration & production (E&P) companies will continue to prioritize shareholders' interests. This means larger shares of free cashflow will go to shareholders, and not to drilling for the sake of increasing output. While our overall balances estimates remain largely unchanged from last month, we have taken down our expectation for demand growth this year by close to 360k b/d and moved it into 2022, due to continuing difficulties containing the COVID-19 Delta variant. Our Brent crude oil forecasts for 2H21, 2022 and 2023 remain largely unchanged at $70, $73 (down $1) and $80/bbl. WTI will trade $2-$3/bbl lower. Feature Chart 1US Crude Recovery Continues US Crude Recovery Continues US Crude Recovery Continues Global crude oil markets are at a transition point. The dominant producer – OPEC 2.0 – begins retuning 400k b/d every month to the market from the massive 5.8mm b/d of spare capacity accumulated during the COVID-19 pandemic. For modeling purposes, it is not unreasonable to assume this will be a monthly increment returned to the market until the accumulated reserves are fully restored. This would take the program into 2H22, per OPEC's 18 July 2021 communique issued following the meeting that produced this return of supply. Thereafter, the core group of the coalition able to increase and sustain higher production – Kuwait, the UAE, Iraq, KSA and Russia – is expected to meet higher demand from their capacity.1 There is room for maneuver in the OPEC 2.0 agreement up and down. We continue to expect the coalition to make supply available as demand dictates – a data-dependent strategy, not unlike that of central banks navigating through the pandemic. This could stretch the return of that 5.8mm b/d of accumulated spare capacity further into 2H22 than we now expect. The pace largely depends on how quickly effective vaccines are distributed globally, particularly to EM economies over the course of this year and next. US Shale Recovery Led By Permian Output While OPEC 2.0 continues to manage member-state output – keeping the level of supply below that of demand to reduce global inventories – US crude oil output is quietly recovering. We expect this to continue into 1H22 (Chart 2). Chart 2Permian Output Recovers Strongly Permian Output Approaches Pre-Covid Peak Permian Output Approaches Pre-Covid Peak The higher American output in the Lower 48 states primarily is due to the continued growth of tight-oil shale production in the low-cost Permian Basin (Chart 3). This has been aided in no small part by the completion of drilled-but-uncompleted (DUC) wells in the Permian and elsewhere. Chart 3E&Ps Favor Permian Assets Permian Output Approaches Pre-Covid Peak Permian Output Approaches Pre-Covid Peak Since last year’s slump, the rig count has increased; however, compared to pre-pandemic levels, the number of rigs presently deployed are not sufficient to sustain current production. The finishing of DUC wells means that, despite the low rig count during the pandemic, shale oil supply has not dipped by a commensurate amount. This is a major feat, considering shale wells’ high decline rates. Chart 4US Producers Remain Focused On Shareholder Priorities US Producers Remain Focused On Shareholder Priorities US Producers Remain Focused On Shareholder Priorities DUCS have played a large role in sustaining overall US crude oil production. According to the EIA, since its peak in June 2020, DUCs in the shale basins have fallen by approximately 33%. As hedges well below the current market price for shale producers roll off, and DUC inventories are further depleted, we expect to see more drilling activity and the return of more rigs to oil fields. We do not expect US crude oil output to surpass its all-time high of 12.9mm b/ of Jan20 by the end of 2023. Instead, exploration & production (E&P) companies will continue to prioritize shareholders' interests. This means only profitable drilling supporting the free cashflow that allows E&Ps to return capital to shareholders will receive funding. US oil and gas companies have a long road back before they regain investors' trust (Chart 4).   Demand Growth To Slow We expect global demand to increase 5.04mm b/d y/y in 2021, down from last month's growth estimate of 5.4mm b/d. We have taken down our expectation for demand growth this year by ~ 360k b/d and moved it into 2022, because of reduced mobility and local lockdowns due to continuing difficulties in containing the COVID-19 Delta variant, particularly in Asia (Chart 5).2 We continue to expect the global rollout of vaccines to increase, which will allow mobility restrictions to ease, and will support demand. This has been the case in the US, EU and is expected to continue as Latin America and other EM economies receive more efficacious vaccines. Thus, as DM growth slows, EM oil demand should pick up (Chart 6). Chart 5COVID-19 Delta Variant's Spread Remains Public Health Challenge Permian Output Approaches Pre-Covid Peak Permian Output Approaches Pre-Covid Peak Chart 6EM Demand Growth Will Offset DM Slowdown EM Demand Growth Will Offset DM Slowdown EM Demand Growth Will Offset DM Slowdown Net, we continue to expect demand for crude oil and refined products to grind higher, and to be maintained into 2023, as mobility rises, and economic growth continues to be supported by accommodative monetary policy and fiscal support. If anything, the rapid spread of the Delta variant likely will predispose central banks to continue to slow-walk normalizing monetary policy and interest rates. Global Balances Mostly Unchanged Chart 7Oil Markets To Remain Balanced Oil Markets To Remain Balanced Oil Markets To Remain Balanced Although we have shifted part of the demand recovery into next year, at more than 5mm b/d of growth, our 2021 expectation is still strong. This is expected to continue next year and into 2023 although not at 2021-22 rates. Continued production restraint by OPEC 2.0 and the price-taking cohort outside the coalition will keep the market balanced (Chart 7). We expect OPEC 2.0's core group of producers – Kuwait, the UAE, Iraq, KSA and Russia – will continue to abide by the reference production levels laid out in 18 July 2021 OPEC communique. Capital markets can be expected to continue constraining the price-taking cohort's misallocation of resources. These factors underpin our call for balanced markets (Table 1), and our view inventories will continue to draw (Chart 8). Table 1BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) To Dec23 Permian Output Approaches Pre-Covid Peak Permian Output Approaches Pre-Covid Peak Our balances assessment leaves our price expectations unchanged from last month, with Brent's price trajectory to end-2023 intact (Chart 9). We expect Brent crude oil to average $70, $73 and $80/bbl in 2H21, 2022 and 2023, respectively. WTI is expected to trade $2-$3/bbl lower over this interval. Chart 8Inventories Will Continue To Draw Inventories Will Continue To Draw Inventories Will Continue To Draw Chart 9Brent Prices Trajectory Intact Brent Prices Trajectory Intact Brent Prices Trajectory Intact   Investment Implications Balanced oil markets and continued inventory draws support our view Brent and refined-product forward curves will continue to backwardate, even if the evolution of this process is volatile. As a result, we remain long the S&P GSCI and the COMT ETF, which is optimized for backwardation. We continue to wait for a sell-off to get long the SPDR S&P Oil & Gas Exploration & Production ETF (XOP ETF).   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Associate Commodity & Energy Strategy ashwin.shyam@bcaresearch.com Commodities Round-Up Energy: Bullish The US EIA expects natural gas inventories at the end of the storage-injection season in October to be 4% below the 2016-2020 five-year average, at 3.6 TCF. At end-July, inventories were 6% below the five-year average (Chart 10). Colder-than-normal weather this past winter – particularly through the US Midwest and Texas natural gas fields – affected production and drove consumption higher this past winter, which forced inventories lower. Continued strength in LNG exports also are keeping gas prices well bid, as Asian and European markets buy fuel for power generation and to accumulate inventories ahead of the coming winter. Base Metals: Bullish The main worker’s union at Chile's Escondida mine, the largest in the world, and BHP reached an agreement on Friday to avoid a strike. The mine is expected to constitute 5% of total mined global copper supply for 2021. China's refined copper imports have been falling for the last three months (Chart 11). Weak economic data – China reported slower than expected growth in retail sales and manufacturing output for July – contributed to lower import levels.  Precious Metals: Bullish Gold has been correcting following its recent decline, ending most days higher since the ‘flash crash’ last Monday, facilitated by a drop in real interest rates. The Jackson Hole Symposium next week will provide insights to market participants regarding the Fed’s future course of action and if it is in fact nearing an agreement to taper asset purchases. According to the Wall Street Journal, some officials believe the program could end by mid-2022 on the back of strong hiring reports. This was corroborated by minutes of the FOMC meeting which took place in July, which suggested a possibility to begin tapering the program by year-end. While the Fed stressed there was no mechanical relationship between the tapering and interest rate hikes, this could be bearish for gold, as real interest rates and the bullion move inversely. On the other hand, political uncertainty and a potential economic slowdown in China will support gold prices. Ags/Softs: Neutral Grain and bean crops are in slightly worse shape this year vs the same period in 2020, according to the USDA. The Department reported 62% of the US corn crop was in good to excellent condition for the week ended 15 August 2021, compared to 69% for the same period last year. 57% of the soybean crop was in good-to-excellent shape for the week ending on the 15th vs 72% a year ago. Chart 10 US WORKING NATGAS IN STORAGE GOING DOWN US WORKING NATGAS IN STORAGE GOING DOWN Chart 11 Permian Output Approaches Pre-Covid Peak Permian Output Approaches Pre-Covid Peak Footnotes 1 Please see our report of 22 July 2021, OPEC 2.0's Forward Guidance In New Baselines, which discusses the longer-term implications of this meeting and the subsequent communique containing the OPEC 2.0 core group's higher reference production levels. It is available at ces.bcareserch.com. 2 S&P Global Platts notes China's most recent mobility restrictions throughout the country will show up in oil demand figures in the near future. We expect similar reduced mobility as public health officials scramble to get more vaccines distributed. Please see Asia crude oil: Key market indicators for Aug 16-20 published 16 August 2021 by spglobal.com. Investment Views and Themes Strategic Recommendations Commodity Prices and Plays Reference Table Trades Closed In 2021 Summary of Closed Trades

Dear Client, We will be presenting our quarterly webcast next week, and, as a result, will not be publishing on 29 July 2021.  We will cover our major calls for the quarter and provide a look-ahead.  I look forward to the Q+A, and am hopeful you will tune in. Bob Ryan Chief Commodity & Energy Strategist   Highlights Chart Of The WeekOPEC 2.0's Hand Strengthened By Production Agreement OPEC 2.0s Hand Strengthened By Production Agreement OPEC 2.0s Hand Strengthened By Production Agreement The deal crafted by OPEC 2.0 over the weekend to add 400k b/d of oil every month from August preserves the coalition, and sends a credible signal of its ability to raise output after its 5.8mm b/d of spare capacity is returned to market next year.1 KSA and Russia will remain primi inter pares, but the position of OPEC 2.0's core producers – not just the UAE, which negotiated an immediate baseline increase – was enhanced for future negotiations. This deal explicitly recognizes they are the only ones capable of increasing output over an extended period. We assume the revised production baselines for core OPEC 2.0 effective May 2022 reflect the coalition's demand expectations from 2H22 onward. Our modeling indicates core OPEC 2.0's output will almost converge on the revised baseline production of 34.3mm b/d by 2H23, when we expect these producers to be at ~ 33.4mm b/d. Holding our demand estimates constant from last week, our revised supply expectations prompt us to move our forecast closer to our June forecast. We expect Brent to average $70/bbl in 2H21, with 2022 and 2023 averaging $74 and $80/bbl (Chart of the Week). Feature The deal concluded by OPEC 2.0 over the weekend will do more than add 400k b/d of spare capacity to the market every month beginning next month. It also does more than preserve the producer coalition's successful production-management strategy.  The big take-away from the deal is the clear message being sent by the coalition's core members – KSA, Russia, Iraq, UAE and Kuwait – that they are able to significantly increase output after their 5.8mm b/d of spare capacity has been returned to the market over the next year or so. It does so by raising the baselines of the core producers starting in May 2022, clearly indicating the capacity and willingness to raise output and keep it there (Table 1). Table 1Baseline Increases For Core OPEC 2.0 OPEC 2.0's Forward Guidance In New Baselines OPEC 2.0's Forward Guidance In New Baselines What OPEC 2.0's Deal Signals Internally, the deal is meant to recognize the investment made by the UAE in particular, which was not being accounted for in its current baseline. Externally – i.e., to competitors outside the coalition – the deal signals OPEC 2.0's successful production management strategy will continue, by raising the likelihood the coalition will remain intact. This has kept the level of supply below demand over the course of the COVID-19 pandemic (Chart 2), and is responsible for the global decline in inventories (Chart 3). Chart 2OPEC 2.0 Durability Increases OPEC 2.0 Durability Increases OPEC 2.0 Durability Increases Chart 3Inventories Will Remain Under Control Inventories Will Remain Under Control Inventories Will Remain Under Control Specifically, the massive spare capacity still to be returned to the market between now and 2H22 can be accomplished with minimal risk of a market-share war breaking out among the core OPEC 2.0 members seeking to monetize their off-the-market production before the other members of the coalition. Most importantly, the revised benchmark production levels that becomes effective May 2022 signal the coalition members with the capacity to increase production can do so. Longer-Term Forward Guidance We assume the revised production baselines for core OPEC 2.0 effective May 2022 reflect the coalition's demand expectations from 2H22 onward. Our modeling indicates core OPEC 2.0's output will approach the revised baseline reference levels of 34.3mm b/d, hitting 33.4mm b/d for crude and liquids output by 2H23 (Table 2).  Table 2BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) To Dec23 OPEC 2.0's Forward Guidance In New Baselines OPEC 2.0's Forward Guidance In New Baselines This implies the core group expects to be able to cover production declines within the coalition and to meet demand increases going forward. The estimates are far enough into the future to prepare ahead of time to increase production. Our estimates for core OPEC 2.0 production reflects our assumption the revised baseline levels do reflect demand expectations of the coalition. In estimating the coalition's production, we rely on historical data from the US EIA, which allows us to estimate future production using regressors we consider reliable (e.g., GDP estimates from the IMF and World Bank).  Non-OPEC 2.0 Production We use EIA historical data for non-OPEC 2.0 production as well. In last week’s balances, we substituted the EIA's estimates for non-OPEC 2.0 producers ex-US for our estimates, which resulted in lower supply numbers throughout our forecast sample.  This threw off our balances estimates in particular, as we did not balance the decrease in supply from this group using the new data set with an increase from another group. We corrected this oversight this week: We will continue to use EIA estimates for non-OPEC 2.0 ex-US countries, but will balance the decrease in oil production from this cohort with increased supply from other countries. Chart 4US Shales Are The Marginal Barrel US Shales Are The Marginal Barrel US Shales Are The Marginal Barrel For US oil production, we will continue to estimate it as a function of WTI price levels, the forward curve and financial variables – chiefly high-yield rates, which serve as a good proxy for borrowing costs for the marginal US shale producer, which we view as the quintessential marginal producer in the global price-taking cohort (Chart 4). Our research indicates US shale producers – like all producers, for that matter – are prioritizing shareholder interests first and foremost. This means they will focus on profitability and margins. While we have observed this tendency for some time, it appears it is gaining speed, as oil and gas producers are now considering whether they want to retain their existing exposure to their hydrocarbon assets.2   There appears to be a reluctance among resource producers generally – this is true in copper, as we have noted – to substantially increase capex. This could be the result of covid uncertainty, demand uncertainty, monetary-policy uncertainty or a real attempt to provide competitive returns. We think it is a combination of all of these, but the picture is clouded by the difficulty in separating all of these uncertainties. Income Drives Oil Demand Chart 5Income Drives Oil Demand Income Drives Oil Demand Income Drives Oil Demand Our demand estimates will continue to be driven by estimates of GDP from the IMF and the World Bank. We have found the level of oil consumption is highly correlated with GDP, particularly for EM states (Chart 5). Holding our demand estimates constant from last week, our revised supply expectations prompt us to move our forecast closer to our June forecast.  This week, we also will adjust our inventory calculations, which will rely less on EIA estimates of OECD stocks. In the recent past, these estimates played a sizeable role in our forecasts. From this month on, they will play a smaller part. This is why, even though our supply estimates have risen from last week, there is not a significant change to our inventory levels. Investment Implications Holding our demand estimates constant from last week, our revised supply expectations prompt us to move our forecast closer to our June forecast. We expect Brent to average $70/bbl in 2H21, with 2022 and 2023 averaging $74 and $80/bbl. We remain bullish commodities in general, given the continued tightness in these markets. We expect this to persist, as capex remains elusive in oil, gas and metals markets. This underpins our long S&P GSCI and COMT ETF commodity recommendations, and our long MSCI Global Metals & Mining Producers ETF (PICK) recommendation.   Robert P. Ryan  Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Associate Commodity & Energy Strategy ashwin.shyam@bcaresearch.com   Commodities Round-Up Energy: Bullish US natural gas exports via pipeline to Mexico averaged just under 7 bcf/d in June, according to the EIA. Exports hit a record high of 7.4 bcf/d on 24 June 2021. The record high for the month was 7.4 Bcf/d on June 24. The EIA attributes the higher exports to increases in industrial and power demand, and high temperatures, which are driving air-conditioning demand south of the US border. Close to 5 bcf/d of the imported gas is used to generate power, according to the EIA. This was up close to 20% y/y. Increases in gas-pipeline infrastructure are allowing more gas to flow to Mexico from the US. Base Metals: Bullish China reportedly will be selling additional copper from its strategic stockpiles later this month, in an effort to cool the market. According to reuters.com, market participants expect China to auction 20k MT of Copper on 29 July 2021. This will bring total sales via auction to 50k MT, as the government earlier this month sold 30k MT at $10,500/MT (~ $4.76/lb). Prior to and since that first auction, copper has been trading on either side of $4.30/lb (Chart 6). Market participants expected a higher volume than the numbers being discussed as we went to press. In addition to auctioning copper, the government reportedly will auction other base metals. Precious Metals: Bullish Interest rates on 10-year inflation-linked bonds remain below -1%, as U.S. CPI inflation rises. US 10-year treasury yields have rebounded since sinking to a five-month low at the beginning of this week. The positive effect of negative real interest rates on gold is being balanced by a rising USD (Chart 7). Safe-haven demand for the greenback is being supported by uncertainty caused by COVID-19’s Delta variant. Gold prices are still volatile after the Fed’s ‘dot shock’ in mid-June.3 This volatility is reducing safe-haven demand for the yellow metal despite rising economic and policy uncertainty. Ags/Softs: Neutral Hot, dry weather is expected over most of the grain-growing regions of the US for the balance of July, which will continue to support prices, according to Farm Futures. Chart 6Copper Prices Going Down Copper Prices Going Down Copper Prices Going Down Chart 7Weaker USD Supports Gold Weaker USD Supports Gold Weaker USD Supports Gold   Footnotes 1Please see 19th "OPEC and non-OPEC Ministerial Meeting concludes" published by OPEC 18 July 2021. 2Please see "BHP said to seek an exit from its petroleum business" published by worldoil.com July 20, 2021.  3Please refer to ‘“Dot Shock” Continues To Roil Gold; Oil…Not So Much’, which we published on  July 1, 2021 for additional discussion. It is available at ces.bcaresearch.com. Investment Views and Themes Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed In 2021 Summary of Trades Closed OPEC 2.0's Forward Guidance In New Baselines OPEC 2.0's Forward Guidance In New Baselines

Highlights Entering 2H21, oil and metals' price volatility will rise as inventories are drawn down to cover physical supply deficits brought about by the re-opening of major economies ex-China. As demand increases and oil and metals supply become more inelastic, forward curves will backwardate further.  This will weaken commodity-price correlations with the USD and boost commodity-index returns. Going into next week's OPEC 2.0 meeting, the Kingdom of Saudi Arabia (KSA) and Russia likely will hold off on further production increases, until greater clarity around US-Iran negotiations and the return of Iran as a bona fide exporter is available. Chinese authorities will release 100k MT of copper, aluminum and zinc into tight domestic markets in July.  A two-day rally followed the news. Since bottoming in March 2020, the XOP and XME ETFs covering oil and gas producers and metals miners are up ~ 218% and ~ 196%, respectively, following the ~ 230% move in crude oil and the ~ 100% rise copper prices.  Higher volatility will present buying opportunities for these ETFs  (Chart of the Week). We remain long commodity index exposure – S&P GSCI and COMT ETF – expecting steeper backwardations. We will go long the PICK ETF at tonight's close again, after being stopped out last week with a 23.9% return. Feature Heading into 2H21, industrial commodity markets will continue to tighten.  In the case of oil, this is caused by OPEC 2.0's production-management strategy – i.e., keeping supply below demand – and capital discipline among producers in the price-taking cohort.1 Base metals, on the other hand, are tightening because demand is recovering much faster than supply.2 Re-opening of major economies will boost refined-product demand in oil markets – e.g., gasoline and jet fuel – which will leave refiners little choice but to continue drawing on inventories to cover supply shortfalls in the near term (Chart 2). Chart of the WeekResources ETFs Follow Prices Higher Resources ETFs Follow Prices Higher Resources ETFs Follow Prices Higher Chart 2Refiners Will Continue Drawing Crude Investments Refiners Will Continue Drawing Crude Investments Refiners Will Continue Drawing Crude Investments Base metals – particularly copper and aluminum – will remain well bid in the face of constrained supply and higher consumption ex-China.  Despite China's widely anticipated decision to release strategic stockpiles of copper, aluminum and zinc next month into a tight domestic market – which we flagged last month – continued inventory draws will be required to cover physical deficits in these markets, particularly in copper (Chart 3).3 Chart 3Copper Inventories Will Draw As Demand Ex-China Rises Copper Inventories Will Draw As Demand Ex-China Rises Copper Inventories Will Draw As Demand Ex-China Rises Chart 4Steeper Backwardation, Higher Volatility Oil, Metals Vol Creates Buying Opportunities Oil, Metals Vol Creates Buying Opportunities Higher Vol On The Way As demand for industrial commodities increases and inventories continue to draw, forward curves will become more backwardated – i.e., material delivered promptly (next day or next week) will command a higher price than commodities delivered next month or next year: Consumers value current supply above deferred supply, and producers and merchants have to charge more to cover inventory replacement costs, which increase when prompt demand outstrips supply. The steepening of forward curves for industrial commodities will lead to higher price volatility in oil and metals markets, particularly copper: Demand will confront increasingly inelastic supply.  In this evolution, prices will be forced to allocate inelastic supply as demand increases.  Sometimes-sharp changes in price are required to equilibrate available supply with demand when this happens.  This can be seen clearly in oil markets, but it holds true for all storable commodities (Chart 4).4 Investment Implications Industrial commodity markets are entering a more volatile phase, which will be characterized by sharp price movements up and down over the short term, as demand continues to outpace supply. Our analysis suggests this is the beginning of a more volatile phase in industrial commodity markets.  The balance of risk in industrial commodity prices will remain to the upside as volatility increases. In the short term, fundamental imbalances can be addressed over a relatively short months-long horizon – i.e., OPEC 2.0 can release spare capacity over a 3-4 month interval to accommodate rising demand – so that price increases do not destroy demand as oil-exporters are rebuilding their fiscal balance sheets. Base metals markets will have a tougher time in the short run finding the supply to meet surging demand, but it can be done over the next year or so without prices getting to the point where demand-destruction sets in. Over the medium to long term, investor-owned oil and gas producers literally are being directed by policymakers, shareholders and courts toward an extended wind-down of production and investment in future production.  Markets have been pricing through just such a situation in the post-COVID-19 world, with OPEC 2.0 managing supply against falling demand and still managing to reduce inventories significantly.  If the world follows the IEA's pathway to a decarbonized future – in which no investment in new oil or gas production is required after 2025 – this will become the status quo for these markets going forward.5 Metals producers, on the other hand, are being encouraged to increase marketable supply at a rapid pace to accommodate demand driven by the build-out of renewable energy – chiefly wind and solar – and the grids that will be required to move this energy. Producers, however, remain reluctant to do so, fearing their capex investment to build out supply will produce physical surpluses that depress returns, similar to the last China-led commodity super-cycle. Supplying the necessary base metals to make this happen will be difficult at best, according to Ivan Glasenberg, CEO at Glencore.  At this week's Qatar Economic Forum, he said copper supply will have to double between now and 2050 to meet expected demand for this critical metal.  “Today, the world consumes 30 million tonnes of copper per year and by the year 2050, following this trajectory, we’ve got to produce 60 million tonnes of copper per year,” he said.  “If you look at the historical past 10 years, we’ve only added 500,000 tonnes per year … Do we have the projects? I don’t think so. I think it will be extremely difficult.”6 The volatility we are expecting in oil, gas and base metals prices, will present buy-the-dip opportunities in related equities vehicles.  Since bottoming in March 2020, the XOP and XME ETFs covering oil and gas producers and metals miners are up ~ 218% and ~ 196%, respectively, matching the ~ 230% move in crude oil and the ~ 100% rise in copper prices.  We remain long commodity index exposure – S&P GSCI, which is up 5.9% and the COMT ETF, which is up 7.6% – expecting steeper backwardations.  The trailing stop on our MSCI Global Metals & Mining Producers ETF (PICK) position recommended 10 December 2020 was elected, which stopped us out with a gain of 23.9%.  We are getting long the PICK again at tonight's close.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Associate Commodity & Energy Strategy ashwin.shyam@bcaresearch.com   Commodities Round-Up Energy: Bullish Commercial crude oil stocks in the US (ex-SPR barrels) fell 7.6mm barrels w/w in the week ended 18 June 2021, according to the US EIA. Including products, US crude and product inventories were down 5.8mm barrels. US domestic crude oil production was down 100k b/d, ending the week at 11.1mm b/d. Overall product supplied, the EIA's proxy for refined-product demand, was up 180k b/d at 20.75mm b/d, which is 129k b/d below 2019 demand for the same period. At 9.44mm b/d, gasoline demand was just below comparable 2019 consumption of 9.47mm b/d, while jet-fuel demand remains severely depressed vs. comparable 2019 consumption at 1.58mm b/d (vs. 1.92mm b/d).  Distillate demand (e.g., diesel fuel) for the week ended 18 June 2021 was 3.95mm b/d vs. 3.97mm b/d for the comparable 2019 period. Base Metals: Bullish Benchmark spot iron ore (62% Fe) prices are holding above $210/MT in trading this week, as demand for the steel input remains strong in China (Chart 5). The Chinese Communist Party (CCP) increased its level of intervention in the iron ore market this week, launching investigations into “malicious speculation,” vowing to “severely punish” anyone found to be engaged in such behavior, according to ft.com.7 Benchmark iron ore prices hit $230/MT in May. We continue to expect exports from Brazil to pick up in 2H21, which will push prices lower in 2H21. Precious Metals: Bullish In the aftermath of last Wednesday’s FOMC meeting gold prices lost nearly $86/oz (Chart 6). Our colleagues at BCA Research's USBS believe markets are paying too much attention to the Fed’s dot plots, and not to the central bank’s verbal guidance.8 Originally, the Fed stated that it will only start raising interest rates once a checklist of three conditions have been met. This checklist includes guidance on actual and expected inflation rates and the labor market. Gold prices did not react to Chair Powell's testimony before the House Select Subcommittee on the Coronavirus Crisis. Ags/Softs: Neutral US spring wheat prices are rallying on the back of dry weather in the northern Plains, while forecasts for benign crop weather in the Midwest pressured soybeans lower this week, according to successfulfarming.com. Chart 5 BENCHMARK IRON ORE 62% FE, CFR CHINA (TSI) GOING DOWN BENCHMARK IRON ORE 62% FE, CFR CHINA (TSI) GOING DOWN Chart 6 US Dollar To Keep Gold Prices Well Bid US Dollar To Keep Gold Prices Well Bid     Footnotes 1     Please see our most recent oil price forecasts published last week in Balance Of Risks Tilts To Higher Oil Prices.  It is available at ces.bcaresearch.com. 2     Please see A Perfect Energy Storm On The Way published on June 3, 2021 for further discussion. 3    Please see Less Metal, More Jawboning published on May 27, 2021, which flagged China's likely decision to release strategic stockpiles of base metals. 4    Chart 4 shows implied volatility as a function of the slope of the forward curve, i.e., the difference between the 1st- and 13th-nearby futures divided by the 1st-nearby future vs implied volatilities for Brent and WTI options.  This modeling extends Kogan et al (2009), mapping realized volatilities calculated using historical settlements of crude oil futures against the slope of crude oil futures conditioned on 6th- vs. 3rd-nearby futures returns (in %). Please see Kogan, L., Livdan, D., & Yaron, A. (2009), "Oil Futures Prices in a Production Economy With Investment Constraints." The Journal of Finance, 64:3, pp. 1345-1375. 5    Please see fn 2's discussion of the IEA's Net Zero by 2050, A Roadmap for the Global Energy Sector beginning on p. 5 under The Case For A Carbon Tax. 6    Please see Copper supply needs to double by 2050, Glencore CEO says published on June 23, 2021 by reuters.com.  Of course, being a copper producer with large-scale base-metals projects due to come on line in the next year or so, Mr. Glasenberg could be talking his book, but as Chart 3 shows, copper has been and likely will be in physical deficits for years. 7     Please see China cracks down on iron ore market, published by ft.com on June 21, 2021. 8    Please see How To Re-Shape The Yield Curve Without Really Trying, published on June 22, 2021.   Investment Views and Themes Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades Image

Highlights Oil demand expectations remain high. Realized demand continues to disappoint. This means OPEC 2.0's production-management strategy – i.e., keeping the level of supply below demand – will continue to dictate oil-price levels. US producers will remain focused on consolidation via M&A and on returning capital to shareholders, in line with the Kingdom of Saudi Arabia's (KSA) expectation. Going forward, shale producers will focus on protecting and growing profit margins. The durability of OPEC 2.0's tactical advantage arising from its enormous spare capacity – ~ 7mm b/d – is difficult to gauge: Tightening global oil markets now in anticipation of Iran's return as a bona fide exporter benefits producers globally, and could accelerate the return of US shales if that return is delayed or re-opening boosts demand more than expected. We are raising our average Brent forecast for 2021 to $66.50 vs. $63/bbl earlier, with 2H21 prices averaging $70/bbl. We are moving our 2022 and 2023 forecasts up slightly to $74 and $81/bbl (Chart of the Week). WTI will trade $2-$3/bbl lower. We remain long the S&P GSCI Dynamic Roll Index ETF (COMT) and the S&P GSCI, expecting tight supply-demand balances to further steepen backwardations in forward curves. Feature While the forecasted rebound in global oil demand continues to drive expectations for higher prices, it is the production discipline of OPEC 2.0 and capital discipline imposed on US shale producers that has and will continue to super-charge the recovery of prices. Continued monetary accommodation and fiscal stimulus notwithstanding, realized global oil demand has mostly flatlined at ~ 96mm b/d following its surge in February, as uncertainty over COVID-19 containment keeps governments hesitant about reopening their economies too quickly. Stronger demand in Asia, led by China, has been offset by weaker demand in India and Japan, where COVID-19 remains a deterrent to re-opening and recovery. The recovery in DM demand generally stalled over this period even as vaccine availability increased (Chart 2). Chart of the WeekOPEC 2.0 Comfortable With Higher Prices Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices Chart 2Global Demand Recovery Stalled Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices That likely will change in 2H21, but it is not a given: The UK, which has been among the world leaders in COVID-19 containment and vaccinations, delayed its full reopening by a month – to July 19 – in an effort to gain more time to bolster its efforts against the Delta variant first identified in India. In the US, New York state lifted all COVID-19-induced restrictions and fully re-opened this week. Still, even in the US, unintended inventory accumulation in the gasoline market – just as the summer driving season should be kicking into high gear – suggests consumers remain cautious (Chart 3). Chart 3Unintended Inventory Accumulation in US Gasoline Market Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices We continue to expect the re-opening of the US and Europe (including the UK) will boost DM demand in 2H21, and wider vaccine availability will boost EM oil demand later in the year and in 2022. For all of 2021, we have lifted our demand-growth estimate slightly to 5.3mm b/d from 5.2mm b/d last month. We expect global demand to grow 4.1mm b/d next year and 1.6mm b/d in 2023. Our 2021 estimates are in line with those of the US EIA and the IEA. OPEC is more bullish on demand recovery this year, expecting growth of 6mm b/d. We continue to believe the risk on the demand side remains to the upside; however, given continued uncertainty around global COVID-19 containment, we remain circumspect. Supply-Side Discipline Drives Oil Prices OPEC 2.0 remains committed to its production-management strategy that is keeping the level of supply below demand. Compliance with production cuts in May reportedly was at 115%, following a 114% rate in April.1 Core OPEC 2.0 – i.e., states with the capacity to increase production – is holding ~ 7mm b/d of spare capacity, according to the IEA, which will allow it to continue to perform its role as the dominant supplier in our modeling (Chart 4). Earlier this year, KSA's Energy Minister Abdulaziz bin Salman correctly recognized the turn in the market that likely ensures OPEC 2.0's dominance for the foreseeable future – i.e., the shift in focus of the US shale-oil producers from production for the sake of production to profitability.2 This is a trend that has been apparent for years as capital markets all but abandoned US shale-oil producers. Chart 4OPEC 2.0 Remains Dominant Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices Producers outside OPEC 2.0 – what we refer to as the "price-taking cohort" – have prioritized shareholder interests as a result of this market pressure, and remain focused on sometimes-forced consolidation via M&A, which we have been expecting.3 The significance of this evolution of shale-oil production is difficult to overstate, particularly as the survivors of this consolidation will be firms with strong balance sheets and a focus on profitability, as is the case with any well-run manufacturing firm. We also expect large producers to opportunistically shed production assets to reduce their carbon footprints, so as to come into compliance with court-ordered emission reductions and shareholder demands to reduce pollution.4 With the oil majors like Shell, Equinor and Oxy divesting themselves of shale properties, production increasingly will be in the hands of firms driven by profitability.5 We expect US shale-oil production to end the year at 9.86mm b/d and to average 9.57mm b/d next year; however, as the shales become the marginal global supply, production could become more volatile (Chart 5). The consolidation of US production also will alter the profitability of firms continuing to operate in the shales. We expect breakeven costs to fall as acquired production by stronger firms results in high-grading of assets – only the most profitable will be produced given market-pricing dynamics – while less profitable acreage will be mothballed until prices support development(Chart 6). Chart 5US Producers Focus On Profitability Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices Chart 6Shale Breakevens Likely Fall As Consolidation Picks Up Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices Supply-Demand Balances Tightening The current round of M&A consolidation and OPEC 2.0's continued discipline lead us to expect continued tightening of global oil supply-demand balances this year and next (Chart 7). This will allow inventories to continue to draw, which will keep forward oil curves backwardated (Chart 8). Chart 7Supply-Demand Balances Will Continue To Tighten Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices Chart 8Tighter Markets, Lower Stocks Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices The critical factor here will be OPEC 2.0's continued calibration of supply in line with realized demand and the return of Iran as a bona fide exporter, which we expect later this year. OPEC 2.0's restoration of ~ 2mm b/d of supply will be done by the beginning of 3Q21, when we expect Iran to begin restoring production and visible exports (i.e., in addition to its under-the-radar sales presently). The return of Iranian supply – and a possible increase in Libyan output – will present some timing difficulties for OPEC 2.0's overall strategy, but they will be short-lived. We continue to monitor output to assess the evolution of balances (Table 1). Table 1BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices Investment Implications Oil demand will increase over the course of 2H21, as vaccines become more widely distributed globally, and the massive fiscal and monetary stimulus deployed worldwide kicks economic activity into high gear. On the supply side, markets will tighten on the back of continued restraint until Iranian barrels return to the market. The balance of risk is to the upside, particularly if the US and Iran are unable to agree terms that restore Iran as a bona fide exporter. In that case, the market tightening now under way will result in sharply higher prices. That said, realized demand growth has stalled over the past three months, which can be seen in unintended inventory accumulation in the US gasoline markets just as the summer driving season opens. We are raising our average Brent forecast for 2021 to $66.50 vs. $63/bbl earlier, with 2H21 prices averaging $70/bbl. We are moving our 2022 and 2023 forecasts up slightly as well to $74 and $81/bbl (Chart of the Week). WTI will trade $2-$3/bbl lower. We remain long the S&P GSCI Dynamic Roll Index ETF (COMT) and the S&P GSCI, expecting tight supply-demand balances to further steepen backwardations in forward curves. The big risk, as highlighted above, remains an acceleration of COVID-19 infections, hospitalizations and deaths, which force governments to delay re-opening or impose localized lockdowns once again. In this regard, KSA's strategy of calibrating its output to realized – vice forecasted – demand likely will remain in place.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Associate Commodity & Energy Strategy ashwin.shyam@bcaresearch.com   Commodities Round-Up Energy: Bullish China's refinery throughput surged 4.4% to 14.3mm b/d in May, a record high that surpassed November 2020's previous record of 14.26mm b/d, according to S&P Platts Global. The increased runs were not unexpected, and were largely accounted for by state-owned refiners, which operated at 80% of capacity after coming out of turnaround season. Turnarounds will fully end in July. In addition, taxes on niche refined-product imports are due to increase, which will bolster refinery margins as inventories are worked down. China's domestic crude oil production was just slightly more than 4mm b/d. Base Metals: Bullish China's Standing Committee approved the release an undisclosed amount of its copper, aluminum and zinc stockpiles via an auction process in the near future, according to reuters.com. The government disclosed its intent on the website of National Food and Strategic Reserves Administration on Wednesday; however, specifics of the auction – volumes and auction schedule, in particular – were not disclosed. Prices had fallen ~ 9% from recent record highs in the lead-up to the announcement, which we flagged last month.6 Prices rallied from lows close to $4.34/lb on the COMEX Wednesday (Chart 9). Precious Metals: Bullish After a worse-than-expected US employment report, we do not expect the Federal Reserve to lift nominal interest rates in Wednesday’s Federal Open Market Committee (FOMC) meeting. The Fed will only raise rates once the US economy reaches a level consistent with its definition of "maximum employment." Wednesday’s interest rate decision will be crucial to gold prices. If the Fed does not mention asset tapering or an interest-rate hike, citing current inflation as a transitory phenomenon, gold demand and prices will rise. On the other hand, if the Fed indicates an interest rate hike sooner than the previously stated 2024, this will weigh on gold prices (Chart 10). Ags/Softs: Neutral As of June 13, 96% of the US corn crop had emerged vs. the five-year average of 91%, according to the USDA. 68% of the crop was rated in good to excellent condition, slightly below the five-year average. In the bean market, 94% of the crop was planted as of 13 June, vs. the five-year average of 88%. The Department reported 86% of the crop had emerged vs. the five-year average of 74%. According to the USDA, 52% of the bean crop was in good-to-excellent condition vs the five-year average of 72%. Chart 9 Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices Chart 10 Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices   Footnotes 1     Please see OPEC+ complies with 115% of agreed oil curbs in May - source published by reuters.com on June 11, 2021. 2     Please see Saudis raise U.S. and Asian crude prices for April delivery published by worldoil.com on March 8, 2021. 3    Please see US shale consolidation continues as Independence scoops up Contango Oil & Gas published by S&P Global Platts on June 8, 2021. 4    We discuss this in A Perfect Energy Storm On The Way, published on June 3, 2021.  Climate activism will become increasingly important to the evolution of oil and natural gas production, and likely will lead to greater concentration of supply in the hands of OPEC 2.0 and privately held producers that do not answer to shareholders. 5    Please see Interest in Shell's Permian assets seen as a bellwether for shale demand published by reuters.com on June 15, 2021. 6    Please see Less Metal, More Jawboning, which we published on May 27, 2021.  It is available at ces.bcaresearch.com. Investment Views and Themes Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades Image

Highlights Political and corporate climate activism will increase the cost of developing the resources required to produce and deliver energy going forward – e.g., oil and gas wells; pipelines; copper mines, and refineries. Over the short run, the fastest way for investor-owned companies (IOCs) to address accelerated reductions in CO2 emissions imposed by courts and boards is to walk away from the assets producing them, which could be disruptive over the medium term. Longer term, state-owned companies (SOCs) not facing the constraints of IOCs likely will be required to provide an increasing share of the resources needed to produce and distribute energy. The real difficulty will come in the medium term. Capex for critical metals like copper languishes, just as the call on these metals steadily increases over the next 30 years (Chart of the Week). The evolution to a low-carbon future has not been thought through at the global policy level. A real strategy must address underinvestment in base metals and incentivize the development of technology via a carbon tax – not emissions trading schemes – so firms can innovate to avoid it. We remain long energy and metals exposures.1 Feature And you may ask yourself, "Well … how did I get here?" David Byrne, Once In A Lifetime Energy markets – broadly defined – are radically transforming from week to week. The latest iteration of these markets' evolution is catalyzed by climate activists, who are finding increasing success in court and on corporate boards – sometimes backed by major institutional investors – and forcing oil and gas producers to accelerate CO2 emission-reduction programs.2 Climate activists' arguments are finding increasing purchase because they have merit: Years of stiff-arming investors seeking clarity on the oil and gas producers' decarbonization agendas, coupled with a pronounced failure to provide returns in excess of their cost of capital, have given activists all of the ammo needed to argue their points. Chart of the WeekCall On Metals For Energy Will Increase A Perfect Energy Storm On The Way A Perfect Energy Storm On The Way This activism is not limited to the courts or boardrooms. Voters in democratic societies with contested elections also are seeking redress for failures of their governments to effectively channel mineral wealth back into society on an equitable basis, and to protect their environments and the habitats of indigenous populations. This voter activism is especially apparent in Chile and Peru, where elections and constitutional conventions likely will result in higher taxes and royalties on metals IOCs operating in these states, which will increase production costs and ultimately be passed on to consumers.3 These states account for ~ 40% of world copper output. IOCs Walk Away Earlier this week, Exxon walked away from an early-stage offshore oil development project in Ghana.4 This followed the unfavorable court rulings and boardroom setbacks experienced by Royal Dutch Shell, Chevron and Exxon recently (referenced in fn. 2). While the company had no comment on its abrupt departure, its action shows how IOCs can exercise their option to put a project back to its host government, thus illustrating one of the most readily available alternatives for energy IOCs to meet court- or board-mandated CO2 emissions targets. If these investments qualify as write-offs, the burden will be borne by taxpayers. As climate activism increases, state-owned companies (SOCs) not facing the constraints of IOCs likely will be required to provide an increasing share of the resources – particularly oil and gas – needed to produce and distribute energy going forward. This is not an unalloyed benefit, as the SOCs still face stranded-asset risks, if they invest in longer-lived assets that are obviated by a successful renewables + grid buildout globally. That is a cost that will have to be compensated, when the SOCs work up their capex allocations. Still, if legal and investor activism significantly accelerates IOCs' capex reductions in oil and gas projects, the SOCs – particularly those in OPEC 2.0 – will be able to expand their position as the dominant supplier in the global oil market, and could perhaps increase their influence on price levels and forward-curve dynamics (Chart 2).5 Chart 2OPEC 2.0s Could Expand If Investor Activism Increases OPEC 2.0s Could Expand If Investor Activism Increases OPEC 2.0s Could Expand If Investor Activism Increases Higher Call On Metals At present, there is a lot of talk about the need to invest in renewable electricity generation and the grid structure supporting it, but very little in the way of planning for this transition. Other than repeated assertions of its necessity, little is being said regarding how exactly this strategy will be executed given the magnitude of the supply increase in metals required. Nowhere is this more apparent than in the refined copper market, which has been in a physical deficit – i.e., production minus consumption is negative – for the last 6 years (Chart 3). Physical copper markets in China, which consumes more than 50% of refined output, remain extremely tight, as can be seen in the ongoing weakness of treating charges and refining charges (TC/RC) for the past year (Chart 4). These charges are inversely correlated to prices – when TC/RCs are low, it means there is surplus refining capacity for copper – unrefined metal is scarce, which drives down demand for these services. Chart 3Coppers Physical Deficit Likely Persist Coppers Physical Deficit Likely Persist Coppers Physical Deficit Likely Persist Chart 4Chinas Refined Copper Supply Remains Tight Chinas Refined Copper Supply Remains Tight Chinas Refined Copper Supply Remains Tight Theoretically, high prices will incentivize higher levels of production. However, after the last decade’s ill-timed investment in new mine discoveries and expansions, mining companies have become more wary with their investments, and are using earnings to pay dividends and reduce debt. This leads us to believe that mining companies will not invest in new mine discoveries but will use capital expenditure to expand brownfield projects to meet rising demand. In the last decade, as copper demand rose, capex for copper rose from 2010-2012, and fell from 2013-2016 (Chart 5). During this time, the copper ore grade was on a declining trend. This implies that the new copper brought online was being mined from lower-grade ore, due to the expansion of existing projects(Chart 6). Chart 5Copper Capex Growth Remains Weak A Perfect Energy Storm On The Way A Perfect Energy Storm On The Way Chart 6Copper Ore-Quality Declines Persist Through Capex Cycle A Perfect Energy Storm On The Way A Perfect Energy Storm On The Way Capex directed at keeping ore production above consumption will not be sufficient to avoid major depletions of ore supplies beginning in 2024, according to Wood Mackenzie. The consultancy foresees a cumulative deficit of ~ 16mm MT by 2040. Plugging this gap will require $325-$500 billion of investment in the copper mining sector.6 The Case For A Carbon Tax The low-carbon future remains something of a will-o'-the-wisp – seen off in the future but not really developed in the present. Most striking in discussions of the low-carbon transition is the assumption of resource availability – particularly bases metals –in, e.g., the IEA's Net Zero by 2050, A Roadmap for the Global Energy Sector, published last month. In the IEA's document, further investment in hydrocarbons is not required beyond 2025. The copper, aluminum, steel, etc., required to build the generation and supporting grid infrastructure will be available and callable as needed to build all the renewable generation the world requires. The document is agnostic between carbon trading and carbon taxes as a way to price carbon and incentivize the technology that would allow firms and households to avoid a direct cost on carbon. A real strategy must address the fact that most of the world will continue to rely on fossil fuels for decades, as development goals are pursued. Underinvestment in base metals and its implications for the buildout of generation and grids has to be a priority if these assets are to be built. Given the 5-10-year lead times base metals mines require to come online, it is obvious that beyond the middle of this decade, the physical reality of demand exceeding supply will assert itself. A good start would be a global effort to impose and collect carbon taxes uniformly across states.7 This would need to be augmented with a carbon club, which restricts admission and trading privileges  to those states adopting such a scheme. Harmonizing the multiple emissions trading schemes worldwide will be a decades-long effort that is unlikely to succeed. Such schemes also can be gamed by larger players, producing pricing distortions. A hard and fast tax that is enforced in all of the members of such a carbon club would immediately focus attention on the technology required to avoid paying it – mobilizing capital, innovation and entrepreneurial drive to make it a reality. This would support carbon-capture, use and storage technologies as well, thus extending the life of existing energy resources as the next generation of metals-based resources is built out. In addition, a carbon tax raises revenue for governments, which can be used for a variety of public policies, including reducing other taxes to reduce the overall burden of taxation. Lastly, a tax eliminates the potential for short-term price volatility in the pricing of carbon – as long as households and firms know what confronts them they can plan around it.  Tax revenues also can be used to reduce the regressive nature of such levies. Investment Implications The lack of a coherent policy framework that addresses the very real constraints on the transition to a low-carbon economy makes the likelihood of a volatile, years-long evolution foreordained. We believe this will create numerous investment opportunities as underinvestment in hydrocarbons and base metals production predisposes oil, natural gas and base metals prices to move higher in the face of strong and rising demand. We remain long commodity index exposure – the S&P GSCI and GSCI Commodity Dynamic Roll Strategy ETF (COMT), which is optimized to take advantage of the most backwardated commodity forward curves in the index. These positions were up 5.3% and 7.2% since inception on December 7, 2017 and March 12, 2021, respectively, at Tuesday's close. We also remain long the MSCI Global Metals & Mining Producers ETF (PICK), which is up 33.9% since it was put on December 10, 2020. Expecting continued volatility in metals – copper in particular – we will look for opportunities to re-establish positions in COMEX/CME Copper after being stopped out with gains. A trailing stop was elected on our long Dec21 copper position established September 10, 2020, which was closed out with a 48.2% gain on May 21, 2021. Our long calendar 2022 vs short calendar 2023 COMEX copper backwardation trade established April 22, 2021, was closed out on May 20, 2021, leaving us with a return of 305%.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Associate Commodity & Energy Strategy ashwin.shyam@bcaresearch.com   Commodities Round-Up Energy: Bullish OPEC 2.0 offered no surprises to markets this week, as it remained committed to returning just over 2mm b/d of production to the market over the May-July period, 70% of which comes from the Kingdom of Saudi Arabia (KSA), according to Platts. While Iran's return to the market is not a given in OPEC 2.0's geometry, we have given better than even odds it will return to the market beginning in 3Q21 and restore most of the 1.4mm b/d not being produced at present to the market over the course of the following year. OPEC itself expects demand to increase 6mm b/d this year, somewhat above our expectation of 5.3mm b/d. Stronger demand could raise Brent prices above our average $63/bbl forecast for this year (Chart 7). Brent was trading above $71/bbl as we went to press. Base Metals: Bullish BHP declared operations at its Escondida and Spence mines were running at normal rates despite a strike by some 200 operations specialists. BHP is employing so-called substitute workers to conduct operation, according to reuters.com, which also reported separate unions at both mines are considering strike actions in the near future. Precious Metals: Bullish The Fed’s reluctance to increase nominal interest rates despite indications of higher inflation will reduce real rates, which will support higher gold prices (Chart 8). We agree with our colleagues at BCA Research's US Bond Strategy that the Fed is waiting for the US labor market to reach levels consistent with its assessment of maximum employment before it makes its initial rate hike in this interest-rate cycle. Subsequent rate changes, however, will be based on realized inflation and inflation expectations. In our opinion, the Fed is following this ultra-accommodative monetary policy approach to break the US liquidity trap, brought about by a rise in precautionary savings due to the pandemic. In addition, we continue to expect USD weakness, which also will support gold and precious metals prices. We remain long gold, expecting prices to clear $2,000/oz this year. Ags/Softs: Neutral Corn prices fell more than 2% Wednesday, following the release of USDA estimates showing 95% of the corn crop was planted by 31 May 2021, well over the 87% five-year average. This was in line with expectations. However, the Department's assessment that 76% of the crop was in good-to-excellent condition exceeded market expectations. Chart 7 By 2023 Brent Trades to $80/bbl By 2023 Brent Trades to $80/bbl Chart 8 Gold Prices Going Up Gold Prices Going Up Footnotes 1     Please see Trade Tables below. 2     Please see OPEC, Russia seen gaining more power with Shell Dutch ruling and EXCLUSIVE BlackRock backs 3 dissidents to shake up Exxon board -sources published by reuters.com June 1, 2021 and May 25, 2021. 3    Please see Chile's govt in shock loss as voters pick independents to draft constitution published by reuters.com May 17, 2021, and Peru’s elite in panic at prospect of hard-left victory in presidential election published by ft.com June 1, 2021.  Peru has seen significant capital flight on the back of these fears.  See also Results from Chile’s May 2021 elections published by IHS Markit May 21, 2021 re a higher likelihood of tax increases for the mining sector.  The risk of nationalization is de minimis, according to IHS. 4    Please see Exxon walks away from stake in deepwater Ghana block published by worldoil.com June 1, 2021. 5    Please see OPEC 2.0's Production Strategy In Focus, which we published on May 20, 2021, for a recap our how we model OPEC 2.0's strategy.  It is available at ces.bcaresearch.com. 6    Please see Will a lack of supply growth come back to bite the copper industry?, published by Wood Mackenzie on March 23, 2021. 7     Please see The Challenges and Prospects for Carbon Pricing in Europe published by the Oxford Institute for Energy Studies last month for a discussion of carbon taxes vs. emissions trading schemes.     Investment Views and Themes Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades Higher Inflation On The Way Higher Inflation On The Way

In yesterday’s Special Report, we initiated a long S&P oil & gas exploration & production / short S&P metals & mining market neutral trade as a way to capitalize on the China/DM growth differential on a 6 to 12-month time horizon. This trade is also a way to express our view that crude oil will likely outperform copper going forward. While we outlined the demand side of the story in the Special Report, today we touch on relative supply dynamics. Ultimately, supply of crude oil and copper is dictated by how much companies invest in capex. It allows them to dig up more commodities in the future, thus increasing supply and lowering commodity prices. The chart below illustrates this relationship for copper and crude producers and highlights that on a relative basis, copper producers’ capex meaningfully outpaced the one of oil producers (relative capex shown inverted). In short, that means that not only relative demand dynamics are a major headwind for the copper/crude oil price ratio, but the supply side of the story will also be a drag. Bottom Line: We reiterate our newly established long S&P oil & gas exploration & production / short S&P metals & mining pair trade. For more details on the rationale behind the trade, please refer to yesterday’s Special Report. More Reasons To Like Our New Intra-commodity Pair Trade More Reasons To Like Our New Intra-commodity Pair Trade

The economic reopening has been an underlying theme throughout most of our research since last September that has allowed us, among other things, to harvest handsome gains from our long “Back-To-Work”/short “COVID-19 Winners” baskets pair trades to the tune of 42%. While in our research we primarily focused on exploiting how the pandemic affected different sectors of the US economy, in this Special Report we take an international approach. Specifically, we recommend a play that will benefit from the unfolding Chinese slowdown (China was the country that first emerged from the pandemic, and it has already gone through peak post-pandemic growth), and from the continuing recovery in developed markets (DMs) that are yet to reach their post-pandemic growth apex. Choosing The Trade Vehicle To express this cyclical 6 to 12-month time horizon trade, we chose an intra-commodity price ratio of long crude oil/short copper. Copper prices are intrinsically driven by China’s insatiable demand for commodities, and today the Middle Kingdom accounts for 60% of global copper consumption, up 200% from just 15 years ago (Chart 1, top panel)! At the same time, the crude oil market does not have a dominant end-demand consumer as even China accounts for only 15% of global consumption. The implication is that oil prices are a good proxy for global ex-China growth, whereas copper is a great China growth gauge. The bottom panel of Chart 1 also links China's consumption of copper relative to that of oil and the CPI differential between China and the rest of the world. Importantly, as DMs now enter a period of high CPI prints, the differential will dive deeper into negative territory supporting our thesis of preferring crude at the expense of copper. In the S&P 500 sector universe, Chart 2 shows that a long S&P oil & gas exploration & production (S&P O&G E&P)/short S&P metals & mining (S&P M&M) position approximates the oil-to-copper ratio. In this report we will stick to using this sub-sector level proxy. Chart 1China And Commodities China And Commodities China And Commodities Chart 2Expressing The Trade Using Sectors Expressing The Trade Using Sectors Expressing The Trade Using Sectors Review Of China’s Slowdown In December 2020, we first pointed out the risk of Chinese growth going on hiatus in the second half of 2021 serving as a catalyst to likely reset the stock market. Now that China is the center piece of our new pair trade, a brief review of Chinese macro data is in order. On the domestic front, China put a break on its fiscal stimulus programs that is not likely to change anytime soon. Since the GFC, China has a tendency to refrain from stimulating the economy – a rule that is only broken once an exogenous shock hits the system (Euro debt crisis in 2011, pop of the Chinese equity bubble in 2015, trade war in 2019, and finally the pandemic in 2020). Absent any black swan events, China’s fiscal support will continue its downward trajectory, which, at the margin, will cap future copper gains (Chart 3, bottom panel). Tack on the natural tightening from the Chinese sovereign bond market, and copper’s cyclically bullish thesis crumbles (Chart 3, middle panel). When we look at other regions that proxy mainland China, a similar message emerges. Chart 4 shows that not only is AUD/USD refusing to break above a key historical  resistance level, but also Taiwanese SAR1 building permits are sniffing out some trouble. Both of these series confirm that Chinese, and by extension, copper’s growth is likely peaking. Chart 3Troubling News At Home… Troubling News At Home… Troubling News At Home… Chart 4...And Abroad ...And Abroad ...And Abroad Chart 5A Key Driver Is Turning A Key Driver Is Turning A Key Driver Is Turning Finally, Chart 5 reiterates just how important China is for the S&P M&M index, which is due for a rough awakening. Review Of DM Growth The long leg of our trade relies on economic recovery in the DM region. The growth story for the US is well-known, so we will not spend much time on it besides reiterating that generous fiscal support and an accommodative Fed are here to stay for the foreseeable future, ensuring that real economic US growth will remain robust. This brings us to the next major DM player – Europe. When it came to the vaccine roll out, the old continent was slow at inoculation, which initially made for a sluggish recovery, but last month’s Eurozone PMI release showed that the common market is picking up steam. On top of that, several leading variables predict that the explosive rise in the euro area’s PMI is not a one-off print. A diffusion index comprising Swedish data remains on the ascent. Sweden is a hypersensitive economy partially focused on the early-stage production of industrials goods which makes it a good indicator of the future overall European growth. Next, the OECD’s Leading Indicator for the Eurozone that enjoys an approximately 5-6-month lead on the euro area PMI ticked up anew (Chart 6). Finally, a liquidity proxy in the form of M2 minus GDP growth reaccelerated after a brief pause emphasizing that the Eurozone’s recovery is here to stay (Chart 7). Chart 6Upbeat Soft Data Coupled… Upbeat Soft Data Coupled… Upbeat Soft Data Coupled… Chart 7...With Plentiful Liquidity... Intra-Commodity Pair Trade Intra-Commodity Pair Trade Chart 8 aggregates these three series into a leading model, which confirms that European PMIs will remain strong. The broader implication is that DM economic activity will remain healthy supporting higher WTI prices, at a time when China’s slowdown will be disproportionately weighing on copper prices. Chart 8...Equals Steady Eurozone PMI ...Equals Steady Eurozone PMI ...Equals Steady Eurozone PMI Dollar Context We also think that the continuing US dollar bear market, which is BCA’s and our base case view, will be more beneficial to WTI prices given their tight historical inverse correlation. Chart 9 also shows that the rally in copper prices wasn’t driven by the greenback, instead it was China stock piling of the metal in light of the recent collapse in prices that drove copper higher. If anything, the US dollar is now a headwind for copper as the massive divergence between copper prices and the greenback will likely close through a catch down phase in the former. Chart 9US Dollar Tailwinds US Dollar Tailwinds US Dollar Tailwinds Chart 10Enticing Industry-level Data Enticing Industry-level Data Enticing Industry-level Data Delving Into Sector-level Data While both the S&P O&G E&P and the S&P M&M sub-industries are highly exposed to their respective commodities, their relative pricing power closely mimics the shape of the business cycle. The implication is that oil producers are more efficient at converting their raw commodity into earnings than mining companies (Chart 10, second panel) – a feature that is also evident once we dissect income statement data (Chart 11). Mixing that with more limited wage pressures in the oil & gas industry makes for a perfect cocktail that will boost relative operating margins favoring E&P producers (Chart 10, third & bottom panels). Chart 11Clean Earnings Pipes Clean Earnings Pipes Clean Earnings Pipes What Is Priced In? Has the market and sell-side analysts already sniffed out this trade opportunity? The short answer is no. On a 12-month forward P/E ratio basis our long S&P O&G E&P / short S&P M&M pair trade is at the neutral zone. Similarly, on a 12-month forward P/S metric, this share price ratio is actually trading below its historical mean and in the neutral zone. The only metric that is a touch elevated is the relative net earnings revisions ratio, but again, it remains far from historical extremes (Chart 12). Switching from analysts’ forecasts to our TTM indicators, neither our Technical nor Valuation indicators are showing any signs of overbought conditions or overvaluation, respectively. Encouragingly, 6-month momentum also had a chance to reset courtesy of the recent pullback in the share price ratio, offering a compelling entry point to this trade (Chart 13). Chart 12Sell-side Is Late To The Party Sell-side Is Late To The Party Sell-side Is Late To The Party Chart 13Technicals Give The Go-ahead Technicals Give The Go-ahead Technicals Give The Go-ahead Bottom Line: Given the unfolding Chinese slowdown, yet still robust DM growth expectations, enticing sector-level data coupled with favorable technicals and valuations, it pays to initiate a long S&P oil & gas exploration & production / short S&P metals & mining market neutral trade as a way to capitalize on the China/DM growth differential on a 6 to 12-month time horizon. The ticker symbols for the stocks in the S&P 500 oil & gas exploration & production and S&P 500 metals & mining indexes are BLBG: S5OILP – COP, EOG, HES, COG, MRO, APA, PXD, DVN, FANG and BLBG: S5METL – FCX, NEM, NUE, respectively.   Arseniy Urazov Senior Analyst ArseniyU@bcaresearch.com   Footnotes 1     Taiwan (province of China).

Overweight Last April following the massacre in oil prices and the consequent slam in the S&P oil & gas exploration & production (O&G E&P) group, we created the USES Crash Indicator to try to forecast a likely recovery path in this index; today we update our analysis. After a hiccup in late-2020, the relative share price ratio is back on track and will likely continue its ascent, especially given crude oil supply/demand dynamics. Odds are high that oil prices will remain upward-sloping as the EIA forecasts demand outpacing supply growth over the course of 2021 and 2022 (not shown). Oil oversupply has been a major drag on oil prices to the point that E&P companies had to put artificial breaks on production. Should these breaks remain in place at the same time as the global economy reopens as we continue to expect, oil prices have further to run. The implication is that rising crude oil prices will pave the way for sustained gains in the S&P O&G E&P relative share price ratio. Bottom Line: Stay overweight the S&P O&G E&P index. The ticker symbols for the stocks in the index are: BLBG: S5OILP – COP, EOG, HES, COG, MRO, APA, PXD, DVN, FANG. Chart 1How It Started... Back On Track Back On Track Chart 2...How It Is Going Back On Track Back On Track  

As the economy is transitioning from liquidity to growth, the oil-to-gold price ratio has caught our attention again this year. As a reminder, last year we successfully traded this high-octane pair using the S&P oil & gas exploration & production (O&G E&P) index on the long side and the global gold miners index on the short side. We pocketed gains of 10% in early May of 2020, only to reinstate the trade again and to scoop a further 32% in gains. This year, the latest ISM manufacturing survey release painted a bright picture for this intra-commodity price ratio once again (see chart), and while we are not reinstituting the pair trade just yet, it is now flashing on our radar screen; we are patient and await a better entry point. Reopening of the economy and related energy demand recovery will underpin oil prices and producers going forward, at the same time as rising real yields will weigh on the shiny metal and gold mining stocks. Bottom Line: Put a stop buy on long S&P O&G E&P/short global gold miners via the XOP/GDX exchange traded funds at a ratio of 1.2. From Liquidity To Growth From Liquidity To Growth

Highlights Both the massive inventory accumulation and robust underlying consumption have been driving Chinese crude imports in recent years. Chinese crude oil import growth will decelerate in 2021 due to a slower pace in the country’s oil inventory accumulation. The country’s underlying crude oil consumption growth will remain robust this year, which will support a still positive growth in Chinese crude oil imports this year. Strong Chinese crude oil imports are positive to global oil prices this year. Feature The gap between China’s total crude oil supply and its domestic crude oil consumption has been widening in recent years, due to a massive buildup in Chinese crude oil inventory (Chart 1A and 1B). In fact, China’s crude oil inventories have quadrupled in the past five years, exceeding two billion barrels as of November 2020 and are equal to about 70% of OECD total inventory (Chart 2). Chart 1AA Massive Buildup In Chinese Crude Oil Inventory A Massive Buildup In Chinese Crude Oil Inventory A Massive Buildup In Chinese Crude Oil Inventory Chart 1BChina: Total Crude Oil Supply Growth Has Exceeded Its Domestic Consumption Growth China: Total Crude Oil Supply Growth Has Exceeded Its Domestic Consumption Growth China: Total Crude Oil Supply Growth Has Exceeded Its Domestic Consumption Growth In addition, China’s crude oil import growth has been outpacing domestic oil consumption growth, while domestic production remains stagnant (Chart 3). Chart 2Crude Oil Inventories In China Have Quadrupled In The Past Five Years Crude Oil Inventories In China Have Quadrupled In The Past Five Years Crude Oil Inventories In China Have Quadrupled In The Past Five Years Chart 3China: Crude Oil Import Growth Has Been Stronger Than Its Domestic Consumption Growth China: Crude Oil Import Growth Has Been Stronger Than Its Domestic Consumption Growth China: Crude Oil Import Growth Has Been Stronger Than Its Domestic Consumption Growth Will China maintain its strong crude oil import growth this year? How will the interplay between domestic consumption and imports evolve in 2021? We expect China’s crude oil consumption growth to remain solid in 2021, growing at an annual rate of about 6-7% and up from the 4.5% growth rate reached in 2020. However, China’s crude oil imports are likely to increase by 4-6% in 2021 from the previous year, slower than the 7.2% growth seen in 2020. The moderation in Chinese oil imports in 2021 will mainly be due to a slower pace of crude oil inventory buildup. Understanding The Surge In Crude Oil Inventory Chart 4China's Crude Oil Inventory Buildup: One Major Driver Behind Its Strong Imports Since 2016 China's Crude Oil Inventory Buildup: One Major Driver Behind Its Strong Imports Since 2016 China's Crude Oil Inventory Buildup: One Major Driver Behind Its Strong Imports Since 2016 The massive buildup in domestic crude oil inventory has been one major driving force behind the strong growth in China's crude oil imports since 2016 (Chart 4). As oil prices continue to rebound, and given China’s existing large oil inventories, we think the pace of inventory accumulation in China will slow in 2021. Therefore, growth in Chinese oil imports this year will likely moderate. China’s crude oil imports currently account for about 75% of the country’s total crude oil supply. Since China’s domestic crude oil production has been stagnant in the last decade, the fluctuations in Chinese crude oil imports are largely driven by the change in the country’s total demand, which includes both domestic consumption and changes in inventories. China’s crude oil import growth has significantly outpaced domestic consumption growth in the past five years, leading to a buildup in inventory. China’s crude oil inventory includes Commercial Petroleum Reserves (CPR), which are held by refiners and traders; and Strategic Petroleum Reserves (SPR), which are held by the government. Our Chinese crude oil inventory proxy1 was constructed based on the crude oil flow diagram shown in Chart 5.  Chart 5How Did We Derive Our Chinese Crude Oil Inventory Proxy? Chinese Commodities Demand: An Unsustainable Boom? Part III: Crude Oil Chinese Commodities Demand: An Unsustainable Boom? Part III: Crude Oil Our research has suggested that since 2016, most of the buildup has occurred in CPR. This is due to the following: The government in 2015 required refiners to keep their inventory level at no less than their 15-days requirement for operation use. Chinese refinery capacity had been expanded at a compound annual growth rate (CAGR) of 2.8% during 2016-2019. These existing and new refineries have been building their inventories to meet government regulations in the past several years.  In addition, the government started to allow independent refineries to import crude oil by setting a quota in mid-2015, and the import quotas have been increased every year. In 2020, the quota reached 184.6 million tons, equaling to about 3,700 kbpd, nearly five times the quota in 2015. The total increase in imports of these independent refiners over the past five years was about 2,950 kbpd, accounting for 70% of the increase in the country’s total crude oil imports during the same period. Chart 6China: Rising Run Rates For Its Independent Refineries China: Rising Run Rates For Its Independent Refineries China: Rising Run Rates For Its Independent Refineries Independent refiners import crude oil for both refinery purposes and to meet the new inventory requirement. Over the last several years, the increased amount of quota has improved Chinese independent refiners’ profitability and refinery capacity run rate, as the import quota allows these private sector refiners to save operating costs by cutting out the “middleman” and by actively managing their own feedstocks. For example, Shandong has the largest number of independent refineries among all provinces. Chart 6 shows that the run rate of the region’s independent refineries has surged since 2016, from about 40% in that year to 75% this year. In addition, since 2016, the fluctuations in their run rates have become much more closely correlated with global oil prices.   Commercial crude oil users have much larger physical reserve space than the SPR. Notably, they tend to sharply increase their imports when crude oil prices are low.  In addition, inventory accumulation often occurs when credit/financing is available with low costs and refiners expect higher prices ahead. Meanwhile, our research shows the SPR development has been slowing considerably in recent years, resulting in little inventory buildup in SPR. The last time the National Bureau of Statistics (NBS) reported the SPR data was December 29, 2017. It showed the SPR was about 37.73 million tons by mid-2017, not far from the country’s target of 40 million tons for the first two phases2 of SPR. This suggests that the country was at least close to finishing its second phase of the SPR in 2017. Since then, there has been little information about the third phase of the SPR progress. We have only been able to find two pieces of news on that subject, and both suggest the construction of the third phase of SPR has been stagnant, and the planning of two sites only started in 2019. As the average construction time for projects in the second phase of SPR was about four years, we do not think these sites were completed in 2020. The NBS data shows that even during the period of mid-2015 and mid-2017, the SPR had only increased by 234 kbpd, about 117 kbpd per year. In comparison, the Chinese total crude oil inventory increased by 600-700 kbpd per year in 2016 and 2017. Clearly, SPR only accounted for a small share of the Chinese total crude oil inventory. Looking forward, we expect a much slower pace of crude oil inventory buildup in China in 2021. Our forecast is based on the following factors: Current Chinese crude oil inventories (CPR and SPR combined) are already in the upper range when comparing the OECD countries (Chart 7). Although the IEA data shows that Japan and Korea have oil stocks of 200 days and 193 days of their respective crude oil net imports, Chinese oil inventories are currently equivalent to 195 days of crude oil net imports and much higher than the 90 days the IEA requires OECD countries to hold. With Brent oil prices having risen by a lot from the April 2020 trough and elevated domestic crude oil inventories, both government and commercial users will likely slow their purchases of overseas oil for inventory accumulation. In comparison, Chinese crude oil inventory accumulation growth slowed sharply in 2018 when Brent oil prices rose by 95% from their trough in mid-2017 (Chart 8), A significant portion of Chinese oil inventory buildup was accumulated over the past five years. At 1,170 kbpd, the largest annual accumulation was in 2020, higher than the 700-900 kbpd fill per year during 2017-2019. Chart 7China's Crude Oil Inventory: No Longer Low China's Crude Oil Inventory: No Longer Low China's Crude Oil Inventory: No Longer Low Chart 8China: Rising Oil Prices Will Likely Slow Down Its Pace Of Crude Oil Inventory Accumulation China: Rising Oil Prices Will Likely Slow Down Its Pace Of Crude Oil Inventory Accumulation China: Rising Oil Prices Will Likely Slow Down Its Pace Of Crude Oil Inventory Accumulation We do not expect the fast inventory accumulation of 2020 to repeat in 2021. Instead, a mean-reversal in the inventory accumulation pace will likely occur. Table 1Our Estimates Of The Scale Of Chinese Crude Oil Inventory In 2021 Chinese Commodities Demand: An Unsustainable Boom? Part III: Crude Oil Chinese Commodities Demand: An Unsustainable Boom? Part III: Crude Oil Our baseline estimate based on China’s 2021 import quota and refinery capacity3 is that Chinese crude oil inventory will increase to 207-210 days of Chinese crude oil imports by this year-end, up from 192 days at last year-end (Table 1). With already-elevated crude oil inventory, the pace of the inventory accumulation in China will be slower than last year. Bottom Line: After a massive buildup over recent years, the pace of inventory accumulation in China will slow in 2021 and probably onwards as well. As a result, Chinese oil import growth will converge with the pace of domestic consumption growth. China’s Robust Crude Oil Consumption Growth In 2021 Chart 9China: Resilient Domestic Crude Oil Consumption Growth In 2020 China: Resilient Domestic Crude Oil Consumption Growth In 2020 China: Resilient Domestic Crude Oil Consumption Growth In 2020 Despite the pandemic outbreak, last year’s underlying consumption of crude oil in China was resilient at a year-on-year growth of 4.5%, even though the rate was smaller than the average growth of 6-7% in 2018-2019 (Chart 9).  The growth in oil consumption last year was mainly from the non-transportation sector. The output of non-transportation fuels, including fuel oil, naphtha, petroleum coke, and petroleum pitch, are mostly having impressive growth, suggesting strong consumption in sectors like chemical products, steel sector and infrastructure (Chart 10). For example, naphtha is the primary feedstock for ethylene production. Ethylene is the building block for a vast range of chemicals from plastics to antifreeze solutions and solvents. Transportation fuel consumption was weak in 2020, with the output of major transportation fuels including gasoline, diesel oil and kerosene in contraction (Chart 11). Chart 10Strong Consumption In Non-Transportation Sectors in 2020 Last Year Strong Consumption In Non-Transportation Sectors in 2020 Last Year Strong Consumption In Non-Transportation Sectors in 2020 Last Year Chart 11Transportation Fuel Consumption Was Weak In 2020 Transportation Fuel Consumption Was Weak In 2020 Transportation Fuel Consumption Was Weak In 2020 In 2021, we expect the underlying consumption growth of crude oil in China to increase to 6-7% from last year’s 4.5%. This will be in line with its growth in both 2018 and 2019 (Chart 9 on page 7). First, the consumption of transportation fuels will likely recover this year. Transportation fuels are the largest consuming sector for Chinese petroleum products. Based on British Petroleum data, gasoline, diesel and kerosene accounted for 55% of total Chinese oil consumption in 2019. We expect the transportation fuel consumption growth to be stronger (i.e., 6-7%) than its five-year compounded annual growth rate (CAGR) of 4.1% during 2015-2019. Chart 12China's Automobile Sales Correlated Well With Its Crude Oil Imports China s Automobile Sales Correlated Well With Its Crude Oil Imports China s Automobile Sales Correlated Well With Its Crude Oil Imports Automobile sales in China correlated well with the country’s crude oil imports (Chart 12, top panel). Despite a year-on-year contraction of 2% for the whole year of 2020, automobile sales had been strong with a double-digit growth nearly every month since May. Only 5% of these automobiles are new energy vehicles (NEV). About 80% of them are gasoline cars and 15% are diesel automobiles. Annual total car sales still account for about 9% of total existing automobiles (Chart 12, bottom panel). This means a 6-7% growth in the transportation consumption of passenger cars and commercial cars is very possible in 2021. The number of airports and airplanes are still on the uptrend in China. The CAGR of Chinese kerosene consumption rose from 10.1% during 2010-2014 to 10.6% during 2015-2019. This suggests that the kerosene consumption growth in China could reach 11% in 2021. Domestic gasoline and diesel prices are near decade lows (Chart 13). This will encourage consumption of these fuels. Second, the oil consumption growth in the industry sector will likely be larger than the 5% in the recent years (Chart 14). Based on the NBS data, the industry sector accounts for about 36% of China’s petroleum product consumption. Chart 13Low Domestic Gasoline And Diesel Prices Encourage Fuel Consumption This Year Low Domestic Gasoline And Diesel Prices Encourage Fuel Consumption This Year Low Domestic Gasoline And Diesel Prices Encourage Fuel Consumption This Year Chart 14Robust Oil Consumption Growth In The Industry Sector In 2021 Robust Oil Consumption Growth In The Industry Sector In 2021 Robust Oil Consumption Growth In The Industry Sector In 2021 Third, infrastructure spending and property market construction will slow in 2H2021 given the credit, fiscal, and regulatory tightening that has been taking place. However, construction only accounts for about 6% of Chinese petroleum product consumption.  Given all of this, achieving a 6-7% underlying consumption growth of crude oil in China this year is possible. Taking into consideration the slower pace of inventory buildup, we expect China’s crude oil imports to increase by 4-6% in 2021 over the previous year, slower than last year’s 7.2% growth. Bottom Line: The underlying consumption growth of crude oil in China is likely to increase to 6-7% in 2021 from last year’s 4.5%, providing solid support to China’s crude oil imports. What About Other Factors Affecting Chinese Crude Oil Imports? Currently, both domestic crude oil production and net exports of Chinese petroleum products exports are small contributors to the growth of Chinese crude oil imports. However, as the Chinese petroleum export sector becomes more competitive in the global market, it will likely take a bigger share of China’s crude oil imports going forward. Chart 15Net Exports Of Chinese Petroleum Products Are On The Uptrend Net Exports Of Chinese Petroleum Products Are On The Uptrend Net Exports Of Chinese Petroleum Products Are On The Uptrend We expect domestic crude oil output to be stagnant in 2021. The breakeven prices for most domestic oil fields are US$50-60 per barrel. Without a considerable rally in oil prices, the total domestic crude oil output is unlikely to pick up. Moreover, due to the massive crude oil inventory buildup in recent years, Chinese oil producers may constrain their output. In this scenario, a reduction in domestic crude oil output by 1-2% in 2021 from 2020 is possible. Nonetheless, this will only increase China’s oil imports by a small amount of about 40-80 kbpd. The net exports of Chinese petroleum products are on the uptrend (Chart 15). Currently net exports of Chinese petroleum products account for only about 6% of Chinese crude oil imports.  However, Chinese refineries are increasingly competitive in global gasoline and diesel markets, since most of the new refineries in the country are high technology equipped and highly efficient. In addition, last July, China started issuing export licenses to private refiners, and we expect the trend to continue. According to Bloomberg, China is set to surpass the US to become the world’s largest oil refiner in 2021. As such, in the coming years we expect rising Chinese exports of petroleum products will demand more imports of crude oil.  We expect Chinese petroleum products net exports to rise by 100-150 kbpd in 2021 15-20% growth from last year), which may increase our estimate of China’s year-on-year crude oil import growth from 4-6% to 5-7% in 2021. However, increasing Chinese petroleum product exports does not increase global final demand for oil. It cannot be viewed as a fundamentally bullish factor for oil prices. Bottom Line: Stagnant domestic crude oil output and rising net exports of Chinese petroleum products will also lead to an increase of China’s crude oil imports.  Investment Implications Chart 16China: An Increasingly Important Factor For Global Oil Demand China: An Increasingly Important Factor For Global Oil Demand China: An Increasingly Important Factor For Global Oil Demand Strong crude oil imports by China have supported global oil prices in recent years. China has become an increasingly important driving force of global oil demand. Its oil imports currently make up about 12% of global oil demand, more than doubled from a decade ago (Chart 16). The country’s crude oil imports will continue expanding this year. Even at a slower rate, the robust oil consumption and imports from China will remain a positive factor for global oil prices in 2021. Beyond 2021, however, the country’s crude oil import growth outlook is facing increasing downside risks. Demand that is due to inventory accumulation is ultimately finite and non-recurring. Moreover, more oil accumulations in 2021 on top of China’s already elevated oil inventories may weigh on Chinese oil imports beyond 2021. In the meantime, US crude oil producers may benefit from continuing strong purchases from China. In 2020, China significantly ramped up its crude oil imports from the US, as the country has pledged to boost purchases of US energy products under the phase one trade deal signed with President Trump in January 2020. Chart 17Chinese Imports Of US Crude Oil May Continue To Rise In 2021 Chinese Imports of US Crude Oil May Continue To Rise In 2021 Chinese Imports of US Crude Oil May Continue To Rise In 2021 In 2020, Chinese imports of US crude oil in volume terms were 155% higher from a year before (Chart 17, top panel). Its share of total Chinese crude oil imports also spiked from 1-2% in late 2019 to 7-8% in the past several months (Chart 17, bottom panel). In the meantime, China’s share of US crude oil export also jumped from 4.6% in 2019 to 14.7% last year. In 2021, our baseline view is that China will want to show goodwill to the newly elected Biden administration by continuing to boost its crude oil purchase from the US. This will benefit US crude oil producers. However, if China buys more from the US, it may buy less from other countries.   Ellen JingYuan He  Associate Vice President ellenj@bcaresearch.com     Footnotes 1By deducting crude oil used in refineries and in direct final consumption from the total supply, we derived the flow of inventory and the level of changes in inventory. By using the cumulative value of the flow inventory data, we were able to derive the stock of inventory. We assume the initial inventory in 2006 was zero. This assumption is reasonable as the first fill of the SPR was in 2007 and the stock of CPR was extremely low at that time as well. In addition, based on the data from the National Bureau of Statistics, we found out that the direct final consumption of crude oil without any transformation only accounted for about 1-2% of total supply. 2 In 2004, the government planned three phases of SPR construction, targeting 10-12 million tons of crude oil SPR for the first phase, 28 million tons for the second phase, and another 28 million tons for the third phase. 3The import quota for independent refiners in 2021 has been increased by 20% (about 823 kbpd), and the country’s refinery capacity will expand at about 500 kbpd per year over 2021-2025. Cyclical Investment Stance Equity Sector Recommendations