Saudi Arabia

OPEC 2.0’s decision to cut 2mm b/d of output beginning in December telescopes the loss of Russian volumes we expect over the course of the coming year. OPEC 2.0 clearly is not playing by the G7’s or the US’s rules. This will keep prices volatile.

Executive Summary Iran Reaches Nuclear Breakout Biden And Putin Court The Middle East Biden And Putin Court The Middle East The next geopolitical crisis will stem from the Middle East. The US, Russia, and China are striving for greater influence there and Iran’s nuclear quest is reaching a critical juncture. The risk of US-Israeli attacks against Iran remains 40% over the medium term and will rise sharply if Iran attempts to construct a deliverable nuclear device. Saudi Arabia may increase oil production but only if global demand holds up, which OPEC will assess at its August 3 meeting. Global growth risks will prevail in the short term and reduce its urgency. Russia will continue to squeeze supplies of energy and food for the outside world. The restart of Nord Stream 1 and the Turkey-brokered grain export proposal are unreliable signals. Russia’s aim is victory in Ukraine and any leverage will be used. The US may be done with the Middle East but the Middle East may not be done with the US. Structurally we remain bullish on gold and European defense stocks but we are booking 17% and 18% gains on our current trades. The deterioration in global growth and likely pullback in inflation will temporarily undercut these trades. Tactical Recommendation Inception Date Return LONG GOLD (CLOSED) 2019-06-12 17.1% LONG EUROPEAN AEROSPACE & DEFENSE / EUROPEAN TECH EQUITIES (CLOSED) 2022-03-18 17.9% Bottom Line: Global demand is weakening, which will weigh on bond yields and commodities. Yet underlying oil supply constraints persist – and US-Iran conflict will exacerbate global stagflation. Feature Chart 1Equity Volatility And Oil Price Volatility Equity Volatility And Oil Price Volatility Equity Volatility And Oil Price Volatility US President Joe Biden visited Saudi Arabia last week in a belated attempt to make amends with OPEC, increase oil production, and reduce inflation ahead of the midterm election. Biden also visited Israel to deter Iran, which is the next geopolitical crisis that markets are underrating. Meanwhile Russian President Vladimir Putin went to Iran on his second trip outside of Russia since this year’s invasion of Ukraine. Putin sought an ally in his conflict with the West, while also negotiating with Turkish President Recep Erdogan, who sought to position himself as a regional power broker. In this report we analyze Biden’s and Putin’s trips and what they mean for the global economy and macro investors. Macroeconomics is bearish for oil in the short term but geopolitics is bullish for oil in the short-to-medium term. The result is volatility (Chart 1). OPEC May Pump More Oil But Not On Biden’s Time Frame Here are the important developments from Biden’s trip: A credible threat against Iran: The US and Israel issued a joint declaration underscoring their red line against Iranian nuclear weaponization.1 Meanwhile the Iranians claimed to have achieved “nuclear breakout,” i.e. enough highly enriched uranium to construct a nuclear device (Chart 2). A balance-of-power coalition to contain Iran: Israel and Saudi Arabia improved relations on the margin. Each took action to build on the strategic détente between Israel and various Arab states that is embodied in the 2020 Abraham Accords.2 This strategic détente has staying power because it is a self-interested attempt by the various nations to protect themselves against common rivals, particularly Iran (Chart 3). Biden also tried to set up a missile defense network with Israel and the Arabs, although it was not finalized.3 Chart 2Iran Reaches Nuclear Breakout Biden And Putin Court The Middle East Biden And Putin Court The Middle East A reaffirmed US-Saudi partnership: The US and Saudi Arabia reaffirmed their partnership despite a rocky patch over the past decade. The rocky patch arises from US energy independence, China’s growth, and US attempts to normalize ties with Iran (Chart 4). These trends caused the Saudis to doubt US support and to view China as a strategic hedge. Chart 3Iran: Surrounded And Outgunned Biden And Putin Court The Middle East Biden And Putin Court The Middle East ​​​​​​ President Biden came into office aiming to redo the Iran deal and halt arms sales to Saudi Arabia. Since then he has been chastened by high energy prices, a low approval rating, and hawkish Iranian policy. On this trip he came cap in hand to the Saudis in a classic example of geopolitical constraints. If the US-Iran deal is verifiably dead, then US-Saudi ties will improve sustainably. (Though of course the Saudis will still do business with China and even start trading with China in the renminbi.) What global investors want to know is whether the Saudis and OPEC will pump more oil. The answer is maybe someday. The Saudis will increase production to save the global business cycle but not the Democrats’ election cycle. They told Biden that they will increase production only if there is sufficient global demand. Global Brent crude prices have fallen by 6% since May, when Biden booked his trip, so the kingdom is not in a great rush to pump more. Its economy is doing well this year (Chart 5). Chart 4Drivers Of Saudi Anxiety Drivers Of Saudi Anxiety Drivers Of Saudi Anxiety ​​​​​ Chart 5Saudis Won't Pump If Demand Is Weak Saudis Won't Pump If Demand Is Weak Saudis Won't Pump If Demand Is Weak ​​​​​​ At the same time, if global demand rebounds, the Saudis will not want global supply constraints to generate punitive prices that cap the rebound or kill the business cycle. After all, a global recession would deplete Saudi coffers, set back the regime’s economic reforms, exacerbate social problems, and potentially stir up political dissent (Chart 6). Related Report  Geopolitical StrategyThird Quarter Geopolitical Outlook: Thunder And Lightning Hence the Saudis will not increase production substantially until they have assessed the global economy and discussed the outlook with the other members of the OPEC cartel in August and September, when the July 2021 agreement to increase production expires. We expect global demand to weaken as Europe and China continue to struggle. Our Commodity & Energy Strategist Bob Ryan argues that further escalation in the energy war between the EU and Russia could push prices above $220 per barrel by Q4 2023, whereas an economic collapse could push Brent down to $60 per barrel. His base case Brent price forecast remains $110 per barrel on average in 2022 and $117 per barrel in 2023 (Chart 7). Chart 6Saudis Will Pump To Prevent Recession Saudis Will Pump To Prevent Recession Saudis Will Pump To Prevent Recession ​​​​​​ Chart 7BCA's July 2022 Oil Price Forecast BCA's July 2022 Oil Price Forecast BCA's July 2022 Oil Price Forecast ​​​​​​ The geopolitical view suggests upside oil risks over the short-to-medium time frame but the macroeconomic view suggests that downside risks will be priced first. Bottom Line: Saudi Arabia may increase production but not at any US president’s beck and call. The Saudis are not focused on US elections, they benefit from the current level of prices, and they do not suffer if Republicans take Congress in November. The downside risk in oil prices stems from demand disappointments in global growth (especially China) rather than any immediate shifts in Saudi production discipline. Volatility will remain high. US-Iran Talks: Dying But Not Dead Yet In fact the Middle East underscores underlying and structural oil supply constraints despite falling global demand. While Iran is a perennial geopolitical risk, the world is reaching a critical juncture over the next couple of years. Investors should not assume that Iran can quietly achieve nuclear arms like North Korea. Since August 2021 we have argued that the US and Iran would fail to put back together the 2015 nuclear deal (the Joint Comprehensive Plan of Action or JCPA). This failure would in turn lead to renewed instability across the Middle East and sporadic supply disruptions as the different nations trade military threats and potentially engage in direct warfare. This forecast is on track after Biden’s and Putin’s trip – but we cannot yet say that it is fully confirmed. Biden’s joint declaration with Israeli Prime Minister Yair Lapid closed any daylight that existed between the US and Israel. Given that there was some doubt about the intentions of Biden and the Democrats, it is now crystal clear that the US is determined to prevent Iran from getting nuclear weapons even if it requires military action. The US specifically said that it will use “all instruments of national power” to prevent that outcome. Chart 8Iran Not Forced To Capitulate Iran Not Forced To Capitulate Iran Not Forced To Capitulate Judging by the tone of the statement, the Israelis wrote the document and Biden signed it.4 Biden’s foreign policy emphasizes shoring up US alliances and partnerships, which means letting allies and partners set the line. Israel’s Begin Doctrine – which says that Israel is willing to attack unilaterally and preemptively to prevent a hostile neighbor from obtaining nuclear weapons – has been reinforced. The US is making a final effort to intimidate Iran into rejoining the deal. By clearly and unequivocally reiterating its stance on nuclear weapons, and removing doubts about its stance on Israel, there is still a chance that the Iranian calculus could change. This is possible notwithstanding Ayatollah Khamenei’s friendliness with Putin and criticisms of western deception.5 After all, why would the Iranians want to be attacked by the US and Israeli militaries? Iran will need to think very carefully about what it does next. Khamenei just turned 83 years old and is trying to secure the Islamic Republic’s power transition and survival after his death. Here are the risks: Iran’s economy, buoyed by the commodity cycle, is not so weak as to force Khamenei to capitulate. Back in 2015 oil prices had collapsed and his country was diplomatically isolated. Today the economy has somewhat weathered the storm of the US’s maximum pressure sanctions (Chart 8). Iran is in bad shape but it has not been brought to its knees. Another risk is that Khamenei believes the American public lacks the appetite for war. Americans say they are weary of Middle Eastern wars and do not feel particularly threatened by Iran. However, this would be a miscalculation. US war-weariness is nearing the end of its course. The US engages in a major military expedition roughly every decade. Americans are restless and divided – and the political elite fear populism – so a new foreign distraction is not as unlikely as the consensus holds. Moreover a nuclear Iran is not an idle threat but would trigger a regional nuclear arms race and overturn the US grand strategy of maintaining a balance of power in the Middle East (as in other regions). In short, the US government can easily mobilize the people to accept air strikes to prevent Iran from going nuclear because there is latent animosity toward Iran in both political parties (Chart 9). Chart 9Risk: Iran Overrates US War-Weariness Biden And Putin Court The Middle East Biden And Putin Court The Middle East Another risk is that Iran forges ahead believing that the US and Israel are unwilling or unable to attack and destroy its nuclear program. The western powers might opt for containment like they did with North Korea or they might attack and fail to eliminate the program. This is hard to believe but Iran clearly cannot accept US security guarantees as an alternative to a nuclear deterrent when it seeks regime survival. At the same time Russia is courting Iran, encouraging it to join forces against the American empire. Iran is planning to sell drones to Russia for use in Ukraine, while Russia is maintaining nuclear and defense cooperation with Iran. Putin’s trip highlighted a growing strategic partnership despite a low base of economic ties  (Chart 10).6 Chart 10Russo-Iranian Ties Russo-Iranian Ties Russo-Iranian Ties ​​​​​​ Chart 11West Vulnerable To Middle East War Biden And Putin Court The Middle East Biden And Putin Court The Middle East While Russia does not have an interest in a nuclear-armed Iran, it is not afraid of Iran alone, and it would benefit enormously if the US and Israel got bogged down in a new war that destabilized the Middle East. Oil prices would rise, the US would be distracted, and Europe would be even more vulnerable (Chart 11). Chart 12China's Slowdown And Dependency On Middle East China's Slowdown And Dependency On Middle East China's Slowdown And Dependency On Middle East China’s interest is different. It would prefer for Iran to undermine the West by means of a subtle and long-term game of economic engagement rather than a destabilizing war in the region that would upset China’s already weak economy. However, Beijing will not join with the US against Iran, especially if Iran and Russia are aligned. Ultimately China needs to access Iranian energy reserves via overland routes so that it gains greater supply security vis-à-vis the American navy (Chart 12). Since June 2019, we have maintained 40% odds of a military conflict with Iran. The logic is outlined in Diagram 1, which we have not changed. Conflict can take various forms since the western powers prefer sabotage or cyber-attacks to outright assault. But in the end preventing nuclear weapons may require air strikes – and victory is not at all guaranteed. We are very close to moving to the next branch in Diagram 1, which would imply odds of military conflict rise from 40% to 80%. We are not making that call yet but we are getting nervous. Diagram 1Iran Nuclear Crisis: Decision Tree Biden And Putin Court The Middle East Biden And Putin Court The Middle East Moreover it is the saber rattling around this process – including an extensive Iranian campaign to deter attack – that will disrupt oil distribution and transport sooner rather than later. Bottom Line: The US and Iran could still find diplomatic accommodation to avoid the next step in our decision tree. Therefore we are keeping the odds of war at a subjective 40%. But we have reached a critical juncture. The next step in the process entails a major increase in the odds of air strikes. Putin’s Supply Squeeze Will Continue As we go to press, financial markets are reacting to President Putin’s marginal easing of Russian political pressure on food and energy supplies. First, Putin took steps toward a deal, proposed by Turkish President Erdogan, to allow Ukrainian grain exports to resume from the Black Sea. Second, Putin allowed a partial restart of the Nord Stream 1 natural gas pipeline, after a total cutoff occurred during the regular, annual maintenance period. However, these moves should be kept into perspective. Nord Stream 1 is still operating at only 40% of capacity. Russia reduced the flow by 60% after the EU agreed to impose a near-total ban on Russian oil exports by the end of the year. Russia is imposing pain on the European economy in pursuit of its strategic objectives and will continue to throttle Europe’s natural gas supply. Russia’s aims are as follows: (1) break up European consensus on Russia and prevent a natural gas embargo from being implemented in future (2) pressure Europe into negotiating a ceasefire in Ukraine that legitimizes Russia’s conquests (3) underscore Russia’s new red line against NATO military deployments in Finland and Sweden. Europe, for its part, will continue to diversify its natural gas sources as rapidly as possible to reduce Russia’s leverage. The European Commission is asking countries to decrease their natural gas consumption by 15% from August to March. This will require rationing regardless of Russia’s supply squeeze. The collapse in trust incentivizes Russia to use its leverage while it still has it and Europe to try to take that leverage away. The economic costs are frontloaded, particularly this winter. The same goes for the Turkish proposal to resume grain exports. Russia will continue to blockade Ukraine until it achieves its military objectives. The blockade will be tightened or loosened as necessary to achieve diplomatic goals. Part of the reason Russia invaded in the first place was to seize control of Ukraine’s coast and hold the country’s ports, trade, and economy hostage. Bottom Line: Russia’s relaxation of food and energy flows is not reliable. Flows will wax and wane depending on the status of strategic negotiations with the West. Europe’s economy will continue to suffer from a Russia-induced supply squeeze until Russia achieves a ceasefire in Ukraine. So will emerging markets that depend on grain imports, such as Turkey, Egypt, and Pakistan. Investment Takeaways The critical juncture has arrived for our Iran view. If Iran does not start returning to nuclear compliance soon, then a fateful path of conflict will be embarked upon. The Saudis will not give Biden more oil barrels just yet. But they may end up doing that if global demand holds up and the US reassures them that their regional security needs will be met. First, the path for oil over the next year will depend on the path of global demand. Our view is negative, with Europe heading toward recession, China struggling to stimulate its economy effectively, and the Fed unlikely to achieve a soft landing. Second, the path of conflict with Iran will lead to a higher frequency of oil supply disruptions across the Middle East that will start happening very quickly after the US-Iran talks are pronounced dead. In other words, oil prices will be volatile in a stagflationary environment. In addition, while inflation might roll over for various reasons, it is not likely to occur because of any special large actions by Saudi Arabia. The Saudis are waiting on global cues. Of these, China is the most important. We are booking a 17% gain on our long gold trade as real rates rise and China’s economy deteriorates (Chart 13). This is in line with our Commodity & Energy Strategy, which is also stepping aside on gold for now. Longer term we remain constructive as we see a secular rise in geopolitical risk and persistent inflation problems. Chart 13Book Gains On Gold ... For Now Book Gains On Gold ... For Now Book Gains On Gold ... For Now We are booking an 18% gain on our long European defense / short European tech trade. Falling bond yields will benefit European tech (Chart 14). We remain bullish on European and global defense stocks. Chart 14Book Gains On EU Defense Vs Tech ... For Now Book Gains On EU Defense Vs Tech ... For Now Book Gains On EU Defense Vs Tech ... For Now ​​​​​​ Chart 15Markets Underrate Middle East Geopolitical Risk Biden And Putin Court The Middle East Biden And Putin Court The Middle East ​​​​​ Stay long US equities relative to UAE equities. Middle Eastern geopolitical risk is underrated (Chart 15). Matt Gertken Chief Geopolitical Strategist mattg@bcaresearch.com   Footnotes 1      The White House, “The Jerusalem U.S.-Israel Strategic Partnership Joint Declaration,” July 14, 2022, whitehouse.gov. 2     Israel and the US will remove international peacekeepers from the formerly Egyptian Red Sea islands of Tiran and Sanafir, which clears the way for Saudi Arabia to turn them into tourist destinations. Saudi Arabia also removed its tight airspace restrictions on Israel, enabling civilian Israeli airlines to fly through Saudi airspace on normal basis. Of course, Saudi allowance for Israeli military flights to pass through Saudi airspace would be an important question in any future military operation against Iran. 3     The US has long wanted regional missile defense integration. The Biden administration is proposing “integrated air defense cooperation” that would include Israel as well as the Gulf Cooperation Council (GCC). A regional “air and missile defense architecture” would counter drones and missiles from rival states and non-state actors such as Iran and its militant proxies. Simultaneously the Israelis are putting forward the proposed Middle East Air Defense Alliance (MEAD) in meetings with the same GCC nations. Going forward, Iran’s nuclear ambitions will give more impetus to these attempts to cooperate on air defense. 4     This is apparent from the hard line on Iran and the relatively soft line on Russia in the document. Israel is wary of taking too hard of a line against Russia because of its security concerns in Syria where Russian forces are present. See footnote 1 above. 5     Khamenei called for long-term cooperation between Russia and Iran; he justified Russia’s invasion of Ukraine as a defense against NATO encroachment; he called for the removal of the US dollar as the global reserve currency. See “Khamenei: Tehran, Moscow must stay vigilant against Western deception,” Israel Hayom, July 20, 2022, israelhayom.com. 6     Russia’s natural gas champion Gazprom signed an ostensible $40 billion memorandum of understanding with Iran’s National Oil Company to develop gas fields and pipelines. See Nadeen Ebrahim, “Iran and Russia’s friendship is more complicated than it seems,” CNN, July 20, 2022, cnn.com. However, while there are longstanding obstacles to Russo-Iranian cooperation, the West’s tough new sanctions on Russia and EU diversification will make Moscow more willing to invest in Iran. Strategic Themes Open Tactical Positions (0-6 Months) Open Cyclical Recommendations (6-18 Months) Regional Geopolitical Risk Matrix

Executive Summary Further GDP Weakness Would Push Brent Lower Further GDP Weakness Would Push Brent Lower Further GDP Weakness Would Push Brent Lower Markets remain alert for indications of what Russia will do next. Last week, President Vladimir Putin threatened “catastrophic consequences” if G7 states are able to impose a price cap on Russian oil sales. A sharp drop in output – more than 3mm b/d – would send prices sharply higher, and could not be replaced in 2H22. KSA and the UAE are signaling their limited ability to significantly increase oil output ahead of US President Joseph Biden’s visit to the region later this week. Our simulation of demand losses of ~500k b/d in 2H22 and ~1.0mm b/d in 2023 suggests Brent could fall $7/bbl to $108/bb in 2H22 and $8/bbl to $109/bbl in 2023, all else equal. A Russian court decision last week briefly halted flows on the Caspian Pipeline Consortium’s (CPC) 1.3mm b/d line moving Kazakh oil to the Black Sea through Russia, adding a new variable into supply-side modeling. A trivial fine was levied, but a larger message was delivered. Sporadic force majeure declarations and output losses in Libya, where Russian mercenaries actively support Khalifa Haftar’s Libyan National Army (LNA), continue to make supply assessments difficult. Bottom Line: Tight supply fundamentals will keep oil markets volatile and biased to the upside, despite recurrent recession fears overwhelming demand expectations.  While a deep recession cannot be discounted, we remain focused on the objective fact of physically tight markets, and Russia's political-economy considerations affecting the evolution of prices. Feature Anyone who has spent time in trading markets will appreciate the implications of a $65-at-$380/bbl bid-ask spread on Brent. This two-way quote represents worst cases scenarios on the demand and supply sides of the market. And huge uncertainty. The bid comes from Citi’s recession-driven view, while the offer is courtesy of JP Morgan’s worst-case supply-shock assessment – i.e., Russia pulling 5mm b/d off the market if G7 states impose a price cap on its exports.1 Related Report  Commodity & Energy StrategyCopper Prices Decouple From Fundamentals Of late, demand-side concerns are driving markets, along with other technical factors we discussed in last week’s report on copper: low liquidity in trading markets; elevated global policy uncertainty, as seen by the two-way quote above; worries Fed tightening will overshoot the mark as it attempts to control hotter inflation, and an expansion of Russia’s economic war that now engulfs Ukraine.2 The latter point touches on events that cross commodity markets globally: Russia is threatening “catastrophic consequences” if G7 states impose a price cap on its oil sales. This goes directly to the supply side, as it most likely entails a dramatic gesture to reduce crude oil output sharply – i.e., more than 3mm b/d – which would send prices soaring. Russia’s coffers are in excellent shape at present, given the high prices its oil, gas and coal producers have been able to fetch since it invaded Ukraine.3 In our modeling, if Russia were to cut the 2.3mm b/d of crude and condensate it sent to Europe last year, Brent prices would move above $140/bbl.4 Higher volumes taken off the market would result in higher prices. These factors all interact with each other producing feedback loops – e.g., higher uncertainty causes lower liquidity in hedging markets and wider bid-ask spreads on smaller volumes – affecting decisions on everything from capex levels to headcounts. Demand Concerns Consume Markets Last month, we lowered our Brent forecast for this year and next to $110/bbl and $117/bbl, respectively, on the back of a sharp downgrade in global growth expectations from the World Bank. The Bank’s forecast prompted us to reduce our 2022 oil demand growth forecast to 2.0mm b/d this year vs 4.8mm b/d in our January forecast, and, for next year, to 1.8mm b/d. Given the obvious concern in markets, we simulated another hit to demand of 500k b/d in 2H22 and 1.0mm b/d next year, due to a further markdown in real GDP growth. This scenario brings our demand growth expectation down to 1.5mm b/d this year and 800k b/d next year. In this simulation, the lower GDP growth takes our average price expectation for 2H22 to $108/bbl and $109/bbl next year, or $7/bbl and $8/bbl lower, respectively (Chart 1). The lower demand we model here is offset to some degree by our maintained hypothesis that OPEC 2.0 – particularly its core producers Saudi Arabia and the UAE – will temper production somewhat (Chart 2), so as not to produce very large unintended inventory accumulations (Chart 3). Chart 1Further GDP Weakness Would Push Brent Lower Further GDP Weakness Would Push Brent Lower Further GDP Weakness Would Push Brent Lower This concern is particularly acute if these producers receive new information that demand is slowing more than they expected. We are certain this will come up when US President Biden is in Riyadh later this week to meet Saudi Crown Prince Mohammed bin Salman Al Saud (MBS), to again discuss, among other things, the Kingdom’s ability and willingness to increase supply. Chart 2Core OPEC 2.0 Will Temper Production Increases... Core OPEC 2.0 Will Temper Production Increases... Core OPEC 2.0 Will Temper Production Increases... Chart 3...To Avoid Unintended Inventory Accumulations ...To Avoid Unintended Inventory Accumulations ...To Avoid Unintended Inventory Accumulations Russia Exerts Supply-Side Influence Russia is at war with Ukraine and the West – i.e., the G7 and NATO states arming and actively seeking to limit its access to revenues from the sale of hydrocarbons. Russia is treating this as a war, and it is operating on multiple fronts, in addition to its kinetic engagement with Ukrainian forces. In a market as finely balanced and uncertain as the current one, small, unexpected shifts in supply or demand can have outsized effects. Last week, for example, a decision by a Russian court briefly halted flows on the Caspian Pipeline Consortium’s (CPC) 1.3mm b/d line moving Kazakh oil to the Black Sea. This boosted prices more than 5% over the ensuing couple of days. Flows were allowed to resume after trivial fine was paid and prices fell. But a larger message was delivered. This remains a powerful lever Moscow can use at a moment’s notice to tighten supplies. Opportunities elsewhere in oil-producing provinces also are continuously cultivated by Russian operatives to influence supplies. Sporadic public demonstrations and force majeure declarations have led to output losses in Libya, where Russian mercenaries actively support Khalifa Haftar’s Libyan National Army (LNA). This continues to make supply assessments difficult. Libya currently produces ~ 650k b/d, according to the US EIA, down from ~ 1.12mm b/d in 4Q21. As in many things, Russia’s playing a game of chess with its opponents and forcing them to react to its threats and decisions. And this strategy is not limited to Ukraine, the EU or oil. For example, the seizure of Shell’s ownership in the Sakhalin-2 LNG facilities by Russia’s state-owned Gazprom was described by The Journal of Petroleum Technology (JPT) as a “backdoor” nationalization of Shell’s interest. This will have long-term consequences far removed from the Ukraine War, and could affect LNG deliveries to Japan and South Korea, which will become critical in a super-tight LNG market going into winter. This couldn’t be more timely, as Japan and South Korean – in a first-ever event – attended the end-June NATO meeting.5 Investment Implications Russia’s war against Ukraine has multiple dimensions, all of which can impact oil and gas prices going forward. Despite the obvious concerns over a deep recession reducing global oil demand – and commodity demand generally – we continue to focus on the objective fact of physically tight markets, and Russia's political-economy considerations affecting the evolution of prices. This informs our view that prices will remain volatile with a significant bias to the upside. Small, unexpected shocks in a fundamentally tight market on the supply side support our view prices will move higher.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Analyst Commodity & Energy Strategy ashwin.shyam@bcaresearch.com Paula Struk Research Associate Commodity & Energy Strategy paula.struk@bcaresearch.com     Commodities Round-Up Energy: Bullish Whether the EU can avoid rationing – and fill its natural-gas storage – ahead of winter will depend on what Russia does with its exports of the gas exported on Nord Stream 1 (NS1) and other pipes (Chart 4). We believe Russia will cut off most of its exports to the EU before winter sets in. It likely will use use the current 10-day maintenance on NS1, which began Monday, as a pretext to cut supplies, in retaliation for the EU cutting off crude oil and refined products imports. President Putin of Russia most likely will offer to keep the gas flowing so inventories can be refilled, in return for the EU lifting sanctions it imposed following Russia's invasion of Ukraine. Precious Metals: Bullish June headline US CPI was reported at 9.1% yoy, continuing the streak of rising prices. The Fed will need to aggressively hike rates to bring price levels lower, raising the risk of plunging the US into a recession. Recession fears will reduce long-term bond yields and should support gold prices. While high inflation is good for gold, the yellow metal saw investment outflows during May and June, as investors opt for the USD as a safe-haven asset. Ags/Softs: Neutral Food prices fell for the third straight month in June, but still are near historic highs following Russia’s invasion of Ukraine.6 Wheat prices fell by 5.7% in June but was still higher by 48.5% compared to 2021 (Chart 5).7 This might be down to recession fears, or, more likely, due to better crop conditions, seasonal availability from new harvests in the northern hemisphere, and more exports from Russia. The UN’s FAO warned factors that drove global prices higher still persist. Russia is expected to harvest one of its largest wheat crops since the fall of the Soviet Union.8 According to the 2022/23 USDA outlook, there will be less supplies and consumption, higher exports and stocks.9 Chart 4 Russia Pulls Oil, Gas Supply Strings Russia Pulls Oil, Gas Supply Strings Chart 5 Wheat Price Level Going Down Wheat Price Level Going Down   Footnotes 1     Please see Citigroup says oil prices could tumble to $65 by the end of the year if a recession whacks demand, published by businessinsider.com on July 5, 2022, and Oil could hit $380 if Russia slashes output over price cap, J.P.Morgan says, published by reuters.com on July 4, 2022. 2     Please see Copper Prices Decouple From Fundamentals published on July 7, 2022. 3    Please see Russia sees extra $4.5 billion in July budget revenue on higher oil prices published by reuters.com on July 5, 2022. 4    Please see Oil, Natgas Prices Set To Surge, which we published on May 19, 2022.  It is available at ces.bcaresearch.com. 5    Please see Japan and South Korea's Attendance at the Upcoming NATO Summit Could Worsen Global Tensions, published by time.com on June 16, 2022. 6    Please see Global food prices may be falling, but economist warns Asia’s food costs could still soar published by CNBC on July 11, 2022. 7     Please see Wheat, Corn Prices Tempered- Easing Global Food Cost Concerns published by University of Illinois on July 1, 2022 . 8    Please see Dollar rises to 20-year highs, sends grains lower published by FarmProgress on July 12, 2022. 9    Please see Grain: World Market and Trade published by USDA on July 12, 2022.   Investment Views and Themes Strategic Recommendations Tactical Trades Trades Closed in 2022

Listen to a short summary of this report.     Executive Summary Higher Real Yields Have Weighed On Equity Valuations Higher Real Yields Have Weighed On Equity Valuations Higher Real Yields Have Weighed On Equity Valuations I had the pleasure of visiting clients in Saudi Arabia, Bahrain, and Abu Dhabi last week. In contrast to the rest of the world, the mood in the Middle East was very positive. While high oil prices are helping, there is also a lot of optimism about ongoing structural reforms. Petrodollar flows are increasingly being steered towards private and public equities. EM assets stand to benefit the most. Producers in the region are trying to offset lost Russian output, but realistically, they will not be able to completely fill the gap in the near term. Today’s high energy prices have largely baked in this reality, as reflected in strongly backwardated futures curves. There was no consensus about how high oil prices would need to rise to trigger a global recession, although the number $150 per barrel got bandied about a lot. Given that most Middle Eastern currencies are pegged to the dollar, there was a heavy focus on Fed policy. Market estimates of the neutral rate in the US have increased rapidly towards our highly out-of-consensus view. Nevertheless, we continue to see modest upside for bond yields over a multi-year horizon. Over a shorter-term 6-to-12-month horizon, the direction of bond yields will be guided by the evolution of inflation. While US CPI inflation rose much more than expected in May, the details of the report were somewhat less worrying, as they continue to show significant supply-side distortions. Bottom Line: Inflation should come down during the remainder of the year, allowing the Fed to breathe a sigh of relief and stocks to recover some of their losses. A further spike in oil prices is a major risk to this view.   Dear Client, Instead of our regular report next week, we will be sending you a Special Report written by Chester Ntonifor, BCA Research’s Chief Foreign Exchange Strategist, discussing the outlook for gold. We will be back the following week with the GIS Quarterly Strategy Outlook, where we will explore the major trends that are set to drive financial markets in the rest of 2022 and beyond. As always, I will hold a webcast discussing the outlook the following week, on Thursday, July 7th. Best regards, Peter Berezin Chief Global Strategist Peter in Arabia I had the pleasure of visiting clients in Saudi Arabia, Bahrain, and Abu Dhabi last week. This note summarizes my impressions and provides some commentary about recent market turmoil. The Mood in the Region is Very Positive In contrast to the rest of the world, the mood in the Middle East was upbeat. Obviously, high oil prices are a major contributor (Chart 1). Across the region, stock markets are still up for the year (Chart 2). Chart 1Oil Prices Have Shot Up Oil Prices Have Shot Up Oil Prices Have Shot Up Chart 2Middle Eastern Stock Markets Are Doing Relatively Well This Year Middle Eastern Stock Markets Are Doing Relatively Well This Year Middle Eastern Stock Markets Are Doing Relatively Well This Year   That said, I also felt that investors were encouraged by ongoing structural reforms, especially in Saudi Arabia where the Vision 2030 program is being rolled out. The program seeks to diversify the Saudi economy away from its historic reliance on petroleum exports. A number of people I spoke with cited the Saudi sovereign wealth fund’s acquisition of a majority stake in Lucid, a California-based EV startup, as the sort of bold move that would have been unthinkable a few years ago. I first visited Riyadh in May 2011 where I controversially delivered a speech entitled “The Coming Commodity Bust” (oil was $120/bbl then and copper prices were near an all-time high). The city has changed immensely since then. The number of restaurants and entertainment venues has increased exponentially. The ban on women drivers was lifted only four years ago. In that short time, it has become a common-day occurrence. Capital Flows Into and Out of the Region are Reflecting a New Geopolitical Reality In addition to high oil prices and structural reforms, geopolitical considerations are propelling significant capital inflows into the region. The freezing of Russia’s foreign exchange reserves sent a shockwave across much of the world, with a number of other EM countries wondering if “they are next.” Ironically, the Middle East has emerged as a neutral player of sorts in this multipolar world, and hence a safer destination for capital flows. On the flipside, the region’s oil exporters appear to be acting more strategically in how they allocate their petrodollar earnings. Rather than simply parking the proceeds of oil sales in overseas US dollar bank accounts, they are investing them in ways that further their economic and political goals. One clear trend is that equity allocations to both overseas public and private markets are rising. Other emerging markets stand to benefit the most from this development, especially EMs who have assets that Middle Eastern countries deem important – assets tied to food security being a prime example. Assuming that the current level of oil prices is maintained, we estimate that non-US oil exports will rise to $2.5 trillion in 2022, up from $1.5 trillion in 2021 (Chart 3). About 40% of this windfall will flow to the Middle East. That is a big slug of cash, enough to influence the direction of equity markets. Chart 3Oil Exporters Reaping The Benefits Of High Oil Prices An Oasis Of Optimism: Notes From The Middle East An Oasis Of Optimism: Notes From The Middle East Middle Eastern Energy Producers Will Boost Output, But Don’t Expect Any Miracles in the Short Term Russian oil production will likely fall by about 2 million bpd relative to pre-war levels over the next 12 months. To help offset the impact, OPEC has already raised production by 200,000 barrels and will almost certainly bump it up again following President Biden’s visit to the region in July (Chart 4). The decision to raise production to stave off a super spike in oil prices is not entirely altruistic. The region’s oil exporters know that excessively high oil prices could tip the global economy into recession, an outcome that would surely lead to much lower oil prices down the road. There was not much clarity on what that tipping point is, but the number $150 per barrel got bandied around a lot. Politics is also a factor. A further rise in oil prices could compel the US to make a deal with Iran, something the Saudis do not want to see happen. Still, there is a practical limit to how much more oil the Saudis and other Middle Eastern producers can bring to market in the near term. Today’s high energy prices have largely baked in this reality, as reflected in strongly backwardated futures curves (Chart 5). Chart 4Output Trends In The Major Oil Producers Output Trends In The Major Oil Producers Output Trends In The Major Oil Producers Chart 5Energy Prices On Both Sides Of The Atlantic An Oasis Of Optimism: Notes From The Middle East An Oasis Of Optimism: Notes From The Middle East Data on Saudi’s excess capacity is notoriously opaque, but I got the feeling that an extra 1-to-1.5 million bpd was the most that the Kingdom could deliver. The same constraints apply to natural gas. Qatar is investing nearly $30 billion to expand its giant North Field, which should allow gas production to rise by as much as 60%. However, it will take four years to complete the project. The share of Qatari liquefied natural gas (LNG) going to Europe has actually declined this year. About 80% of Qatar’s LNG is sold to Asian buyers under long-term contracts that cannot be easily adjusted. And even if those contracts could be rewritten, this would only bring limited benefits to Europe. For example, Germany has no terminals to accept LNG imports, although it is planning to build two. While there was plenty of sympathy to Europe’s plight in the region, there was also a sense that European governments had been cruising for a bruising by doubling down on strident anti-fossil fuel rhetoric over the past decade without doing much to end their dependence on Russian oil and gas. In that context, few in the region seemed willing to bend over backwards to help Europe. In the meantime, the US remains Europe’s best hope. US LNG shipments to Europe have tripled since last year. The US is now sending nearly three quarters of its liquefied gas to Europe. This has pushed up US natural gas prices, although they still remain a fraction of what they are in Europe. Huge Focus on the Fed Chart 6Most Of The Increase In Bond Yields Has Been In The Real Component Most Of The Increase In Bond Yields Has Been In The Real Component Most Of The Increase In Bond Yields Has Been In The Real Component Most Middle Eastern currencies are pegged to the dollar, and hence the region effectively imports its monetary policy from the US. Not surprisingly, clients were very focused on the Federal Reserve. Many expressed concern about the abrupt pace of rate hikes. One of our high-conviction views is that the neutral rate of interest in the US has risen as the household deleveraging cycle has ended, fiscal policy has become structurally looser, and a growing number of baby boomers have transitioned from working (and saving) to retirement (and dissaving). The markets have rapidly priced in this view over the course of 2022. The 5-year/5-year forward Treasury yield – a proxy for the neutral rate – has increased from 1.90% at the start of the year to 3.21% at present. Most of this increase in the market’s estimate of the neutral rate has occurred in the real component. The 5-year/5-year forward TIPS yield has climbed from -0.49% to 0.84%; in contrast, the implied TIPS breakeven inflation rate has risen from only 2.24% to 2.37% (Chart 6). Implications of Higher Bond Yields on Equity Prices and the Economy Chart 7Higher Real Yields Have Weighed On Equity Valuations Higher Real Yields Have Weighed On Equity Valuations Higher Real Yields Have Weighed On Equity Valuations As both theory and practice suggest, there is a strong negative correlation between real bond yields and equity valuations. Chart 7 shows that the S&P 500 forward P/E ratio has been moving broadly in line with the 5-year/5-year forward TIPS yield. The bad news is that there is still scope for bond yields to rise over the long haul. Our fair value estimate of 3.5%-to-4% for the neutral rate is about 25-to-75 basis points above current pricing. The good news is that a high neutral rate helps insulate the economy from a near-term recession. Recessions typically occur only when monetary policy turns restrictive. A few clients cited the negative Q1 GDP reading and the near-zero Q2 growth estimate in the Atlanta Fed GDPNow model as evidence that a US recession is either close at hand or has already begun (Chart 8). Chart 8Underlying US Growth Is Expected To Be Solid In Q2 An Oasis Of Optimism: Notes From The Middle East An Oasis Of Optimism: Notes From The Middle East We would push back against such an interpretation. In contrast to the -1.5% real GDP print, real Gross Domestic Income (GDI) rose by 2.1% in Q1. Conceptually, GDP and GDI should be equal, but since the two numbers are compiled in different ways, there can often be major statistical discrepancies. A simple average of the two suggests the US economy still grew in the first quarter. More importantly, real final sales to private domestic purchasers rose by 3.9% in Q1. This measure of economic activity – which strips out the often-noisy contributions from inventories, government expenditures, and net exports – is the best predictor of future GDP growth of any item in the national accounts (Table 1). Table 1A Good Sign: Real Final Sales To Private Domestic Purchasers Rose By 3.9% In Q1 An Oasis Of Optimism: Notes From The Middle East An Oasis Of Optimism: Notes From The Middle East As far as Q2 is concerned, real final sales to private domestic purchasers are tracking at 2.0% according to the Atlanta Fed model – a clear deceleration from earlier this year, but still consistent with a generally healthy economy. Growth will probably slow in the third quarter, reflecting the impact of higher gasoline prices, rising interest rates, and lower asset prices. Nevertheless, the fundamental underpinnings for the economy – low household debt, $2.2 trillion in excess savings, a dire need to boost corporate capex and homebuilding, and a strong labor market – remain in place. The odds of a recession in the next 12 months are quite low. Gauging Near-Term Inflation Dynamics A higher-than-expected neutral rate of interest implies that bond yields will probably rise from current levels over the long run. Over a shorter-term 6-to-12-month horizon, however, the direction of yields will be guided by the evolution of inflation. While the core CPI surprised on the upside in May, the details of the report were somewhat less worrying, as they continue to show significant supply-side distortions. Excluding vehicles, core goods prices rose 0.3% in May, down from a Q1 average of 0.7% (Chart 9). Recent commentary from companies such as Target suggest that goods inflation will ease further. Chart 9Goods Inflation Is Moderating, While Service Price Growth Is Elevated An Oasis Of Optimism: Notes From The Middle East An Oasis Of Optimism: Notes From The Middle East Stripping out energy-related services, services inflation slowed slightly to 0.6% in May from 0.7% in April. A deceleration in wage growth should help keep a lid on services inflation over the coming months (Chart 10). Chart 10A Deceleration In Wage Growth Should Help Keep Services Inflation Contained An Oasis Of Optimism: Notes From The Middle East An Oasis Of Optimism: Notes From The Middle East During his press conference, Fed Chair Powell described the rise in inflation expectations in the University of Michigan survey as “quite eye-catching.” Although long-term inflation expectations remain a fraction of what they were in the early 1980s, they did rise to the highest level in 14 years in June (Chart 11). Powell also noted that the Fed’s Index of Common Inflation Expectations has been edging higher. The Fed’s focus on ensuring that inflation expectations remain well anchored is understandable. That said, there is a strong correlation between the level of gasoline prices and inflation expectations (Chart 12). If gasoline prices come down from record high levels over the coming months, inflation expectations should drop.  Chart 11Consumer Long-Term Inflation Expectations Keep Rising, But Are Still Not At Historically High Levels Consumer Long-Term Inflation Expectations Keep Rising, But Are Still Not At Historically High Levels Consumer Long-Term Inflation Expectations Keep Rising, But Are Still Not At Historically High Levels Chart 12Lower Gasoline Prices Would Help Soothe Consumer Fears Over Inflation Lower Gasoline Prices Would Help Soothe Consumer Fears Over Inflation Lower Gasoline Prices Would Help Soothe Consumer Fears Over Inflation The Fed expects core PCE inflation to fall to 4.3% on a year-over-year basis by the end of 2022. This would require month-over-month readings of about 0.35 percentage points, which is slightly above the average of the past three months (Chart 13). Our guess is that the Fed may be highballing its near-term inflation projections in order to give itself room to “underpromise and overdeliver” on the inflation front. If so, we could see inflation estimates trimmed later this year, which would provide a more soothing backdrop for risk assets. Chart 13AUS Inflation Will Fall By More Than The Fed Expects If The Monthly Change In Core PCE Is Less Than 0.35% (I) US Inflation Will Fall By More Than The Fed Expects If The Monthly Change In Core PCE Is Less Than 0.35% (I) US Inflation Will Fall By More Than The Fed Expects If The Monthly Change In Core PCE Is Less Than 0.35% (I) Chart 13BUS Inflation Will Fall By More Than The Fed Expects If The Monthly Change In Core PCE Is Less Than 0.35% (II) US Inflation Will Fall By More Than The Fed Expects If The Monthly Change In Core PCE Is Less Than 0.35% (II) US Inflation Will Fall By More Than The Fed Expects If The Monthly Change In Core PCE Is Less Than 0.35% (II) Concluding Thoughts on Investment Strategy According to Bank of America, fund managers cut their equity exposure to the lowest since May 2020. Optimism on global growth fell to a record low. Meanwhile, bears outnumbered bulls by 39 percentage points in this week’s AAII poll (Chart 14). If the stock market is about to crash, it will be the most anticipated crash in history. In my experience, markets rarely do what most people expect them to do. Chart 14Sentiment Towards Equities Is Pessimistic Sentiment Towards Equities Is Pessimistic Sentiment Towards Equities Is Pessimistic Chart 15Global Equities Are More Attractively Valued After The Recent Sell-Off Global Equities Are More Attractively Valued After The Recent Sell-Off Global Equities Are More Attractively Valued After The Recent Sell-Off Chart 16US And European EPS Estimates Have Been Trending Higher This Year US And European EPS Estimates Have Been Trending Higher This Year US And European EPS Estimates Have Been Trending Higher This Year US equities are trading at 16.3-times forward earnings, with non-US stocks sporting a forward P/E ratio of 12.1 (Chart 15). Despite the decline in share prices, earnings estimates in both the US and Europe have increased since the start of the year (Chart 16). The consensus is that those estimates will fall. However, if our expectation that a recession will be averted over the next 12 months pans out, that may not happen. A sensible strategy right now is to maintain a modest overweight to stocks while being prepared to significantly raise equity exposure once clear evidence emerges that inflation has peaked. Peter Berezin Chief Global Strategist peterb@bcaresearch.com Follow me on        LinkedIn Twitter       View Matrix An Oasis Of Optimism: Notes From The Middle East An Oasis Of Optimism: Notes From The Middle East Special Trade Recommendations Current MacroQuant Model Scores An Oasis Of Optimism: Notes From The Middle East An Oasis Of Optimism: Notes From The Middle East

Executive Summary Brent Stable As Demand + Supply Fall Brent Stable As Demand + Supply Fall Brent Stable As Demand + Supply Fall Oil demand growth will slow this year and next by 1.6mm b/d and 1mm b/d, respectively. These expectations are in line with sharp downgrades in World Bank and IMF economic forecasts, which cite pressures from the Ukraine War, COVID-19-induced lockdowns in China, and central-bank policy efforts to contain rising inflation. Lower oil demand will be offset by lower supply from Russia and OPEC 2.0, which now are ~ 1.5mm b/d behind on pledges to restore production taken from the market during the pandemic. In 2022, US production will increase ~750k b/d year-on-year. The strategic relationship between the US and core OPEC 2.0 producers Saudi Arabia and the UAE is fraying. The Core's unwillingness to increase production despite pleas from the Biden administration likely motivated the US’s record SPR release of 180mm barrels (1mm b/d over 6 months). This will be augmented by another 60mm-barrel release of refined products by IEA member states. The EU's threat to stop importing half of Russia's 5mm b/d of oil exports would, if realized, force Russian storage to fill, and lead to production shut-ins. Oil prices would surge to destroy enough demand to cover this loss. Our base-case Brent forecast is at $94/bbl this year and $88/bbl in 2023, leaving our forecast over the period mostly unchanged. Bottom Line: Despite major shifts in global oil supply and demand over the past month, oil markets have remained mostly balanced. We remain long commodity index exposure via the S&P GSCI index, and the COMT ETF. We also are long oil and gas producer exposure via the XOP, and base metals producers via the PICK and XME ETFs. Feature Related Report  Commodity & Energy StrategyDesperate Times, Desperate Measures: Aramco And The Saudi Security Dilemma Oil demand and supply growth are weakening on the back of the Ukraine War, COVID-19-induced lockdowns in China, and central-bank efforts to contain rising inflation. We expect global demand growth to slow this year and next by 1.6mm b/d and 1mm b/d, respectively, in line with downgrades in IMF and World Bank global growth forecasts.1 Demand will fall to 100mm b/d on average this year, down from our earlier expectation of 101.5mm b/d published in March. For next year, we expect global oil consumption to come in at 102.2mm b/d, down from our March estimate of 103.2mm b/d (Chart 1). EM consumption, the engine of oil-demand growth, falls to 54.2mm b/d vs. 55.8mm b/d in last month's forecast for 2022 demand. We have been steadily lowering our estimate for 2022 Chinese demand this year due to its zero-tolerance COVID policy and its associated lockdowns, and again take it down 250k b/d in this month's balances to 15.7mm b/d on average. In our estimates, Chinese oil demand grows 2.6% from its 2021 level of 15.3mm b/d. We have been expecting DM oil consumption to flatten out this year, following massive fiscal and monetary stimulus fueling oil demand during and after the pandemic, and continue to expect it to come in at ~ 45.7mm b/d this year. Chart 1Sharply Lower Oil Demand Expected Sharply Lower Oil Demand Expected Sharply Lower Oil Demand Expected Oil Supply Gets Complicated Oil supply will continue to weaken along with demand this year, primarily due to sanctions imposed on Russia by Western buyers following its invasion of Ukraine. Russia's production reportedly was just above 10mm b/d. Estimates of Russian production losses over 2022-23 range from 1mm b/d to as much as 1.7mm b/d over at the US EIA. The outlier here is the IEA, which warns Russian production will fall 1.5mm b/d this month, then accelerate to 3mm b/d beginning in May. In our base-case modeling, we expect Russian output to average 9.8mm b/d in 2022 and 9.9mm b/d next year (Chart 2). Tracking Russia's production became more complicated, as the government this week announced it no longer would be reporting these data. Prices and satellite services will be needed to impute Russia's output in the future. Russia and the Kingdom of Saudi Arabia (KSA) are the putative leaders of OPEC 2.0 (otherwise known as OPEC+). In the wake of Russia's invasion of Ukraine, OPEC, the original cartel led by KSA, continues to maintain solidarity with Russia, referring in its Monthly Oil Market Report (MOMR), for example, to the "conflict between Russian and Ukraine," or the "conflict in Eastern Europe" – not the war in Ukraine. This would suggest KSA and its allies continue to place a high value in maintaining the OPEC 2.0 structure, which has shown itself to be an extremely useful organization for managing production and production declines among non-Core states – i.e., those states outside the Gulf that cannot increase output, or are managing declining production due to lack of capital, labor or both (Chart 3). Chart 2Brent Stable As Demand + Supply Fall Brent Stable As Demand + Supply Fall Brent Stable As Demand + Supply Fall Chart 3OPEC 2.0 Remains Useful To KSA And Russia War, Lockdowns, Rate Hikes Depress Oil Demand War, Lockdowns, Rate Hikes Depress Oil Demand The strategic relationship between core OPEC 2.0 producers capable of maintaining higher production – KSA and the UAE – and the US is fraying. Both states showed no interest in increasing production despite pleas from the Biden administration following Russia's invasion of Ukraine, and have shown a propensity to expand their diplomatic and financial relationships, e.g., exploring oil sales denominated in Chinese RMB, beyond their US relationships.2 This likely motivated the US’s record SPR release of 180mm barrels (1mm b/d over 6 months). This will be augmented by another 60mm-barrel release of refined products by IEA member states. Outside the OPEC 2.0 coalition, we continue to expect higher output from the US, led by shale oil production. According to Rystad Energy, horizontal drilling permits in the Permian basin hit an all-time high in March.3 If these permits are converted into new projects, oil supply growth will be boosted starting 2023. The US government’s recent announcement to lease around 144,000 acres of land to oil and gas companies – in a bid to bring down high US oil prices – also will spur supply growth towards the beginning of next year.4 These bullish factors are balanced out by nearer-term headwinds. Bottlenecks resulting from pent-up demand released following global lockdowns, the Russia-Ukraine crisis, and investor-induced capital austerity means US oil producers will not be able to turn on the taps as quickly this year as they've been able to do in days gone by. Given the near-term bearish factors and longer-term bullish factors, we expect total US crude production to grow slower this year and ramp up at a faster pace the next. US shale output (i.e., Lower 48 states (L48) ex Gulf of Mexico) is expected to average 9.73mm b/d in 2022 and 10.53mm b/d in 2023 (Chart 4). Total US crude supply is expected to average 11.92mm b/d and 12.74mm b/d, respectively, over this period. Additional production increases are expected from Canada, Brazil and Norway. Chart 4Shales Continue To Pace US Onshore Output Increases Shales Continue To Pace US Onshore Output Increases Shales Continue To Pace US Onshore Output Increases Upside Risk Remains KSA's and the UAE's strategy to hold off on production increases despite US entreaties upends one of our expectations – i.e., that these state would increase production as the deficit in OPEC 2.0 output being returned to the market widened. We are coming around to the idea this could represent a desire to diversify their exposure to USD payments and assets, which, as Russia's invasion of Ukraine demonstrated, can become liabilities in an economic war. This also would begin to reduce the heavy reliance KSA and the UAE place on the US vis-à-vis defending its interests.5 Lastly, we would observe KSA's and the UAE's spare capacity is being husbanded closely, given it constitutes most, if not all, of OPEC 2.0's 3.4mm b/d of spare capacity (Chart 5). There are multiple scenarios in which this spare capacity would be needed by global markets to address production outages. One of the most imposing is an EU embargo on Russian oil imports floated by France this week, which triggers a cut-off of natural gas supplies by Russia to the EU.6 An embargo of Russian oil imports by the EU is a very low-probability event, but it is not vanishingly small. The EU imports about 2.5mm b/d of Russia's crude oil exports. The EU's threat to stop importing half of Russia's 5mm b/d of oil exports would, if realized, force Russian pipelines and storage to fill, and would lead to production shut-ins. Oil prices would have to surge to destroy enough demand to cover this loss of supply, even after OPEC's spare capacity was released into the market. If realized, such an event also would throw the world into recession, in our view. The prospect of a cut-off of Russian oil imports by the EU was addressed last month by Energy Minister Alexander Novak, who said such an act would prompt Russia to shut down natural gas exports to the EU.7 If Russia follows through on such a threat, it would shut down much of the EU's industrial and manufacturing activity. The experience of this past winter – when aluminum and zinc smelters were forced to shut as natural gas prices surged and made electricity from gas-fired generation too expensive for their operations – remains fresh in the mind of the market. An oil-import ban by the EU followed by a cut-off of natgas exports by Russia almost surely would spike volatility in these markets (Chart 6). In addition, a global recession would be a foregone conclusion, in our view. Chart 5OPEC Spare Capacity Concentrated In KSA, UAE War, Lockdowns, Rate Hikes Depress Oil Demand War, Lockdowns, Rate Hikes Depress Oil Demand Chart 6Oil+ Gas Volatility Would Spike If EU Cuts Russian Oil Imports Oil+ Gas Volatility Would Spike If EU Cuts Russian Oil Imports Oil+ Gas Volatility Would Spike If EU Cuts Russian Oil Imports Markets Remain Roughly Balanced … For Now Our supply-demand modeling indicates production losses are roughly balanced by consumption losses at present (Chart 7). If anything, the lost demand slightly outweighs the loss of production, when we run our econometric models. However, we are maintaining a $10/bbl risk premium in our estimates for 2022-23 Brent prices, which keeps our current forecast close to last month's levels. Persistent strength in the USD, particularly in the USD real effective exchange rate, acts as a headwind on prices by making oil more expensive ex-US (Chart 8). We expect this to continue, given the Fed's avowed commitment to raise policy rates to choke off inflation, which, all else equal, will make USD-denominated returns attractive. Chart 7Markets Remain Mostly Balanced Markets Remain Mostly Balanced Markets Remain Mostly Balanced Chart 8Strong USD Restrains Oil Prices War, Lockdowns, Rate Hikes Depress Oil Demand War, Lockdowns, Rate Hikes Depress Oil Demand Investment Implications Despite the major shifts in oil supply and demand over the past month, markets have remained mostly balanced (Table 1). Falling Russian output and weak OPEC 2.0 production – where most states are managing production declines – is being exacerbated by falling Chinese demand and SPR releases from the US and IEA. The market does not yet need the 1.3mm b/d of Iranian output that is being held at bay due to a diplomatic impasse between the US and Iran, which we believe will persist. With overall economic output growth slowing – per the forecasts of the major supranational agencies (WTO, IMF, World Bank) – weaker demand can be expected to persist. Table 1BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) To Dec23 War, Lockdowns, Rate Hikes Depress Oil Demand War, Lockdowns, Rate Hikes Depress Oil Demand This is not to say upside risk is non-existent. A move by the EU to ban Russian oil imports could set in motion sharply higher oil and gas prices and a deep EU recession, as discussed above. This could trigger an immediate need for OPEC spare capacity and those Iranian barrels waiting to return to export markets. We remain long commodity index exposure via the S&P GSCI index, and the COMT ETF. We also are long oil and gas producer exposure via the XOP, and base metals producers via the PICK and XME ETFs.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Analyst Commodity & Energy Strategy ashwin.shyam@bcaresearch.com Paula Struk Research Associate Commodity & Energy Strategy paula.struk@bcaresearch.com   Commodity Round-Up Energy: Bullish Russia's concentration of exposure to OECD Europe – as customers for its energy exports – exceeds the latter's concentration of imports from Russia by a wide margin. Russia produced 10.1mm b/d of crude and condensates in 2021. Of the 4.7mm b/d of this Russia exported last year, OECD Europe was its largest customer, accounting for 50% of total oil exports, according to the US EIA (Chart 9). On the natgas side, more than one-third of the ~ 25 Tcf of natgas produced by Russia last year was exported via pipeline or as LNG, based on 2021 data from the EIA. This amounted to almost 9 Tcf. Most of this – 84% – was exported via pipeline to the OECD Europe, with the biggest customers being Germany, Turkey, Italy and France. As is the case with crude oil and liquids, OECD Europe is Russia's biggest natgas customer, accounting for ~ 75% of exports in either gaseous or liquid form. There is an argument to be made Russia needs OECD Europe as much or more than the latter needs Russia. Ags/Softs: Neutral Grains and vegetable oils are at multi-year or all-time highs, as a result of the war in Ukraine. This week, corn futures hit the highest since 2012, while wheat futures surged amid the ongoing war and unfavorable weather in U.S. growing areas. The U.N. Food and Agriculture Organization's Food Price Index rose 12.6% from February, its highest level since 1990. According to the FAO, the war in Ukraine was largely responsible for the 17.1% rise in the price of grains, including wheat and corn. Together, Russia and Ukraine account for around 30% and 20% of global wheat and corn exports. The cost of fertilizers has increased by almost 30% in many places due to the supply disruptions caused by the war and the tightening of natural gas markets, which is being driven by EU efforts to diversify away from Russian imports of the commodity.8 Planting is expected to be very irregular in the upcoming grain-sowing months, navigate through much higher prices for fuel and fertilizers (Chart 10). Chart 9 War, Lockdowns, Rate Hikes Depress Oil Demand War, Lockdowns, Rate Hikes Depress Oil Demand Chart 10 Wheat Price Level Going Down Wheat Price Level Going Down     Footnotes 1     Please see the IMF's April 2022 World Economic Outlook report entitled War Sets Back the Global Recovery, and the World Bank's Spring Meetings 2022 Media Roundtable Opening Remarks by World Bank Group President David Malpass, posted on April 18, 2022. 2     Please see, e.g., Saudi Arabia Considers Accepting Yuan Instead of Dollars for Chinese Oil Sales published by wsj.com on March 15, 2022.   3    Please see Permian drilling permits hit all-time high in March, signaling production surge on the horizon, published by Rystad Energy on April 13, 2022. 4    Please see Joe Biden resumes oil and gas leases on federal land, published by the Financial Times on April 15, 2022. 5    Please see Desperate Times, Desperate Measures: Aramco And The Saudi Security Dilemma, which we published on January 14, 2014. In that report, we noted, "… the U.S. has decided to stop micromanaging the Middle East. The latter policy sucked in too much of Washington's material resources, blood and treasure, at a time when regional powers like China and Russia were looking to establish their own spheres of influence in East Asia and Eurasia respectively." Building deeper commercial relationships with China also would bind both states together in terms of addressing KSA's security concerns, given China's existing relationships with Iran. This is a longer-term strategy, in our view. 6    Please see An EU embargo on Russian oil in the works - French minister, published by reuters.com on April 19, 2022. 7     Please see War in Ukraine: Russia says it may cut gas supplies if oil ban goes ahead, published by bbc.co.uk on March 8, 2022. 8    Please refer to Food prices soar to record levels on Ukraine war disruptions, published by abcNEWS on April 8, 2022.   Investment Views and Themes Strategic Recommendations Trades Closed in 2022 Image

Executive Summary Higher Prices Expected Higher Prices Expected Higher Prices Expected Global oil supply will move lower for a few months, until shipping can be re-routed and re-priced in response to sanctions against Russian oil producers and refiners.  In the wake of another outbreak of COVID-19 in China, oil demand will likely move marginally lower in the near term.  Chinese fiscal stimulus to support demand and Chinese equity markets will be bullish for oil, natgas and metals. Work-arounds by China and India to circumvent Western sanctions likely will keep the hit to Russian oil production contained to March and April.  However, longer term – 2024 and beyond – sanctions will put Russia's oil output on a downward trajectory. Saudi Arabia will launch an experiment this year to be paid in yuan for oil exports to China.  As a risk-management strategy, KSA needs USD alternatives for storing wealth and retaining access to its foreign reserves, given the success of sanctions in restricting Russia's access to its foreign reserves following its invasion of Ukraine. Our Brent forecast is higher, averaging $93/bbl for this year and in 2023. Bottom Line: We recommend buying the dip in any oil-and-gas equity sell-off.  We remain long the XOP ETF.  We also remain long the S&P GSCI and COMT ETF – long commodity-index based vehicles that benefit from higher commodity prices and increasing backwardation in these markets, particularly oil. Feature Shipping delays in the wake of sanctions – official and self-imposed – against Russian oil and gas exports will stretch out global hydrocarbon supply chains in 1H22. This will have the effect of reducing actual supply, as these vessels are re-routed, and work-arounds are found to get oil to ports accepting Russian material.1 Related Report  Commodity & Energy Strategy2022 Key Views: Past As Prelude For Commodities So far, China and India appear to be moving quickly to develop sanctions work-arounds. Both have long-term trading relationships with Russia, and, in the case of India, the capacity to revive a treaty covering rupee-invoicing of trade in commodities and arms. Estimates of the total hit to Russian oil production resulting from export sanctions imposed by the West following its invasion of Ukraine last month range as high as 5mm b/d in output losses, but we do not share that view.2 There is a strong desire for discounted oil in China and India, and to find alternatives to USD-denominated trade. This has been catalyzed by the sanctions on Russia's central bank and the shutdown of access to its foreign reserves. Payment-messaging systems competitive with the Brussels-based SWIFT network have been stood up already. These will be refined in the wake of the Ukraine war by states with a long-standing desire to diversify payment systems away from the world's reserve currency (i.e., the USD). Among these states, the Kingdom of Saudi Arabia (KSA) is reported to be exploring alternatives for diversifying away from USD-based payment systems, and foreign-reserves custodial relationships dependent on Western central-bank oversight – particularly the US Fed.3 In addition, as ties between China and GCC states have strengthened, the Kingdom might also be looking to diversify its defense partnerships, particularly given the open hostility between the Biden administration in the US and KSA's leadership. Monitoring Chinese state media coverage of this will provide a good indication of the extent of such cooperation. Assessing Highly Uncertain Supply In our base case, Russian output likely falls by ~ 1mm b/d over the March-April period because of shipping delays that force production to be throttled back at the margin due to storage constraints. In its magnitude, this is a similar assumption to the reference case considered by the Oxford Institute for Energy Studies (OIES) but is extended for two months (Table 1).4 We expect shipping delays and payment work-arounds to be sorted out in a couple of months, which, given the incentives of all involved, does not seem unreasonable. Table 1BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) To Dec23 Uncertainty Tightens Oil Supply Uncertainty Tightens Oil Supply In our base case modeling, supply changes by core-OPEC 2.0 in 2022 are required to meet physical deficits brought about by less-than-expected volumes returned to the market by the entire coalition from August 2021 to now. This amounts to ~ 1.2mm b/d by our reckoning. For all of 2022, we assume core-OPEC 2.0 will lift supply by 1.3mm b/d, with most of this being provided to markets beginning in May 2022. In 2023, supplies from KSA, UAE and Kuwait are assumed to increase by roughly 0.2mm b/d, led by KSA (Chart 1). This is higher relative to our previous estimates, given our expectation, this core group will have to lift output to compensate not only for reduced Russian output and supply-chain delays this year and next, but falling output within the producer coalition's other non-core states. Outside OPEC 2.0, stronger WTI futures prices in spot markets and along the entire forward curve drive our estimate of US shale output (L48 ex-GoM) to 9.89mm b/d in 2022 (0.86mm b/d above 2021 levels) and 10.58mm b/d in 2023 (0.69mm above our 2022 levels). Supply-chain disruptions and cost inflation showing up in US shale producers' operations likely will dampen output increases.5 For the US, we expect 2022 average US production of 12.1mm b/d, or 900k b/d higher than 2021 output, and 12.8mm b/d in 2023, which is 700k b/d higher than 2022 levels (Chart 2). Chart 1Still Expecting Core-OPEC 2.0 Production Increases Uncertainty Tightens Oil Supply Uncertainty Tightens Oil Supply Chart 2US Oil Output Slightly Higher US Oil Output Slightly Higher US Oil Output Slightly Higher   Higher Brent prices will encourage short-term production increases from North Sea producers and others. However, it is not clear whether this will incentivize the years-long projects that will be needed to offset the lack of capex in the sector over the past decade or so. One of our high-conviction views resulting from the dearth of capex in oil and gas production is increasingly tighter markets by mid-decade – likely apparent by 2024 – which will require higher prices to reverse the lack of investment in new production. In line with our House view, we are not restoring the return of up to 1.3mm b/d of Iranian production to markets, given the guidance from this source proved unreliable earlier this month when it suspended talks with the US on its nuclear deal. We also are not assuming ceasefire talks between Ukraine and Russia will end to the Ukraine war, given the unreliability of the source (Russia) in these reports. Softer Demand Near Term Over the next few months, we expect the recent upsurge in COVID-19 cases in China to reduce Asian demand, but not tank it relative to our existing assumptions.6 Even though this was expected in our balances estimates, we are reducing our 2Q22 demand estimate by an additional 250k b/d, which is split evenly between DM and EM economies. This reflects the direct short-term hit to EM demand from China's lockdowns and a stronger USD, which raises the local-currency costs of oil, as well as the knock-on effects of additional supply-chain disruptions. Global consumption for 2022 is expected to be 4.4mm b/d higher on average vs 2021 levels, coming in at 101.54mm b/d, and 1.7mm b/d higher in 2023 vs. 2022 levels. We expect the Russian sanctions work-arounds being pursued by China and India – together accounting for a bit more than 20% of global oil demand – will be effective and will put overall EM demand back on trend in 2H22, assuming China's COVID-19 outbreak is brought under control (Chart 3).   Chart 3COVID-19 Hits China Demand, But Does Not Tank EM Overall COVID-19 Hits China Demand, But Does Not Tank EM Overall COVID-19 Hits China Demand, But Does Not Tank EM Overall While markets remain highly fluid – subject to sharp changes in perceptions of fundaments and their trajectories – these supply-demand estimates continue to point to relatively a balanced market this year and next (Chart 4). That said, the supply-demand fundamentals still leave inventories extremely tight, which means they will  provide limited buffering against sudden shifts in supply, demand or both (Chart 5). This will, in our estimation, keep forward curves backwardated, which will support our long-term positions in long commodity-index exposure (i.e., the S&P GSCI and the COMT ETF).  Chart 4Markets Remain Balanced... Markets Remain Balanced... Markets Remain Balanced... Chart 5...And Inventories Remain Tight ...And Inventories Remain Tight ...And Inventories Remain Tight Our base-case balances estimates translate into a 2022 Brent price forecast that averages $93/bbl, and a 2023 average estimate of $93/bbl, which are lower than our previous forecasts of $94/bbl and $98/bbl, respectively. For 1Q22, we now expect prices to average $98/bbl; 2Q22 to average $98.25/bbl; 3Q22 $88.45/bbl; and 4Q22 $87.30/bbl. Risks To Our View The supply side of our modeling remains exposed to exogenous political risks, chiefly: A failure on the part of core-OPEC 2.0 to increase production to offset lower-than-expected output outside the coalition's core; Lower-than-expected US oil output, given stronger-than-expected production discipline; and A return of up to 1.3mm b/d of Iranian barrels, which we no longer are assuming in our balances. We continue to believe core-OPEC 2.0 will increase production because it is in their interest not to allow inventory depletion to accelerate and for prices to move higher faster. The local-currency cost of oil in EM economies – the growth engine for oil demand – is high and going higher. In real terms – i.e., inflation-adjusted terms – it is even higher, as the real effective USD trade-weighted FX rate exceeds that of the nominal rate (Chart 6). This can be seen in the local-currency costs of oil in the world's largest consumers (Chart 7). We expect an announcement from core-OPEC 2.0 by the end of this month regarding a production increase. Chart 6High Real USD FX Rates Increase Local Oil Costs Uncertainty Tightens Oil Supply Uncertainty Tightens Oil Supply Chart 7Local-Currency Oil Costs In Large Consuming States Local-Currency Oil Costs In Large Consuming States Local-Currency Oil Costs In Large Consuming States   Of course, KSA's diversification to USD alternatives as a risk-management strategy makes it less certain it will lead an output increase in exchange for an increased US commitment to its defense. Regarding US shale output, producers remain disciplined in their capital allocation. Even though we expect higher prices across the WTI forward curve will incentivize additional production, we could be over-estimating the extent of this increase in our modeling. Lastly, as noted above, Iran and Russia are indicating their trade concerns have been addressed by the US, which presumably will presumably will be followed by the return up to 1.3mm b/d of production to export markets. However, forward guidance from these producers has not been particularly reliable, and we could be wrong here as well. This would be a bearish fundamental on the supply side, which would pressure prices lower. Investment Implications Given the breakdown in talks between the US and Iran – presumably under pressure from Russia for guarantees the US would not sanction its trade with Iran – our Brent price forecast remains above $90/bbl (Chart 8). We expect the near-term price increase will dissipate as the sanctions work-arounds – particularly by China and India – re-route oil flows. Core OPEC 2.0 producers – KSA, the UAE and Kuwait – have sufficient surplus capacity to increase production to allow refiners to re-build inventories. This big question for markets now is will they bring it to market in the near term? KSA's interest in exploring yuan-linked oil trade with China adds an element of uncertainty to whether production will be increased. Perhaps that is a goal of this exercise: The US is being shown there are alternatives available to large oil exporters re terms of trade and providers of defense services. Chart 8Higher Prices Expected Higher Prices Expected Higher Prices Expected There is sufficient spare capacity available at present to address the current physical deficits in global markets. Our analysis indicates markets are balanced but still tight, as can be seen in current and expected inventory levels. We remain long the XOP ETF and the S&P GSCI and COMT ETF. The latter ETFs provide long commodity-index based exposure that benefits from higher commodity prices and increasing backwardation in commodity markets generally, particularly oil.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Associate Commodity & Energy Strategy ashwin.shyam@bcaresearch.com     Commodities Round-Up Precious Metals: Bullish Markets expected the Federal Reserve's rate hike of 25 basis points in the March and was not disappointed. Further rate hikes this year will occur against the backdrop of high geopolitical uncertainty and inflation, both of which are bullish for gold. The Russia-Ukraine crisis has added a new layer of complexity, and the Fed will need to proceed with caution to curb inflation but not over-tighten the economy.       Footnotes 1     Please see All at sea: Russian-linked oil tanker seeks a port, published by straitstimes.com on March 10, 2022 for examples of shipping delays. 2     Please see Could Russia Look to China to Export More Oil and Natural Gas? published by naturalgasintell.com on March 9, and India says it’s in talks with Russia about increasing oil imports., published on March 15, for additional reporting. See also Besides China, Putin Has Another Potential De-dollarization Partner in Asia published by cfr.org, which discusses India-Russia trade agreements between 1953-92 with the signing of the 1953 Indo-Soviet Trade Agreement. 3    Please see Saudi considering China’s yuan for oil purchases published by al-monitor.com on March 16. 4    Please see the OIES Oil Monthly published on March 14. 5    Oil producers in a ‘dire situation’ and unable to ramp up output, says Oxy CEO published on March 8 by cnbc.com. 6    A resurgence of COVID-19 in China was not unexpected. It was one of our key views going into 2022. Please see 2022 Key Views: Past As Prelude For Commodities, which we published on December 16, 2021. In that report, we noted, "… China still is operating under a zero-tolerance COVID-19 policy, and has relied on less efficacious vaccines that appear to offer no protection against the omicron variant of the coronavirus. This also is a risk for EM economies that rely on these vaccines. However, the roll-out of mRNA vaccines globally via joint ventures will be gathering steam in 2H22, which is bullish for commodity demand." We continue to expect Chinese authorities to deploy mRNA vaccines or antivirals to combat this outbreak.   Investment Views and Themes Strategic Recommendations Trades Closed in 2021 Image

Executive Summary Risk Premium Abates, But Does Not Disappear Oil Risk Premium Abates, But Still Remains Oil Risk Premium Abates, But Still Remains The risk premium in crude oil and natural gas prices is abating, and we expect that to continue. In the immediate aftermath of Russia's invasion, Brent crude oil traded close to $105/bbl on Thursday. At the urging of China's Xi Jinping, Russian President Vladimir Putin suggested he is prepared to enter negotiations with Ukraine in Minsk to discuss the latter's neutrality. Whether Ukraine is amenable to negotiations framed in this manner remains to be seen. Nothing has changed in supply-demand balances for oil or natgas. Markets are tight, and more supply is needed. In this highly fluid situation, we project Brent crude oil will average $100.00/bbl in 1Q22; $90.30/bbl in 2Q22; $85.00/bbl in 3Q22; and $85.00/bbl in 4Q22 (see Chart). Our estimate for 2023 Brent averages $85.00/bbl. Upside risk dominates in the near term. We expect the Kingdom of Saudi Arabia (KSA), the United Arab Emirates (UAE), and Kuwait, the only members of OPEC 2.0 with the capacity to increase and sustain higher production, to lift output by 1.75mm b/d. The Iran nuclear deal likely gets a boost from the Russian invasion, which will hasten the return of ~ 1.0mm b/d of production in 2H22, perhaps sooner. We also expect the US, and possibly the OECD, to release strategic petroleum reserves, but, as typically is the case, this will have a fleeting impact on markets and pricing. These supply increases will return prices closer to our base case forecast, which we raise slightly to $85/bbl from 2H22 to end-2023. If we fail to see an increase in core-OPEC production, or the US shales, or if Iranian barrels are not returned to export markets, oil prices have a good chance of moving to $140/bbl, as can be seen in the accompanying Chart. Bottom Line: We remain long commodity-index exposure (S&P GSCI and the COMT ETF), along with equity exposure to oil and gas producers via the XOP ETF.  

Executive Summary Oil-Price Risk Skewed Upward Scenarios For Oil Prices Scenarios For Oil Prices The $10-$15/bbl risk premium in Brent prices will dissipate over the next month. Russia's best outcome is to follow the off-ramp offered by the US. President Biden's call to KSA's King Salman last week will result in higher oil output from the Kingdom, the UAE and Kuwait, in return for deeper US defense commitments. The Biden administration and Iran are in a hurry to get a deal done: The US wants lower oil prices, and Iran needs the revenue. Our Brent forecasts for 2022 and 2023 are revised slightly to $81.50 and $79.75/bbl, respectively, reflecting supply-demand adjustments. Price risks are tilted to the upside: A miss on any of the above assumptions will keep prices above $90/bbl, and push them higher. Bottom Line: Oil demand will remain robust this year and next.  To keep prices from surging from current levels into demand-destruction territory, additional supply is needed.  Most of this will come from KSA, the UAE and the US shale-oil producers.  We expect prices to fall from current prompt levels this year and next.  This will support sovereign budgets and oil producers' free cashflow goals.  We remain long the XOP ETF. Feature The $10-$15/bbl risk premium in Brent crude oil prices will dissipate, as the following supply-side events are ticked off: 1)   Russia gets on the off-ramp offered by the US last week to de-escalate the threat of another invasion of Ukraine by withdrawing its troops from the border;1 2)   OPEC 2.0's core producers – the Kingdom of Saudi Arabia (KSA), the United Arab Emirates (UAE), and Kuwait – increase supply in return for deeper US security commitments; 3)   Iran restores its remaining 1.0 – 1.2mm b/d of production to the market, following the restoration of its nuclear deal with Western powers; and 4)   US shale-oil producers step up production in response to higher WTI prices. Politics, Then Economics The first three assumptions above are political in nature, requiring a bargain be struck among contending interests to resolve. We do not believe Russia's endgame is to jeopardize its future oil and gas exports to the West, particularly to the EU (Chart 1). The US is warning that another invasion of Ukraine will put the use of the Nord Stream 2 pipeline to deliver gas to Germany at risk.2 It also is worthwhile noting NATO is aligned with the US on this stance. Russia derived 40-50% of its budget revenues from oil and gas production, and ~ 67% of its export revenue from oil and gas over the decade ended in 2020.3 Of course, only President Putin can determine whether oil and gas sales can be diversified enough – e.g., via higher shipments to China – to offset whatever penalties the West imposes. But, in a game-theoretic sense, the stakes are very high, and taking the US off-ramp is rational. Chart 1Russia's Critical Exports: Oil + Gas Lower Oil Prices On The Way Lower Oil Prices On The Way We expect the second assumption to play out in the near term, following US President Joe Biden's call to KSA's King Salman last week. The outreach stressed the US commitment to defend KSA and, presumably, its close allies in the Gulf (the UAE and Kuwait).4 KSA already has increased its production to 10.15mm b/d under the OPEC 2.0 agreement to restore 400k b/d beginning in August 2021. We estimate the coalition had fallen behind on this effort by ~ 1mm b/d, as only KSA, the UAE and Kuwait presently have the capacity to lift production and sustain it (Table 1). KSA's reference production level agreed at OPEC 2.0's July 2021 meeting will rise to 11.5mm b/d in June, up 500k b/d from its current level (Table 2). This means KSA could flex into another 850k b/d between now and the end of May; and another 500k b/d after that. The UAE's and Kuwait's reference production levels will rise 330k and 150k b/d in June to 3.5mm b/d and 3.0mm b/d, respectively. Markets will need these incremental volumes as demand continues to recover and non-core OPEC 2.0 production continues to fall (Chart 2). Table 1BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) To Dec23 Lower Oil Prices On The Way Lower Oil Prices On The Way Table 2Baseline Increases For Core OPEC 2.0 Lower Oil Prices On The Way Lower Oil Prices On The Way Our third assumption reflects our reading of the signaling by Iran over the past few weeks, which indicate growing confidence a deal with the US to restore the Joint Comprehensive Plan of Action (JCPOA) is in the offing.5 The politics here converge with the economics: the Biden Administration wants to increase oil supply ahead of mid-term elections in the US to keep gasoline prices under control; Iran needs to increase its revenues. Both sides get an immediate need satisfied. However, the risks to KSA and its Gulf allies will increase as Iran's revenues grow, because it will be able to fund proxy-war operations against the Gulf states. This is why deepening the US defense commitment to the region is critical to KSA and its allies. The last assumption reflects our view US E+P companies are being incentivized to lift production by high prompt and deferred prices. We continue to expect these companies – particularly those in the US shales, where the majority of the production increase will occur – to husband their capital resources closely, and to continue to prioritize shareholder interests. As capital availability declines – primarily due to reduced investor interest in investing in hydrocarbon production – these firms will have to focus on reducing operating costs and increasing productivity over the next decade to fund growth. Relative to 2021, we expect US oil production to increase 0.85mm b/d this year and by 0.53mm b/d in 2023 relative to this year, as producers respond to higher prices (Chart 3). Chart 2Increased Core OPEC 2.0 Production Becoming Critical Lower Oil Prices On The Way Lower Oil Prices On The Way Chart 3US Oil Production Will See Another Up Leg US Oil Production Will See Another Up Leg US Oil Production Will See Another Up Leg Supply-Demand Balances Are Tight Global oil demand growth this year is reduced slightly in our balances – going to 4.5mm b/d from 4.8mm b/d, mostly reflecting our assessment of slowing growth as central banks remove monetary accommodation. We lifted next year's growth estimate slightly, to 1.7mm b/d. These estimates still leave our growth expectations above the major data providers, the highest of which is OPEC's 4.2mm b/d estimate. We continue to expect DM demand to level off this year and next, and EM demand to retake its position as the global demand growth engine (Chart 4). The supply side remains tight, with average global crude oil and liquid fuels production estimated at 101.5mm b/d for 2022 and 102.8mm b/d for next year. With demand expected to average 101.5mm b/d this year and 103.2mm b/d next year, markets will remain balanced but tight (Chart 5). This means inventories will continue to be strained, leaving little in the way of a cushion to absorb unexpected supply losses (Chart 6).  Chart 4EM Demand Retakes Growth-Engine Role EM Demand Retakes Growth-Engine Role EM Demand Retakes Growth-Engine Role Chart 5Markets Remain Balanced But Tight... Markets Remain Balanced But Tight... Markets Remain Balanced But Tight... Chart 6...Keeping Pressure On Inventories ...Keeping Pressure On Inventories ...Keeping Pressure On Inventories Markets Remain Balanced But Tight Our supply-demand analysis indicates markets will remain balanced but tight, with inventories under pressure until supply increases. This will predispose markets to higher price volatility, as low inventories force prices to ration supply. This will increase the backwardation in the Brent and WTI curves, which will bolster the convenience yield in both of these markets (Chart 7).6 We expect implied volatility to remain elevated, as a result (Chart 8). Chart 7Backwardation Will Keep Convenience Yield Elevated Lower Oil Prices On The Way Lower Oil Prices On The Way Chart 8High Volatility Will Persist High Volatility Will Persist High Volatility Will Persist Because of these low inventory values, Brent prices for 2022 are higher than our previous estimate. By 2023, the effects of increased supply from KSA, UAE, Kuwait – albeit a marginal increase – and the US kick in to reduce prices. As supply increases, the risk premium currently embedded in Brent prices will decline, pushing them to our forecasted levels for 2022 and 2023 of $81.50/bbl and $79.75/bbl, respectively. For 1H22, we expect Brent prices to average $87.20/bbl, and in 2H22 we're forecasting a price of $75.80/bbl on the back of increased production. Next year, higher output will keep prices close to $80/bbl, with 1H23 Brent averaging $79.85 and 2H23 averaging $79.70/bbl. Word Of Caution Our analysis is predicated on strong assumptions regarding the incentives of oil producers taking a rational view of the need for stability and supply in markets. The bottom panel of Chart 9 provides an indication of how tenuous markets are if our assumptions are mistaken, and core OPEC 2.0 does not increase production, Iranian barrels are not returned to the market, or the US shale supply response is less vigorous than we expect. The highest price trajectory occurs when all of our assumptions prove wrong, which takes Brent prices above $140/bbl by the end of 2023. It goes without saying this is non-trivial. But we'll say it anyway: This is non-trivial. We can reasonably expect feedback loops in such a case – e.g., US and Canadian production kicks into high gear, and once-idled North Sea are brought back into service. However, this takes time, and will cause demand destruction on a global scale. Chart 9Scenarios For Oil Prices Scenarios For Oil Prices Scenarios For Oil Prices   Investment Implications Oil markets will remain tight and volatile until additional supplies are forthcoming. We are expecting core OPEC 2.0 to lift output by 3.2mm b/d this year, and for the US Lower 48 production to average 9.8mm b/d. The US production increase will be led by higher shale-oil output, which we expect to average 7.4mm b/d this year and 7.8mm b/d in 2023. Given the tight markets we expect, we remain long the XOP ETF, and commodity index exposure in the form of the S&P GSCI and the COMT ETF, an optimized version of the S&P GSCI.   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 Marketed volumes of US natural gas are expected to hit a record high of just under 107 Bcf/d next year as prices stabilize close to $4/MMBtu, in the EIA's latest estimate. This is up from just over 104 Bcf/d of marketed production this year, which itself was a 3 Bcf/d increase over 2021 levels. Almost all of this will come from the Lower 48 (97%). We expect US LNG exports to increase on the back of rising production and further investment in export terminals. Most of this will be shipped to Europe, in our estimation, as EU states seek to diversify LNG sources in the wake of the Russia-Ukraine standoff currently underway. LNG imports accounted for roughly one-fifth of all natural gas supplied to the UK and EU-27 in 2020, according to the EIA, which notes, "Growing volumes of flexible LNG supplies, primarily from the United States, contributed to the notable increases in LNG imports to Europe from 2019 to 2021." Wide price differentials can be expected to support the flow of LNG to Europe from the US (Chart 10). Base Metals: Bullish Iron ore prices took a hit after China’s National Development and Reform Commission (NDRC) stated its intentions to stabilize iron ore markets, crack down on speculation and false price disclosures after prices in 2022 rallied sharply last week.  Authorities believe price strength is coming from speculation and hoarding, which is adding to inflationary pressures.  However, fundamental factors have been, and likely will keep iron ore prices buoyed.  Based on past steel inventory levels and seasonal patterns, steel production will increase and more than double current inventory levels by end-March. Monetary policy easing, and the push by China’s steel industry to become carbon-neutral over the next five years are additional fundamental factors supporting iron ore prices. Precious Metals: Bullish The January print for US CPI jumped 7.5% year-on-year, beating estimates as headline inflation rose to a 40-year high.  Markets are expecting around five interest increases this year (Chart 11).  BCA’s US Bond Strategy expects rate hikes will be around 100 – 125 bps this year.  Gold prices initially fell on the possibility of increasing rate hikes and a hawkish Fed, but in the second half of last week settled at subsequently higher prices on each day.  Apart from increased inflation demand, this was likely due to markets’ fear of the possibility of an ultra-hawkish Fed, which could tighten US financial conditions and see a rotation out of US equity markets into safe-haven assets or into other markets ex-US, both of which will be bullish for gold. Chart 10 Lower Oil Prices On The Way Lower Oil Prices On The Way Chart 11 US Policy Rate Expectations Going Up US Policy Rate Expectations Going Up         Footnotes 1     Please see Background Press Call by a Senior Administration Official on the President’s Call with Russian President Vladimir Putin, released by the US White House on February 12, 2022. 2     Please see Long-Term EU Gas Volatility Will Increase, which we published on February 3, 2022 for further discussion.  The EU is a huge market for Russia supplies Germany with 65% of its gas.  Approximately 78% of total natural gas exports (pipeline + LNG) from Russia went to the EU in 2020. 3    Please see Russia’s Unsustainable Business Model: Going All In on Oil and Gas, published on January 19, 2021 by the Hague Centre for Strategic Studies (HCSS). 4    Please see Readout of President Joseph R. Biden, Jr.’s Call with King Salman bin Abdulaziz Al-Saud of Saudi Arabia, released on February 7, 2022. The readout noted, " issues of mutual concern, including Iranian-enabled attacks by the Houthis against civilian targets in Saudi Arabia." Energy security also was discussed, which we read as code for a deal to increase production in return for a deepening of US defense commitments. This line is followed closely by Gulf media – e.g., It took Biden a year to realize Saudi Arabia’s vital regional role, published by arabnews.com on February 13, 2022, which notes: "If Putin decides to invade Ukraine, the Saudis are the only ones who could help relieve the unsteady oil markets by pumping more crude, being the largest crude exporter in the OPEC oil production group. The White House emphasized that both leaders further reiterated the commitment of the US and Saudi Arabia in ensuring the stability of global energy supplies. 5    Please see Iran 'is in a hurry' to revive nuclear deal if its interests secured -foreign minister, published by reuters.com on February 14, 2022. 6    Please see our November 4, 2021 report entitled Despite Weaker Prices Crude Oil Backwardation Will Persist for additional discussion of convenience yields and volatility.   Investment Views and Themes Strategic Recommendations Trades Closed in 2021 Image  

Highlights The Kingdom of Saudi Arabia (KSA), Iraq, the UAE and Kuwait – the OPEC 2.0 states capable of increasing production this year – will have to step up for coalition members unable to lift output, including Russia. US shale-oil output also will have to increase to cover demand. The COVID-19 omicron variant has proven to be less severe than anticipated, which likely will translate into a faster recovery in oil demand than was expected in December. One risk looms large: China's zero-COVID policy greatly reduced virus transmission in the country; however, this also reduced natural antibody protection in its population. This is exacerbated by a lack of mRNA vaccine availability. Faltering supply and strong demand will keep inventories tight, reducing buffers to supply shocks – e.g., the Kirkuk–Ceyhan Oil Pipeline explosion this week. We are returning our Brent forecast for 2022 to $80/bbl; for 2023, we continue to expect $81/bbl (Chart of the week). Our forecast assumes OPEC 2.0 will increase supply so as to keep Brent prices below $90/bbl. US shale-oil output also is expected to rise. We continue to see oil-price risk skewed to the upside. Still, demand-destruction from high prices or widespread omicron-induced lockdowns remain clear risks to our outlook. Feature Given the relatively mild symptoms associated with the COVID-19 omicron variant, global oil demand likely will continue to recover lost ground and return to trend sooner than expected. Faltering supply from OPEC 2.0 member states means prices will remain elevated, and perhaps push higher. On the back of these fundamentals, we are restoring our Brent price forecast to $80/bbl for this year, and $81/bbl for 2023. This is the consensus view, and we find ourselves in the uncomfortable position of sharing it. Chart 1 Presently, the oil market is bulled up, expecting high prices this year and next, with Brent forecasts clustering in the $80-$85/bbl range out to 2025.1 Some headline-grabbing forecasts call for $100-plus prices, as top OPEC 2.0 producers – e.g. Russia, Angola and Nigeria– continue to strain in their efforts to restore production, and demand remains buoyant (Chart 2). Chart 2 A consensus usually emerges after most market participants have adjusted their positioning to reflect a commonly held view. This usually is a temporary equilibrium. The market typically finds the highest-pain price trajectory required to shatter the consensus view – e.g., selling off because widely held demand expectations are too high or supply expectations are too low, and vice versa. Ultimately, a fundamental shock destabilizes the consensus, and prices move higher or lower to reflect the new reality. The biggest risks to our price forecast are demand destruction from high prices or widespread omicron-induced lockdowns.2 To keep prices from finding a new equilibrium above $90/bbl, a policy response from OPEC 2.0 to increase production will be required. In addition, US shale-oil output will have to increase. This is not to say we are dismissing above-consensus price realizations: Inventories will continue to draw hard as long as the level of supply remains below demand. This will leave little in the way of buffer stocks to even out price spikes, as the Ceyhan pipeline explosion demonstrated earlier this week.3 Geopolitical tensions are high in eastern Europe as Russia and the West square off, and in the Persian Gulf as Iran squares off against GCC states and the US.4 These structural and geopolitical risks leave markets exposed to volatile price spikes. OPEC 2.0 Falters Chart 3 Chart 4 Our forecast is contingent on the core OPEC 2.0 member states ex-Russia – KSA, Iraq, the UAE and Kuwait – increasing production by an average of ~ 3.34mmb/d in 2022 and 2.76 mmb/d in 2023 relative to 2021. Most of the increases comes from KSA, Iraq and UAE (Chart 3). In addition, we expect US shale-oil producers to increase their average output by 0.6mm b/d this year, and 1.07mm b/d in 2023 relative to 2021 (Chart 4). In 2022, US crude oil supply reaches 11.7mm b/d, and in 2023 it goes to 12.13mm b/d in our estimates. The slower increase in US output this year largely is a function of the delay we expect in assembling rigs and crews to significantly lift production from current levels. These production increases are needed to make up for ongoing downgrades of OPEC 2.0 member states' ability to increase output, including Russia, where we expect crude oil production to remain flat at a little over 10mm b/d this year on average (Table 1). Table 1BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) To Dec23 Higher Output Needed To Constrain Oil Prices Higher Output Needed To Constrain Oil Prices Back in July 2021, the coalition agreed to restore 400k b/d of production taken off the market in the wake of COVID-19 demand destruction. Thus far, the coalition has only managed to restore ~ 1.86mm b/d of the 2mm b/d pledged for August to December 2021, according to the Oxford Institute for Energy Studies (OIES). For this year, the OIES notes OPEC 2.0 "will struggle to return more than 2 mb/d of withheld supplies in 2022, compared to the headline target of 3.76 mb/d."5 Our view rests on a policy call at the end of the day: We believe OPEC 2.0 – KSA in particular – is well aware of the demand-destruction potential high nominal prices and a strong USD pose, particularly as the US Fed is embarking on a rate-hike program to accompany the quantitative-tightening measures recently adopted. Absent a concerted effort to raise production by the core OPEC 2.0 states ex-Russia and the US shale producers, prices could move above $86/bbl as supply tightens and demand continues to rise. This can be seen in The Chart of the Week (the dashed brown curve depicting our estimate for prices without higher production). Importantly, even if such a concerted effort emerges, a failure to resolve the Iran nuclear talks with the US and its allies this year would keep more than 1mm b/d of production from returning to the market. This would push average Brent prices this year and next to or above $90/bbl. Oil Demand Recovery To Continue Provided we do not see widespread lockdowns resulting from the rapid transmission of the omicron variant, we expect global demand to grow close to 4.8mm b/d this year and 1.6mm b/d in 2023 (Chart 5). This reflects our view that – baring too-high prices or another full-scale COVID-induced lockdown in a key market like China – demand resumes its return to trend. It is important to point out that the increase in oil demand we expect is being driven by economic growth, which means consumers likely can withstand high prices, just as long as they do not become excessive – i.e., entrenched above $90/bbl in our view. Chart 5Global Oil Demand Forecast Remains Steady Global Oil Demand Forecast Remains Steady Global Oil Demand Forecast Remains Steady Chart 6OPEC 2.0 Production Policy Kept Supply Below Demand OPEC 2.0 Production Policy Kept Supply Below Demand OPEC 2.0 Production Policy Kept Supply Below Demand In our base case model, we continue to see markets remaining balanced (Chart 6) – assuming we get the policy calls right – and OECD oil inventories falling (Chart 7). Even with an uptick in inventories, which presently are 31.5mm barrels above the 2010-14 average, days-forward-cover for the OECD will remain low (Chart 8). Chart 7Crude Inventories Continue To Draw Crude Inventories Continue To Draw Crude Inventories Continue To Draw Chart 8 Investment Implications The consensus view calls for oil prices to remain at current elevated levels, and to perhaps push higher. We share that view – and have maintained it for some time – which gives us pause. A consensus not only reflects a shared view. It likely reflects broad similarities in the way market participants are positioned in their capex, investment and trading outlooks. This is inherently unstable. We expect oil prices to remain elevated, and have returned our 2022 Brent forecast to $80/bbl on average. Our 2023 forecast for Brent remains $81/bbl. We continue to recommend positions that benefit from tightening markets in which forward curves are backwardated and likely to remain so. Even if we see production increasing – from the OPEC 2.0 core producers ex-Russia and the US shales – we still expect forward Brent and WTI curves to remain backwardated (prompt-delivery prices exceed deferred-delivery prices). We remain long the S&P GSCI and the COMT ETF to express this view. If we fail to see production increase to keep prices from breaching and sustaining levels above $90/bbl, long index exposure will post higher gains. The risk to our view is two-fold: 1) High prices leading to demand-destruction, which is made more acute when the USD is strong; and 2) widespread omicron-induced lockdowns, which could once again reduce consumption and lead to global supply-chain gridlock. High prices leading to demand destruction, or another round of lockdowns would force us to reconsider our positioning.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Associate Commodity & Energy Strategy ashwin.shyam@bcaresearch.com Paula Struk Research Associate Commodity & Energy Strategy paula.struk@bcaresearch.com Commodities Round-Up Energy: Bullish It's very early days, but EU experts are reviewing a draft plan leaked to the media earlier this month, which could result in gas- and nuclear-powered generation being included among sustainable energy sources, and suitable to bridge the global energy transition to renewable power. The draft of the common classification system for EU funding of sustainable economic activities, or taxonomy, apparently states gas plants can earn a “transitional” label if they meet several criteria, including an emissions limit of 270g of CO2e/kWh, or if their annual emissions average 550kg CO2e/kW or less over 20 years. This criterion would be applied to judging environmental performance of a gas plant over 20 years, but offers no guarantee that its emissions would drop over time. The chair of the expert panel said draft rules for nukes raised questions over "whether a plant can guarantee its green credentials today, if its obligation to manage nuclear waste – one of the main environmental concerns about the fuel – does not kick in until as late as 2050," according to euractiv.com, which broke the story earlier this month. Base Metals: Bullish Indonesia has become more restrictive with exports of raw commodities in order to attract more downstream investments and to play a bigger role in producing finished goods. Of these commodities, Indonesia’s supply of nickel, relative to the world is the highest, constituting ~ 38% of total global nickel supply. In 2020, the nation banned nickel ore exports, and is now considering a progressive export tax on low nickel content products such as ferronickel and nickel pig iron. This tax could reduce foreign investment in Indonesia’s nickel mines and global supply, which would, all else equal, support prices. These developments arrive on the back of low nickel inventories, which helped prices of the key battery metal reach a 10-year high last week (Chart 9).   Precious Metals: Bullish In 2021, gold ETFs were hit by outflows of ~ $9 billion, the main reason the yellow metal was unable to reach its 2020 high above the $2,000/oz mark (Chart 10). For this year, we expect a supportive gold market, as real interest rates will remain weak despite the Fed’s hawkish tilt to lift nominal interest rates higher. In line with BCA’s Foreign Exchange Strategy service, we expect the USD to fall over the 12-18 month horizon, which will also bolster gold. Chart 9 Tighter Nickel Balances Going Forward Will Push Prices Higher Tighter Nickel Balances Going Forward Will Push Prices Higher Chart 10       Footnotes 1     Please see Column: Oil prices expected to rise with big variation in projections: Kemp, published by reuters.com on January 19, 2022. 2     High nominal oil prices and a strong USD compound the former demand-destruction risk.  The latter risk of wide-spread omicron-induced lockdowns is elevated in China at present.  Its success in shutting down the transmission of earlier COVID-19 mutations has reduced the amount of antibodies to the virus in the population.  This is compounded by a lack of mRNA vaccine production and distribution, which leaves the country at risk to wide-spread omicron transmission.  In states with large shares of the population carrying COVID-19 antibodies – e.g., the UK – omicron is less of a risk and is on course to becoming endemic.  Please see 2022 Key Views: Past As Prelude For Commodities and Endemic COVID-19 Will Spur Commodities' Next Leg Higher which we published on December 16, 2021 and January 13, 2022 for discussions. 3    Oil flows are expected to return to normal in short order.  Please see Halted Iraq-Turkey flows to resume within hour: Botas, published by argusmedia.com on January 19, 2022. 4    Please see Russia/Ukraine: Implications From Kazakhstan and Geopolitical Charts For The New Year published by BCA Research's Geopolitical Strategy service on January 7 and 14, 2022, respectively, for discussions. 5    Please see Key Themes for the Global Energy Economy in 2022 published by the Oxford Institute for Energy Studies on January 18, 2022.   Investment Views and Themes Strategic Recommendations Trades Closed in 2021 Image

HighlightsThe power shortage in China due to depleted coal inventories and low hydro availability will push copper and aluminum inventories lower, as refineries there – which account for roughly one-half of global capacity – are shut to conserve power (Chart of the Week).Given the critical role base metals will play in the decarbonization of the global economy, alternative capacity will have to be incentivized ex-China by higher prices to reduce refining-concentration risk in the future.Unexpectedly low renewable-energy output in the EU and UK following last year's cold winter will keep competition with China for LNG cargoes elevated this winter.  It also highlights the unintended consequences of phasing down fossil-fuel generation without sufficient back-up.The US Climate Prediction Center kept its expectation for a La Niña at 70-80%, which raises the odds of a colder-than-normal winter for the Northern Hemisphere.  Normal-to-warmer temps cannot be entirely dismissed, however.Increased production of highly efficacious COVID-19 vaccines globally – particularly in EM economies – will stoke economic growth and release pent-up demand among consumers.We remain long 1Q22 natgas exposure via call spreads; long commodity index exposure (S&P GSCI and COMT ETF) to benefit from increasing backwardation as inventories of industrial commodities fall; and long the PICK ETF to benefit from expected tightening of base metals markets.FeatureNatgas prices are surging in the wake of China's and Europe's scramble to cover power shortages arising from depleted coal inventories and low hydroelectric generation in the former, and unexpectedly low output from renewables in the latter (Chart 2).1Given all the excitement of record-high gas prices in the EU and surging oil prices earlier this week, it is easy to lose sight of the longer-term implications of these developments for the global decarbonization push. Chart of the WeekBase Metals Refining Concentrated In China La Niña And The Energy Transition La Niña And The Energy Transition   Chart 2Surge In Gas Prices Continues La Niña And The Energy Transition La Niña And The Energy Transition  Global copper inventories have been tightening (Chart 3) along with aluminum balances (Chart 4).2 Power shortages in China- which accounts for ~40% of global refined copper output and more than 50% of refined aluminum - are forcing shutdowns in production by authorities seeking to conserve energy going into winter. In addition, the upcoming Winter Olympics in February likely will keep restrictions on steel mills, base-metals refiners, and smelters in place, so as to keep pollution levels down and skies blue. Chart 3Supply-Demand Balance Tightening In Copper Supply-Demand Balance Tightening In Copper Supply-Demand Balance Tightening In Copper   Chart 4Along With Aluminum Balances... Along With Aluminum Balances... Along With Aluminum Balances...  This will keep prices well supported and force manufacturers to draw on inventories, which will keep forward curves for copper (Chart 5) and aluminum (Chart 6) backwardated. Higher costs for manufactured goods can be expected as well, which will exacerbate the cost-push inflation coming through from clogged global supply chains. This slowdown in global supply chains is largely the result of global aggregate demand improving at a faster rate than supply.3 Chart 5Copper Prices And Backwardation Copper Prices And Backwardation Copper Prices And Backwardation   Chart 6...Will Increase Along With Aluminum ...Will Increase Along With Aluminum ...Will Increase Along With Aluminum  The pressures on base metals markets highlight the supply-concentration risks associated with the large share of global refining capacity located in China. This makes refined base metals supplies and inventories globally subject to whatever dislocations are impacting China at any point in time. As the world embarks on an unprecedented decarbonization effort, this concentration of metals refining capacity becomes increasingly important, given the centrality of base metals in the build-out of renewable-energy and electric-vehicles (EVs) globally (Chart 7).In addition, increasing tension between Western states and China supports arguments to diversify supplies of refined metals in the future (e.g., the US, UK and Australia deal to supply US nuclear-powered submarine technology to Australia, and the tense Sino-Australian trade relationship that led to lower Chinese coal inventories).4 Chart 7The Need For Refined Metals Grows La Niña And The Energy Transition La Niña And The Energy Transition  EU's Renewables Bet SoursUnlike China, which gets ~ 11% of its electricity from renewables and ~ 63% of its power from coal-fired generation (Chart 8), the EU gets ~ 26% of its power from renewables and ~ 13% from coal (Chart 9). In fact, the EU's made a huge bet on renewables, particularly wind power, which accounts for ~55% of its renewables supply. Chart 8China's Dependence On Coal … La Niña And The Energy Transition La Niña And The Energy Transition   Chart 9… Greatly Exceeds The EU's La Niña And The Energy Transition La Niña And The Energy Transition  Unexpectedly low renewable-energy output in the EU and UK this summer – particularly wind power – forced both to scramble for natgas and coal supplies to cover power needs.5 As can be seen in Chart 9, the EU has been winding down its fossil-fuel-fired electric generation in favor of renewables. When the wind stopped blowing this year the EU was forced into an intense competition with China for LNG cargoes in order to provide power and rebuild storage for the coming winter (Chart 10). Chart 10The Scramble For Natgas Continues La Niña And The Energy Transition La Niña And The Energy Transition  The current heated – no pun intended – competition for natgas going into the coming winter is the result of two policy errors, which will be corrected by Spring of next year. On China's side, coal inventories were allowed to run down due to diplomacy, which left inventories short going into winter. In the EU, wind power availability fell far short of expectations, another result of a policy miscalculation: Nameplate wind capacity is meaningless if the wind stops blowing. Likewise for sun on a cloudy day.Natgas Price Run-Up Is TransitoryThe run-up in natgas prices occasioned by China's and the EU's scramble for supplies is transitory. Still, uncertainty as to the ultimate path global gas prices will take is at its maximum level at present.The US Climate Prediction Center kept its expectation for a La Niña at 70-80%, which raises the odds of a colder-than-normal winter for the Northern Hemisphere. Even so, this is a probabilistic assessment: Normal-to-warmer temps cannot be dismissed, given this probability. A normal to warmer winter would leave US inventories and the availability to increase LNG exports higher, which would alleviate much of the pricing pressure holding Asian and European gas prices at eye-watering levels presently.Going into 1Q22, we expect increased production of highly efficacious COVID-19 vaccines globally – particularly in EM economies – will stoke economic growth and release pent-up demand among consumers as hospitalization and death rates continue to fall (Chart 11).6 At that point, we would expect economic activity to pick up significantly, which would be bullish for natgas. We also expect US and Russian natgas production to pick up, with higher prices supporting higher rig counts in the US in particular. Chart 11Expect Continued COVID-19 Progress La Niña And The Energy Transition La Niña And The Energy Transition  Investment ImplicationsAs the world embarks on an unprecedented decarbonization effort, it is important to follow the supply dynamics of base metals, which will provide the materials needed to build out renewable generation and EVs.The current price pressure in natural gas markets resulting from policy miscalculations cannot be ignored. Still, this pressure is more likely to be addressed quickly and effectively than the structural constraints in base metals markets.On the base metals side, producers remain leery of committing to large capex projects at the scale implied by policy projections for the renewables buildout.7In addition, current market conditions highlight concentration risks in these markets – particularly on the refining side in base metals, where much of global capacity resides in China. On the production and refining side of EV materials, battery technology remains massively concentrated to a few countries (e.g., cobalt mining and refining in the Democratic Republic of Congo and China, respectively).This reinforces our view that oil and gas production and consumption likely will not decay sharply unless and until these capex issues and concentration risks are addressed. For this reason, we remain bullish oil and gas. Robert P. Ryan Chief Commodity & Energy Strategistrryan@bcaresearch.comAshwin ShyamResearch AssociateCommodity & Energy Strategyashwin.shyam@bcaresearch.com Commodities Round-UpEnergy: BullishDelegates at OPEC 2.0's Ministerial Meeting on Monday likely will agree to increase the amount of oil being returned to markets by an additional 100-200k b/d. This would take the monthly production rate of production being restored from 400k b/d to 500-600k b/d. Depending on how quickly mRNA vaccine production in large EM markets is rolled out, this incremental increase could remain in place into 2Q22. This would assuage market concerns prices could get to the point that demand is destroyed just as economic re-opening is beginning in EM economies. Our view remains that the producer coalition led by Saudi Arabia and Russia will continue to balance the need for higher revenues of member states with the fragile recovery in EM economies. We continue to expect prices in 2022 to average $75/bbl and $80/bbl in 2023 (Chart 12). This allows OPEC 2.0 states to rebuild their balance sheets and fund their efforts to diversify their economies without triggering demand destruction.Base Metals: BullishA power crunch and decarbonization policies in China are supporting aluminum prices at around 13-year highs, after reaching a multi-year peak earlier this month (Chart 13). The energy-intensive electrolytic process of converting alumina to metal makes aluminum production highly sensitive to fluctuations in power prices. High power prices and electricity shortages are impacting aluminum companies all over China, one of which is Yunnan Aluminium. According to the Financial Times, the company accounts for 10% of total aluminum supply in the world’s largest producer.Precious Metals: BullishGold prices dipped following a hawkish FOMC meeting last week. More Fed officials see a rate hike in 2022, compared to the previous set of projections released in June. Fed Chair Jay Powell also hinted at a taper in the asset purchase program on the back of a rebounding US economy, provided a resurgence in COVID-19 does not interrupt this progress. A confirmation of what markets were expecting – i.e., paring asset purchases by year-end – and possible rate hikes next year have buoyed the US dollar and Treasury yields. The USD competes directly with gold for safe-haven investment demand. Higher interest rates will increase the opportunity cost of holding the yellow metal. As a result, gold prices will be subdued when the USD is strengthening. We remain bearish the USD, and, therefore, bullish gold. Chart 12Oil Forecasts Hold Steady Oil Forecasts Hold Steady Oil Forecasts Hold Steady   Chart 12Aluminum Prices Recovering Aluminum Prices Recovering Aluminum Prices Recovering    Footnotes1     Please see China's Yunnan imposes output curbs on aluminium, steel, cement makers published by reuters.com on September 13, 2021.2     NB: Global aluminum inventory data are unreliable and we do not publish them.3    Please see, e.g., Supply Chains, Global Growth, and Inflation, published by gspublishing.com on September 20, 2021.4    Please see US-China: War Preparation Pushes Commodity Demand, a Special Report we published on August 26, 2021, for further discussion.5    We discuss this in last week's report entitled Natgas Markets Continue To Tighten, which is available at ces.bcaresearch.com.6    Please see Upside Price Risk Rises For Crude, which updated our oil-price balances and forecasts. We highlight the recent agreements to mass produce the highly effective mRNA COVID-19 vaccines globally as bullish for oil prices. It also will be bullish for natgas and other commodities.7     Please see Assessing Risks To Our Commodity Views, which we published on July 8, 2021, for additional discussion. Investment Views and ThemesStrategic RecommendationsTactical TradesCommodity Prices and Plays Reference TableTrades Closed in 2021Summary of Closed Trades