Saudi Arabia

Highlights Stronger global growth in the wake of continued and expected fiscal and monetary stimulus, and progress against COVID-19 are boosting oil demand assumptions by the major data suppliers for this year.  We lifted our 2021 global demand estimate by 640k b/d to 98.25mm b/d, and assume OPEC 2.0 will make the necessary adjustments to keep Brent prices closer to $60/bbl than not, so as not to disrupt a fragile recovery. We are maintaining our 2022 and 2023 Brent forecasts at $65/bbl and $75/bbl. Commodity markets are ignoring the rising odds of armed conflict involving the US, Russia and China and their clients and allies.  Russia has massed troops on Ukraine’s border and warned the US not to interfere.  China has massed warships off the coast of the Philippines, and continues its incursions in Taiwan’s air-defense zone, keeping US forces on alert.  Intentional or accidental engagement would spike oil prices.  Two-way price risk abounds.  In addition to the risk of armed hostilities, faster distribution of vaccines would accelerate recovery and boost prices above our forecasts.  Downside risk of a resurgence in COVID-19-induced lockdowns remains, as rising death and hospitalization rates in Brazil, India and Europe attest (Chart of the Week). Feature Oil-demand estimates – ours included – are reviving in the wake of measurable progress in combating the COVID-19 pandemic in major economies, and an abundance of fiscal and monetary stimulus, particularly out of the US.1 On the back of higher IMF GDP projections, we lifted our 2021 global demand estimate by 640k b/d to 98.25mm b/d in this month’s balances. In our modeling, we assume OPEC 2.0 will make the necessary adjustments to keep Brent prices closer to $60/bbl than not, so as not to disrupt a fragile recovery. In an unusual turn of events, the early stages of the recovery in oil demand will be led by DM markets, which we proxy using OECD oil consumption (Chart 2). Thereafter, EM economies, re-take the growth lead next year and into 2023. Chart of the WeekCOVID-19 Deaths, Hospitalizations Threaten Global Recovery Upside Oil Price Risks Are Increasing Upside Oil Price Risks Are Increasing Chart 2DM Demand Surges This Year DM Demand Surges This Year DM Demand Surges This Year Absorbing OPEC 2.0 Spare Capacity We continue to model OPEC 2.0, the producer coalition led by the Kingdom of Saudi Arabia (KSA) and Russia, as the dominant producer in the market. The growth we are expecting this year will absorb a significant share of OPEC 2.0’s spare capacity, most of which – ~ 6mm b/d of the ~ 8mm b/d – is to be found in KSA (Chart 3). The core producers’ spare capacity allows them to meet recovering demand faster than the US shale producers can mobilize rigs and crews and get new supply into gathering lines and on to main lines. We model the US shale producers as a price-taking cohort, who will produce whatever the market allows them to produce. After falling to 9.22mm b/d in 2020, we expect US production to recover to 9.56mm b/d this year, 10.65mm b/d in 2022, and 11.18mm in 2023 (Chart 4). Lower 48 production growth in the US will be led by the shales, which will account for ~ 80% of total US output each year. Chart 3Core OPEC 2.0 Spare Capacity Will Respond First To Higher Demand Core OPEC 2.0 Spare Capacity Will Respond First To Higher Demand Core OPEC 2.0 Spare Capacity Will Respond First To Higher Demand Chart 4Shale Is The Marginal Barrel In The Price Taking Cohort Shale Is The Marginal Barrel In The Price Taking Cohort Shale Is The Marginal Barrel In The Price Taking Cohort OPEC 2.0’s dominant position on the supply side allows it to capture economic rents before non-coalition producers, which will remain a disincentive to them until the spare capacity is exhausted. Thereafter, the price-taking cohort likely will fund much of its E+P activities out of retained earnings, given their limited ability to attract capital. Equity investors will continue to demand dividends that can be maintained and grown, or return of capital via share buybacks. This will restrain production growth to those firms that are profitable. We expect the OPEC 2.0 coalition’s production discipline will keep supply levels just below demand so that inventories continue to fall, just as they have done during the COVID-19 pandemic, despite the demand destruction it caused (Chart 5). These modeling assumptions lead us to continue to expect supply and demand will continue to move toward balance into 2023 (Table 1). Chart 5Supply-Demand Balances in 2021 Supply-Demand Balances in 2021 Supply-Demand Balances in 2021 Table 1BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) Upside Oil Price Risks Are Increasing Upside Oil Price Risks Are Increasing We continue to expect this balancing to induce persistent physical deficits, which will keep inventories falling into 2023 (Chart 6). As inventories are drawn, OPEC 2.0’s dominant-producer position will allow it to will keep the Brent and WTI forward curves backwardated (Chart 7).2 We are maintaining our 2022 and 2023 Brent forecasts at $65/bbl and $75/bbl (Chart 8). Chart 6OPEC 2.0 Policy Continues To Keep Supply Below Demand... OPEC 2.0 Policy Continues To Keep Supply Below Demand... OPEC 2.0 Policy Continues To Keep Supply Below Demand... Chart 7OECD Inventories Fall to 2023 OECD Inventories Fall to 2023 OECD Inventories Fall to 2023 Chart 8Brent Forecasts Rise As Global Economy Recovers Brent Forecasts Rise As Global Economy Recovers Brent Forecasts Rise As Global Economy Recovers Two-Way Price Risk Abounds Risks to our views abound on the upside and the downside. To the upside, the example of the UK and the US in mobilizing its distribution of vaccines is instructive. Both states got off to a rough start, particularly the US, which did not seem to have a strategy in place as recently as January. After the US kicked its procurement and distribution into high gear its vaccination rates soared and now appear to be on track to deliver a “normal” Fourth of July holiday in the US. The UK has begun its reopening this week. Both states are expected to achieve herd immunity in 3Q21.3 The EU, which mishandled its procurement and distribution likely benefits from lessons learned in the UK and US and achieves herd immunity in 4Q21, according to McKinsey’s research. Any acceleration in this timetable likely would lead to stronger growth and higher oil prices. The next big task for the global community will be making vaccines available to EM economies, particularly those in which the pandemic is accelerating and providing the ideal setting for mutations and the spread of variants that could become difficult to contain. The risk of a resurgence in large-scale COVID-19-induced lockdowns remains, as rising death and hospitalization rates in Brazil, India and Europe attest. Cry Havoc The other big upside risk we see is armed conflict involving the US, Russia, China and their clients and allies. Commodity markets are ignoring these risks at present. Even though they do not rise to the level of war, the odds of kinetic engagement – planes being shot down or ships engaging in battle in the South China Sea – are rising on a daily basis. This is not unexpected, as our colleagues in BCA Research’s Geopolitical Strategy pointed out recently.4 Indeed, our GPS service, led by Matt Gertken, warned the Biden administration would be tested in this manner by Russia and China from the get-go. Russia has massed troops on Ukraine’s border and warned the US not to interfere. China has massed warships off the coast of the Philippines, and continues its incursions in Taiwan’s air-defense zone, keeping US forces on alert. Political dialogue between the US and Russia and the US and China is increasingly vitriolic, with no sign of any leavening in the near future. Intentional or accidental engagement could let slip the dogs of war and spike oil prices briefly. Finally, OPEC 2.0 is going to have to accommodate the “official” return of Iran as a bona fide oil exporter, if, as we expect, it is able to reinstate its nuclear deal – i.e., the Joint Comprehensive Plan of Action (JCPOA) – with Western states, which was abrogated by then-President Donald Trump in 2018. This may prove difficult, given our view that the oil-price collapse of 2014-16 was the result of the Saudis engineering a market-share war to tank prices, in an effort to deny Iran $100+ per-barrel prices that had prevailed between end-2010 and mid-2014. OPEC 2.0, particularly KSA, has not publicly involved itself in the US-Iran negotiations. However, it is worthwhile recalling that following the disastrous market-share war launched in 2014, KSA and the rest of OPEC 2.0 did accommodate Iran’s return to markets post-JCPOA.   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 Brent and WTI prices rallied sharply following the release of the EIA’s Weekly Petroleum Status Report showing a 9.1mm-barrel decline in US crude and product stocks for the week ended 9 April 2021. This was led by a huge draw in commercial crude and distillate inventories (5.9mm barrels and 2.1mm barrels, respectively). These draws came on the back of generally bullish global demand upgrades by the major data services (EIA, IEA and OPEC) over the past week. These assessments were supported by EIA data showing refined-product demand – i.e., “product supplied” – jumped 1.1mm b/d for the week ended 9 April. With vaccine distributions picking up steam, despite setbacks on the Johnson & Johnson jab, the storage draws and improved demand appear to have catalyze the move higher. Continued weakness in the USD also provided a tailwind, as did falling real interest rates in the US. Base Metals: Bullish Nickel prices fell earlier this week, as China’s official Xinhua news agency reported that Chinese Premier, Li Keqiang stressed the need to strengthen raw materials’ market regulation, amidst rising commodities prices, which been pressuring corporate financial performance (Chart 9). This statement came after China’s top economic advisor, Liu He also called for authorities to track commodities prices last week. Nickel prices fell by around $500/ ton earlier this week on this news, and were trading at $16,114.5/MT on the London Metals exchange as of Tuesday’s close. Other base metals were not affected by this news. Precious Metals: Bullish The US dollar and 10-year treasury yields fell after March US inflation data was released earlier this week. US consumer prices rose by the most in nearly nine years. The demand for an inflation hedge, coupled with the falling US dollar and treasury yields, which reduce the opportunity cost of purchasing gold, caused gold prices to rise (Chart 10). This uncertainty, coupled with the increasing inflationary pressures due to the US fiscal stimulus will increase demand for gold. Spot COMEX gold prices were trading at $1,746.20/oz as of Tuesday’s close. Ags/Softs: Neutral The USDA reported ending stocks of corn in the US stood at 1.35 billion bushels, well below market estimates of 1.39 billion and the 1.50 billion-bushel estimate by the Department last month, according to agriculture.com’s tally.  Global corn stocks ended at 283.9mm MT vs a market estimate of 284.5mm MT and a Department estimate of 287.6mm MT.  Chart 9Base Metals Are Being Bullish Base Metals Are Being Bullish Base Metals Are Being Bullish Chart 10Gold Prices To Rise Gold Prices To Rise Gold Prices To Rise   Footnotes 1     Please see US-Russia Pipeline Standoff Could Push LNG Prices Higher, which we published on 8 April 2021 re the IMF’s latest forecast for global growth.  Briefly, the Fund raised its growth expectations for this year and next to 6% and 4.4%, respectively, nearly a full percentage-point increase versus its January forecast update for 2021 2     A backwardated forward curve – prompt prices trading in excess of deferred prices – is the market’s way of signaling tightness.  It means refiners of crude oil value crude availability right now over availability a year from now.  This is exactly the same dynamic that drives an investor to pay $1 today for a dollar bill delivered tomorrow than for that same dollar bill delivered a year from now (that might only fetch 98 cents today, e.g.). 3    Please see When will the COVID-19 pandemic end?, published 26 March 2021 by McKinsey & Co. 4    Please see The Arsenal Of Democracy, a prescient analysis published 2 April 2021 by BCA’s Geopolitical Strategy.  The report notes the Biden administration “still faces early stress-tests on China/Taiwan, Russia, Iran, and even North Korea.  Game theory helps explain why financial markets cannot ignore the 60% chance of a crisis in the Taiwan Strait. A full-fledged war is still low-probability, but Taiwan remains the world’s preeminent geopolitical risk.”   Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades Higher Inflation On The Way Higher Inflation On The Way

Highlights Continued upgrades to global economic growth – most recently by the IMF this week –will support higher natgas prices.  In our estimation, gas for delivery at Henry Hub, LA, in the coming withdrawal season (November – March) is undervalued at current levels at ~ $2.90/MMBtu. Inventory demand will remain strong during the current April-October injection season, following the blast of colder-than-normal weather in 1Q21 that pulled inventories lower in the US, Europe and Northeast Asia. The odds the US will succeed in halting completion of the final leg of the Russian Nord Stream 2 natural gas pipeline into Germany are higher than the consensus expectation.  Our odds the pipeline will not be completed this year stand at 50%, which translates into higher upside risk for natural gas prices.  We are getting long 1Q22 calls on CME/NYMEX Henry Hub-delivered natgas futures struck at $3.50/MMBtu vs. short 1Q22 $3.75/MMBtu calls at tonight's close.  The probability of Nord Stream 2 cancellation is underpriced, which means European TTF and Asian JKM prices will have to move higher to attract LNG cargoes next winter from the US, if the pipeline is cancelled (Chart of the Week). Feature As major forecasting agencies continue to upgrade global growth prospects, expectations for industrial-commodity demand – energy, bulks, and base metals – also are moving higher. This week, the IMF raised its growth expectations for this year and next to 6% and 4.4%, respectively, nearly a full percentage-point increase versus its January forecast update for 2021.1 This upgrade follows a similar move by the OECD last month.2 In the US, the EIA is expecting industrial demand for natural gas to rise 1.35 Bcf/d this year to 23.9 Bcf/d; versus 2019 levels, industrial demand will be 0.84 Bcf/d higher in 2021. For 2022, industrial demand is expected to be 24.2 Bcf/d. US industrial demand likely will recover faster than the EU's, given the expectation of a stronger recovery on the back of massive fiscal and monetary stimulus. Overall natgas demand in the US likely will move lower this year, given higher natgas prices expected this year and next will incentivize electricity generators to switch to coal at the margin, according to the EIA. Total demand is expected to be 82.9 Bcf/d in the US this year vs. 83.3 Bcf/d last year, owing to lower generator demand. Pipeline-quality gas output in the US – known as dry gas, since its liquids have been removed for other uses – is expected to average 91.4 Bcf/d this year, essentially unchanged. Lower consumption by the generators and flat production will allow US gas inventories to return to their five-year average levels of 3.7 Tcf by the end of October, in the EIA's estimation (Chart 2). Chart of the WeekUS-Russia Geopolitical Risk Underpriced US-Russia Pipeline Standoff Could Push LNG Prices Higher US-Russia Pipeline Standoff Could Push LNG Prices Higher Chart 2US Natgas Inventories Return To Five-Year Average US-Russia Pipeline Standoff Could Push LNG Prices Higher US-Russia Pipeline Standoff Could Push LNG Prices Higher US Liquified Natural Gas (LNG) exports are likely to expand, as Asian and European demand grows (Chart 3). Prior to the boost in US LNG demand from colder weather, exports set monthly records of 9.4 Bcf/d and 9.8 Bcf/d in November and December of last year, respectively, with Asia accounting for the largest share of exports (Chart 4). This also marked the first time LNG exports exceeded US pipeline exports to Mexico and Canada. The EIA is forecasting US LNG exports will be 8.5 bcf/d and 9.2 Bcf/d this year and next, versus pipeline exports of 8.8 Bcf/d and 8.9 Bcf/d in 2021 and 2022, respectively. Chart 3US LNG Exports Continue Growing US-Russia Pipeline Standoff Could Push LNG Prices Higher US-Russia Pipeline Standoff Could Push LNG Prices Higher Chart 4US LNG Exports Set Records In November And December 2020 US-Russia Pipeline Standoff Could Push LNG Prices Higher US-Russia Pipeline Standoff Could Push LNG Prices Higher US LNG exports – and export potential given the size of the resource base at just over 500 Tcf – now are of a sufficient magnitude to be a formidable force in global markets, particularly in Europe. This puts it in direct conflict with Russia, which has targeted Europe as a key market for its pipeline natural gas exports. US-Russia Standoff Looming Over Nord Stream 2 Given the size and distribution of global oil and gas production and consumption, it comes as no surprise national interests can, at times, become as important to pricing these commodities as supply-demand fundamentals. This is particularly true in oil, and increasingly is becoming the case in natural gas. That the same dramatis personae – the US and Russia – should feature in geopolitical contests in oil and gas markets also should not come as a surprise. In an attempt to circumvent transporting its natural gas through Ukraine, Russia is building a 1,230 km underwater pipeline from Narva Bay in the Kingisepp district of the Leningrad region of Russia to Lubmin, near Greifswald, in Germany (Map 1). The Biden administration, like the Trump administration and US Congress, is officially attempting to halt the final leg of the pipeline from being built, although Biden has not yet put America’s full weight into stopping it. Biden claims it will be up to the Europeans to decide what to do. At the same time, any major Russian or Russian-backed military operation in Ukraine could trigger an American action to halt the pipeline in retaliation. Map 1Nord Stream 2 Route US-Russia Pipeline Standoff Could Push LNG Prices Higher US-Russia Pipeline Standoff Could Push LNG Prices Higher In our estimation, there is a 50% chance that the Nord Stream 2 natural gas pipeline will not be completed this year or go into operation as planned given substantial geopolitical risks. The $11 billion pipeline would connect Russia directly to Germany with a capacity of about 55 billion cubic meters, which, combined with the existing Nord Stream One pipeline, would equal 110 BCM in offshore capacity, or 55% of Russia's natural gas exports to Europe in 2019. The pipeline’s construction is 94% complete, with the Russian ship Akademik Cherskiy entering Danish waters in late March to begin laying pipes to finish the final 138-kilometer stretch, according to Reuters. The pipeline could be finished in early August at the pace of 1 kilometer per day.3 The Russian and German governments are speeding up the project to finish it before US-Russia tensions, or the German elections in September, interrupt the construction process again. It is not too late for the US to try to halt the pipeline through sanctions. But for the Americans to succeed, the Biden administration would have to make an aggressive effort. Notably the Biden administration took office with a desire to sharpen US policy toward Russia.4 While Biden seeks Russian engagement on arms reduction treaties and the Iranian nuclear negotiations, he mainly aims to counter Russia, expand sanctions, provide weapons to Ukraine, and promote democracy in Russia’s sphere of influence. The result will almost inevitably be a new US-Russia confrontation, which is already taking shape over Russia’s buildup of troops on the border with Ukraine, where US and Russian meddling could cause civil war to reignite (Map 2). Map 2Russia’s Military Tensions With The West Escalate In Wake Of Biden’s Election And Ukraine’s Renewed Bid To Join NATO US-Russia Pipeline Standoff Could Push LNG Prices Higher US-Russia Pipeline Standoff Could Push LNG Prices Higher Tensions in Ukraine are directly tied to US military cooperation with Ukraine and any possibility that Ukraine will join the NATO military alliance, a red line for Putin. Nord Stream 2 is Russia’s way of bypassing Ukraine but a new US-Russia conflict, especially a Russian attack on Ukraine, would halt the pipeline. The pipeline’s completion would improve Russo-German strategic relations, undercut US liquefied natural gas exports to Germany and the EU, and reduce the US’s and eastern Europe’s leverage over Russia (and Germany). Biden says his administration is planning to impose new sanctions on firms that oversee, construct, or insure the pipeline, and such sanctions are required under American law.5 Yet Biden also wants a strong alliance with Germany, which favors the pipeline and does not want to escalate the conflict with Russia. The American laws against Nord Stream have big loopholes and give the president discretion regarding the use of sanctions, which means Biden would have to make a deliberate decision to override Germany and impose maximum sanctions if he truly wanted to halt construction.6 This would most likely occur if Russia committed a major new act of aggression in Ukraine or against other European democracies. The German policy, under the current ruling coalition led by Chancellor Angela Merkel’s Christian Democratic Union, is to finish the pipeline despite Russia’s conflicts with the West and political repression at home. Russia provides more than a third of Germany’s natural gas imports and this pipeline would bypass eastern Europe’s pipeline network and thus secure Germany’s (and Austria’s and the EU’s) natural gas supply whenever Russia cuts off the flow to Ukraine (through which roughly 40% of Russian natural gas still must pass to reach Europe). Germany's Election And Natgas Politics Germany wants to use natural gas as a bridge while it phases out nuclear energy and coal. Natural gas has grown 2.2 percentage points as a share of Germany’s total energy mix since the Fukushima disaster of 2011, and renewable energy has grown 7.7ppt, while coal has fallen 7.3ppt and nuclear has fallen 2.5ppt (Chart 5). The German federal election on September 26 complicates matters because Merkel and the Christian Democrats are likely to underperform their opinion polls and could even fall from power. They do not want to suffer a major foreign policy humiliation at the hands of the Americans or a strategic crisis with Russia right before the election. They will insist that Biden leave the pipeline alone and will offer other forms of cooperation against Russia in compensation. Therefore, the current German government could push through the pipeline and complete the project even in the face of US objections. But this outcome is not guaranteed. The German Greens are likely to gain influence in the Bundestag after the elections and could even lead the German government for the first time – and they are opposed to a new fossil fuel pipeline that increases Russia’s influence. Chart 5Germany Sees Nord Stream 2 Gas As Bridge To Low-Carbon Economy US-Russia Pipeline Standoff Could Push LNG Prices Higher US-Russia Pipeline Standoff Could Push LNG Prices Higher Hence there is a fair chance that the pipeline does not become operational: either Americans halt it out of strategic interest, or the German Greens halt it out of environmental and strategic interest, or both. True, there is a roughly equal chance that Merkel’s policy status quo survives in Germany, which would result in an operational pipeline. The best case for Germany might be that the current government completes the pipeline physically but the next government has optionality on whether to make it operational. But 50/50 odds of cancellation is a much higher risk than the consensus holds. The Russian policy is to finish Nord Stream 2 while also making an aggressive military stance against the West’s and NATO’s influence in Ukraine. This would expand Russian commodity and energy exports and undercut Ukraine’s natgas transit income. It would also increase Russian leverage over Germany – and it would divide Germany from the eastern Europeans and Americans. A preemptive American intervention would elicit Russian retaliation. The Russians could respond in the strategic sphere or the economic sphere. Economically they could react by cutting off natural gas to Europe, but that would undermine their diplomatic goals, so they would more likely respond by increasing production of natural gas or crude oil to steal American market share. In any scenario Russian retaliation would likely cause global price volatility in one or more energy markets, in addition to whatever volatility is induced by the cancellation of Nord Stream 2 itself. US-Russia tensions are likely to escalate but only Ukraine and Nord Stream 2, or the separate Iranian negotiations, have a direct impact on global energy supply. If Germany goes forward with the pipeline, then Russia would need to be countered by other means. The Americans, not the Germans, would provide these “other means,” such as military support to ensure the integrity of Ukraine and other nations’ borders. The Russians may gain a victory for their energy export strategy but they will never compromise on Ukraine and they will still need to focus on the broader global shift to renewable energy, which threatens their economic model and hence ultimately their regime stability. So, the risk of a market-moving US-Russia conflict can be delayed but probably not prevented (Chart 6). Chart 6US-Russia Conflit Likely US-Russia Conflit Likely US-Russia Conflit Likely Bottom Line: The Nord Stream 2 pipeline is not guaranteed to be completed this year as planned. The US is more likely to force a halt to the Nord Stream 2 pipeline than the consensus holds, especially if Russia attacks Ukraine. If the US fails to do so, then the German election will become the next signpost for whether the pipeline will become operational. If the Americans halt the pipeline, then US-Russian conflict either already erupted or will occur sooner rather than later and will likely impact global oil or natural gas prices. Investment Implications Our subjective assessment of 50% odds the US will succeed in halting completion of the final leg of Nord Stream 2 are higher than the consensus expectation. This translates directly into higher upside risk for natural gas prices in the US and Europe later this year and next. Given our view, we are getting long 1Q22 calls on CME/NYMEX Henry Hub-delivered natgas futures struck at $3.50/MMBtu vs. short 1Q22 $3.75/MMBtu calls at tonight's close. The probability of Nord Stream 2 cancellation is underpriced, which means the odds of higher prices in the LNG market are underpriced (Chart 7). The immediate implication of our view is European TTF prices will have to move higher to attract LNG cargoes next winter from the US, if the Nord Stream 2 pipeline's final leg is cancelled. This also would tighten the Asian markets, causing the JKM to move higher as well (Chart 8). Any indication of colder-than-normal weather in the US, Europe or Asian markets would mean a sharper move higher. Chart 7Natgas Tails Are Too Narrow For Next Winter US-Russia Pipeline Standoff Could Push LNG Prices Higher US-Russia Pipeline Standoff Could Push LNG Prices Higher Chart 8Nord Stream 2 Cancellation Would Boost JKM Prices Nord Stream 2 Cancellation Would Boost JKM Prices Nord Stream 2 Cancellation Would Boost JKM Prices   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Matt Gertken Vice President Geopolitical Strategy mattg@bcaresearch.com Commodities Round-Up Energy: Bullish The US and Iran began indirect talks earlier this week in Vienna aimed at restoring the Joint Comprehensive Plan of Action (JCPOA), otherwise known as the "Iran nuclear deal." All of the other parties of the deal – Britain, China, France, Germany and Russia – are in favor of restoring the deal. BCA Research believes this is most likely to occur prior to the inauguration of a new president who is expected to be a hardliner willing to escalate Iran’s demands. US President Biden can unilaterally ease sanctions and bring the US into compliance with the deal, and Iran could then reciprocate. If a deal is not reached by August it could take years to resolve US-Iran tensions. China could offer to cooperate on sanctions and help to broker negotiations following the signing of its 25-year trade deal with Iran last week. Russia likely would demand the US not pressure its allies to cancel the Nord Stream 2 deal, in return for its assistance in brokering a deal. Base Metals: Bullish Iron ore prices continue to be supported by record steel prices in China, trading at more than $173/MT earlier this week. Even though steel production reportedly is falling in the top steel-producer in China, Tangshan, as a result of anti-pollution measures, for iron ore remains stout. As we have previously noted, we use steel prices as a leading indicator for copper prices. We remain long Dec21 copper and will be looking for a sell-off to get long Sep21 copper vs. short Sep21 copper if the market trades below $4/lb on the CME/COMEX futures market (Chart 9). Precious Metals: Bullish Gold held support ~ $1,680/oz at the end of March, following an earlier test in the month. We remain long the yellow metal, despite coming close to being stopped out last week (Chart 10). The earlier sell-off appeared to be caused by a need to raise liquidity to us. We continue to expect the Fed to hold firm to its stated intent to wait for actual inflation to become manifest before raising rates, and, therefore, continue to expect real rates to weaken. This will be supportive of gold and commodities generally (Chart 10). Ags/Softs: Neutral Corn continues to be well supported above $5.50/bu, following last week's USDA report showing farmers intend to increase acreage planted to just over 91mm acres, which is less than 1% above last year's level. Chart 9 Copper Prices Surge As Global Storage Draws Copper Prices Surge As Global Storage Draws Chart 10 Gold Disconnected From US Dollar And Rates Gold Disconnected From US Dollar And Rates       Footnotes 1     Please see the Fund's April 2021 forecast Managing Divergent Recoveries. 2     We noted last week these higher growth expectations generally are bullish for industrial commodities – energy, metals, and bulks.  Please see Fundamentals Support Oil, Bulks, And Metals, which we published 1 April 2021.  It is available at ces.bcaresearch.com. 3    For the rate of construction see Margarita Assenova, “Clouds Darkening Over Nord Stream Two Pipeline,” Eurasia Daily Monitor 18: 17 (February 1, 2021), Jamestown Foundation, jamestown.org. For the current status, see Robin Emmott, “At NATO, Blinken warns Germany over Nord Stream 2 pipeline,” Reuters, March 23, 2021, reuters.com. 4    The Democratic Party blames Russia for what it sees as a campaign to undermine the democratic West and recreate the Soviet sphere of influence. See for example the 2008 invasion of Georgia, the failure of the Obama administration’s 2009-11 diplomatic “reset,” the Edward Snowden affair, the seizure of Crimea and civil war in Ukraine, the survival of Syria’s dictator, and Russian interference in US elections in 2016 and 2020. 5    The Countering Russian Influence in Europe and Eurasia Act of 2017, and the Protecting Europe’s Energy Security Act of 2019/2020, contain provisions requiring sanctions on firms that have contributed in any way a minimum of $1 million to the project, or provide pipe-laying services or insurance. There are exceptions for services provided by the governments of the EU member states, Norway, Switzerland, or the UK. The president has discretion over the implementation of sanctions as usual. 6    The German state of Mecklenburg-Vorpommern is creating a shell foundation to enable the completion of the pipeline. It can shield companies from American sanctions aimed at private companies, not sovereigns.    Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Summary of Closed Trades Higher Inflation On The Way Higher Inflation On The Way

Highlights The Biden Administration's $2.25 trillion infrastructure plan rolled out yesterday will, at the margin, boost global demand for energy and base metals more than expected later this year and next.  Global GDP growth estimates – and the boost supplied by US stimulus – once again will have to be adjusted higher (Chart of the Week). Energy and metals fundamentals continue to tighten. OPEC 2.0's so-far-successful production management strategy will keep the level of supply just below demand, which will keep Brent crude oil on either side of $60/bbl. Base-metals output will struggle to meet higher demand from the ongoing buildout of renewables infrastructure and growing electric-vehicle sales. Of late, concerns that speculative positioning suggests prices will head lower – or, at other times, higher – are entirely misplaced: Spec positioning conveys no information on price levels or direction.  Energy and metals prices, on the other hand, do convey useful information on spec positioning, demonstrating specs do not lead the news or prices, they follow them. Short-term headwinds caused by halting recoveries and renewed lockdowns – particularly in the EU – will fade in 2H21 as vaccines roll out, if the experience of the UK and US are any guide.  Continued USD strength, however, would remain a headwind. Feature If the Biden administration is successful in getting its $2.25 trillion infrastructure-spending bill through Congress, the US will join the rest of the world in the race to re-build – in some cases, build anew – its long-neglected bridges, roads, schools, communications and high-speed transportation networks, and, critically, its electric-power grid.  There's a lot of game left to play on this, but our Geopolitical Strategy group is giving this bill an 80% of passage later this year, after all the wrangling and log-rolling in Congress is done. In and of itself, the infrastructure-directed spending coming out of Biden's plan will be a catalyst for higher US industrial commodity demand – energy, metals and bulks.  In addition, it will support the lift in the demand boost coming out of higher GDP growth globally, which will be pushed higher by US fiscal spending, as the Chart of the Week shows.  Of note is the extremely robust growth expected in India, China and the US, which are among the largest consumers of industrial commodities globally.  Overall growth in the G20 and globally will be expansive in 2022 as well. Chart of the WeekBiden's $2.25 Trillion Infrastructure Bill Will Boost Global Commodity Demand Fundamentals Support Oil, Bulks, And Metals Fundamentals Support Oil, Bulks, And Metals Higher GDP growth translates directly into higher demand for commodities, all else equal, as can be seen in the relationship between EM and DM GDP, supply and inventories and Brent crude oil prices in Chart 2.  While we have reduced our Brent forecast for this year to $60/bbl on the back of renewed demand-side weakness in the EU due to problems in acquiring and distributing COVID-19 vaccines, we expect this to be reversed next year and into 2025, with prices trading between $60-$80/bbl (Chart 3).  OPEC 2.0, the oil-producer coalition led by the Kingdom of Saudi Arabia (KSA) and Russia, has done an excellent job of keeping the level of oil supply below demand over the course of the pandemic, which we expect to continue to the end of 2025.1 Chart 2Higher GDP Growth Presages Higher Commodity Demand Higher GDP Growth Presages Higher Commodity Demand Higher GDP Growth Presages Higher Commodity Demand Chart 3Brent Crude Oil Prices Will Average - / bbl to 2025 Brent Crude Oil Prices Will Average $60 - $80 / bbl to 2025 Brent Crude Oil Prices Will Average $60 - $80 / bbl to 2025 As the Biden plan makes its way through Congress, markets will get a better idea of how much diesel fuel, copper, steel, iron ore, etc., will be required in the US alone.  What is important to note here that the US is just moving to the starting line, whereas other economies like China and the EU already have begun their investment cycles in renewables and EVs.  At present, key markets already are tight, particularly copper (Chart 4) and aluminum (Chart 5).  In both markets, we expect physical deficits this year and next, which inclines us to believe the metals leg of this renewables buildout is just beginning – higher prices will be required to incentivize the development of new supply.2  Chart 4Copper Will Post Physical Deficit... Copper Will Post Physical Deficit... Copper Will Post Physical Deficit... Chart 5...As Will Aluminum ...As Will Aluminum ...As Will Aluminum This is particularly important in copper, where growth in mining output of ore has been flat for the past two years.  Copper is the one metal that spans all renewables technologies, and is a bellwether commodity for global growth.  We expect copper to trade to $4.50/lb (up ~ $0.50/lb vs spot) on the COMEX in 4Q21 on the back of increasing demand and tight supplies – i.e., falling mining supply and refined copper output growth (Chart 6). Worth noting also is steel rebar and hot-rolled coil prices traded at record highs this week on Chinese futures markets.  Stronger steel markets continue to support iron ore prices, although the latter is trading off its recent highs and likely will move lower toward the end of the year as Brazilian supply returns to the market.3  We use steel prices as a leading indicator for copper prices – steel leads copper prices by ~ 9 months.  This makes sense when one considers steel is consumed early in infrastructure and construction projects, while copper consumption occurs later as airports and houses are fitted with copper for electric, plumbing and communications applications. Chart 6Copper Ore Output Flat Copper Ore Output Flat Copper Ore Output Flat   Does Speculative Positioning Matter? Of late, media pundits and analysts have cited an unwinding of speculative positions in oil and metals markets following sharp run-ups in net long positions as a harbinger of weaker prices in the near future (Chart 7).4  At other times, speculation has been invoked as a reason for price surges – e.g., when oil rocketed  toward $150/bbl in mid-2008, which was followed by a price collapse at the start of the Global Financial Crisis (GFC).5 Brunetti et al note, "The role of speculators in financial markets has been the source of considerable interest and controversy in recent years. Concern about speculative trading also finds support in theory where noise traders, speculative bubbles, and herding can drive prices away from fundamental values and destabilize markets." (p. 1545) Chart 7Speculative Positioning Lower In Brent Than WTI Speculatives Positioning Lower in Brent Than WTI Speculatives Positioning Lower in Brent Than WTI We recently re-tested earlier findings in our research, which found that knowledge of how specs are positioned – either on the long or the short side of the market – conveys no information on the level of prices or the change that should be expected given that knowledge.  However, knowledge of the price level does convey useful information on how speculators are positioned in futures markets.6 In cointegrating regressions of speculative positions in crude oil, natural gas and copper futures on price levels for these commodities, we find the level of prices to be a statistically significant determinant of spec positions. We find no such relationship using spec positions as an explanatory variable for prices.7 On the other hand, Chart 2 above is an example of statistically significant relationships for Brent and WTI price as a function of supply-demand fundamentals displaying coefficients of determination (r-squares) of close to 90% in the post-GFC period (2010 to now).  This supports our earlier findings regarding spec behavior: They follow prices, they don't lead them.8 We are not dismissive of speculation.  It plays a critical role in markets, by providing the liquidity that enables commodity producers and consumers to hedge their price exposures, and to investors seeking to diversify their portfolios with commodity exposures that are uncorrelated to their equity and bond holdings.  Short-Term Headwinds Likely Dissipate COVID-19 remains the largest risk to markets generally, commodities in particular.  The mishandling of vaccine rollouts in the EU has pushed back our assumption for demand recovery deeper into 2H21, but it has not derailed it.  We expect COVID-related deaths and hospitalizations to fall in the EU as they have in the UK and the US following the widespread distribution of vaccines, which should occur in the near future as Brussels organizes its pandemic response (Chart 8).  Making vaccines available for other states in dire straits will follow, which will allow the global re-opening to progress as lockdowns are lifted (Chart 9). Chart 8EU Vaccination Rollouts Will Boost Global Economic Recovery Fundamentals Support Oil, Bulks, And Metals Fundamentals Support Oil, Bulks, And Metals Chart 9Global Re-Opening Has Slowed, But Will Resume In 2H21 Fundamentals Support Oil, Bulks, And Metals Fundamentals Support Oil, Bulks, And Metals The other big risk we see to commodities is persistent USD strength (Chart 10).  The dollar has rallied for the better part of 2021, largely on the back of improving US economic prospects relative to other states, and success in its vaccination efforts.  The resumption of the USD's bear market may have to wait until the rest of the world catches up with America's public-health response to the pandemic, and the global economy ex-US and -China enters a stronger expansionary mode. Bottom Line: We remain bullish industrial commodities expecting demand to improve as the EU rolls out vaccines and begins to make progress in arresting the pandemic and removing lockdowns.  Global fiscal and monetary policy, which likely will be bolstered by a massive round of US infrastructure spending beginning in 4Q21 will catalyze demand growth for oil and base metals.  This will prompt another round of GDP revisions to the upside.  The dollar remains a headwind for now, but we expect it to return to a bear market in 2H21. Chart 10The USD's Evolution Remains Important The USD's Evolution Remains Important The USD's Evolution Remains Important   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 Going into the April 1 meeting of OPEC 2.0 today, we are not expecting any increase in production.  OPEC earlier this week noted demand had softened, mostly due to the slow recovery from the COVID-19 pandemic in the EU, which, based on their previous policy decisions, suggests the producer coalition will not be increasing production.  The coalition led by KSA and Russia will have to address Iran's return as a major exporter to China this year, which appears to have been importing ~ 1mm b/d of Iranian crude this month (Chart 11).  This puts Iran in direct competition with KSA as a major exporter to China, in defiance of the US re-imposition of sanctions against Iranian exports.  China and Iran over the weekend signed a 25-year trade pact that also could include military provisions, which could, over time, alter the balance of power in the Persian Gulf if Chinese military assets – naval and land warfare – deploy to Iran under their agreement.  Details of the deal are sparse, as The Guardian noted in its recent coverage.  Among other things, government officials in Tehran have come under withering criticism for entering the deal, which they contend was signed with a "politically bankrupt regime."  The Guardian also noted US President Joe Biden " is prepared to make a new offer to Iran this week whereby he will lift some sanctions in return for Iran taking specific limited steps to come back into compliance with the nuclear agreement, including reducing the level to which it enriches uranium," in the wake of the signing of this deal. Base Metals: Bullish Copper fell this week, initially on an inventory build, and has now settled right under the $4/lb mark, as investors await details on the US infrastructure bill unveiled in Pittsburgh, PA, on Wednesday.  According to mining.com, a major chunk of the proposed bill will be devoted to investments in infrastructure, which will be metals-intensive.  Precious Metals: Bullish Gold fell further this week, as US treasury yields rose, buoyed by the increased US vaccine efforts and President Biden’s proposed spending plans (Chart 12). USD strength also worked against the yellow metal, which has been steadily declining since the beginning of this year.  COMEX gold fell below the $1,700/oz mark for the third time this month and settled at $1,683.90/oz on Tuesday. Chart 11 Sporadic Producers Will Be Accomodated Sporadic Producers Will Be Accomodated Chart 12 Gold Trading Lower On The Back of A Strong Dollar Gold Trading Lower On The Back of A Strong Dollar     Footnotes 1     Please see Five-Year Brent Forecast Update: Expect Price Range of $60 - $80/bbl, which we published 25 March 2021.  It is available at ces.bcaresearch.com. 2     Please see Industrial Commodities Super-Cycle Or Bull Market?, which we published 4 March 2021 for additional discussion, particularly regarding the need for additional capex in energy and metals markets. 3    Please see UPDATE 1-Strong industrial activity, profit lift China steel futures, published by reuters.com 29 March 2021. 4    See, e.g., Column: Frothy oil market deflates as virus fears return published 23 March 2021. 5    Brunetti, Celso, Bahattin Büyüksahin, and Jeffrey H. Harris (2016), " Speculators, Prices, and Market Volatility," Journal of Financial and Quantitative Analysis, 51:5, pp. 1545-74, for further discussion. 6    Please see Specs Back Up The Truck For Oil, which we published 26 April 2018, and Feedback Loop: Spec Positioning & Oil Price Volatility published 10 May 2018.  Both are available at ces.bcaresearch.com. 7     We group money managers (registered commodity trading advisors, commodity pool operators and unregistered funds) and swap dealers (banks and trading companies providing liquidity to hedgers and speculators) together to test these relationships. 8    In our earlier research, we also noted our results generally were supported in the academic literature.  See, e.g., Fattouh, Bassam, Lutz Kilian and Lavan Mahadeva (2012), "The Role of Speculation in Oil Markets: What Have We Learned So Far?" published by The Oxford Institute For Energy Studies.   Investment Views and Themes Strategic Recommendations Commodity Prices and Plays Reference Table Summary of Closed Trades Higher Inflation On The Way Higher Inflation On The Way

In the May 7, 2020 report, we argued that structurally low oil prices could, eventually necessitate a devaluation of the Saudi riyal. Our assumption for average oil prices was and remains $40 in 2020, $40 in 2021 and $35 in 2022. As a long-term bet, we continue to recommend selling Saudi Arabian riyals in the forward market. This trade has very little carry cost, extremely low volatility and, if our analysis proves correct, it will have a substantial payoff. This is not just a bet on devaluation but on a rising probability of devaluation over the long run. Even if the kingdom does not devalue its currency, three-year currency forwards will, at some point, start pricing some devaluation risk. That will be sufficient to make this trade profitable. Oil Prices: Low For Longer The spot crude oil price has rallied close to 30% since October 29, 2020 despite the decline in the global mobility index on the back of renewed lockdown measures in Europe and the US (Chart 1). The mobility index’s weak reading is a clear sign of reduced current oil demand in major DM and in some EM economies.1 How do we square the relapse in global mobility with the latest rebound in spot oil prices? Odds are that investor buying has been largely responsible for the latest rebound in crude prices from early November lows. Investors flocking to oil is also consistent with purchases of assets that benefit from the reflation trade. Importantly, the spot crude price has recently risen more than medium-term (two-year) forwards (Chart 2) and, critically, long-term (three- and five-year) forwards have failed to advance. Given subdued current demand for crude, this also suggests that the spot price has been supported by investors. Chart 1Spot Oil Prices Have Diverged From Short-Term Demand Saudi Arabia: Oil And Macro Adjustment Saudi Arabia: Oil And Macro Adjustment Chart 2Spot Oil Prices Are Above Forward Prices Saudi Arabia: Oil And Macro Adjustment Saudi Arabia: Oil And Macro Adjustment   Moreover, the strong rise in Chinese oil imports since May was partially due to inventory restocking. Recently, Chinese imports of crude oil and petroleum products have weakened as the restocking phase comes to an end (Chart 3). Going forward, we assume Chinese final demand for oil and oil products will be running at 3-4% in the coming years, in the best case scenario. Global oil demand will rise next year, as the deployment of coronavirus vaccines revive mobility and travel. However, greater demand will be offset by higher production as OPEC+ producers continuously increase oil output in 2021 (Chart 4). Chart 3Chinese Oil Imports Have Slowed Saudi Arabia: Oil And Macro Adjustment Saudi Arabia: Oil And Macro Adjustment Chart 4Oil Production Will Rise For Major Producers Saudi Arabia: Oil And Macro Adjustment Saudi Arabia: Oil And Macro Adjustment   Beyond next year’s normalization period, the rotation towards renewables and green technology will emerge as headwinds to the oil market. On the supply side, the group of OPEC+ producers has been suppressing oil production. Given the weak state of a number of petro-economies and their troubling socio-political situations, these producers, particularly Russia, Nigeria and Iraq, are incentivized to raise their crude production.  In the long run, the OPEC+ arrangement of suppressing crude output will likely prove unsustainable. Ultimately, every producer’s overreaching objective is to maximize the net present value of its potential cash flow from oil. Due to inflation, $45 today is worth more than $45 in five or ten years. OPEC+ production constraints work as long as oil producers believe this setup is maximizing the net present value of their very long-term cash flow from oil. When producers realize that, in the long run, oil prices will remain under $50, they will rush to produce and sell as much as they can at current prices. Early signs of such behavior are already occurring as the UAE’s state-run oil company plans to invest in oil production at a time when the country is producing well below its capacity. Remarkably, the five-year forward oil price is now at $48 per barrel, which is close to its lows in April 2020 and January 2016 (Chart 5). A break below its previous lows will send a signal to oil producers, incentivizing them to produce and sell more oil at current prices. In short, tensions among OPEC+ members will rise over capping crude output. This was demonstrated in last week’s OPEC+ meeting during which members faced difficulty in reaching an agreement. These tensions will grow and will eventually lead to either sharply increased production quotas or reneging on the agreement. In addition, US President-elect Joe Biden and his new administration will likely start talks with Iran and provide some sanction relief. The motive is to undo some of Trump’s policies and re-establish some of Obama’s signature foreign policy accomplishments. The outcome of a U-turn in the US approach to Iran will be an increase in Iranian crude output (Chart 6). Chart 5Long-Term Oil Prices Remain Depressed Saudi Arabia: Oil And Macro Adjustment Saudi Arabia: Oil And Macro Adjustment Chart 6Iranian Oil Production Will Increase With Biden's Presidency Saudi Arabia: Oil And Macro Adjustment Saudi Arabia: Oil And Macro Adjustment   Bottom Line: Oil prices will remain depressed going forward, averaging $40 in 2021 and $35 in 2022. These estimates form the basis of our analysis regarding Saudi Arabia’s required macro adjustments. Fiscal Tightening: How Much And For How Long? The Saudi government has already undertaken substantial fiscal tightening this year. Going forward, the government projects that fiscal spending in nominal terms will contract by 7.3%, 3.5% and 1.5% in 2021, 2022 and 2023, respectively (Chart 7). Under these assumptions, and if oil prices average $40 in 2021 and $35 in 2022, the fiscal deficit will be wide at –14% and –16% of GDP (Table 1). Chart 7Saudi Arabia: Fiscal Austerity Will Persist Saudi Arabia: Oil And Macro Adjustment Saudi Arabia: Oil And Macro Adjustment Table 1Projections For Oil Prices, Fiscal Balance, BoP And SAMA’s FX Reserves Saudi Arabia: Oil And Macro Adjustment Saudi Arabia: Oil And Macro Adjustment   Nevertheless, fiscal austerity cannot be sustained for many years. Fiscal fatigue could set in as tight policy becomes socially and politically unacceptable. Hence, risk to the government’s spending projections is to the upside. The budget deficit, however, is not an ultimate constraint. Authorities can allow the budget deficit to balloon and finance it via bond issuance. In our simulation, we assume the government will finance about 25% of the fiscal deficit in 2021 and 2022 by issuing US dollar-denominated government bonds. The rest will be financed by local currency bond issuance. This raises the question whether the kingdom has sufficient savings to domestically finance its large fiscal deficits. As we wrote in the previous report, this is not a pertinent question. The basis is that when domestic commercial banks buy government bonds, they create new money/deposits “out of thin air.” This is true for any country in the world that has its own currency. If large fiscal deficits are only financed by domestic banks purchasing local currency bonds, it will lead neither to higher interest rates nor to the crowding out of the private sector. This is the least painful adjustment and the Saudi authorities could be tempted to resort to this solution, i.e., urge commercial banks to buy a substantial portion of local currency government bond issuance. So far this year, 20% of Saudi Arabia’s fiscal deficit has been financed via the issuance of US dollar bonds, 55% by local currency bonds, and 25% by drawing on the government's US dollar reserves at the central bank. Commercial banks’ purchases of local currency government bonds can continue for many years, allowing the kingdom to finance its budget deficits. The central bank may or may not need to provide commercial banks with liquidity (excess reserves) for banks to continue doing it. Chart 8Saudi Arabia: Broad Money And Excess Reserves Saudi Arabia: Oil And Macro Adjustment Saudi Arabia: Oil And Macro Adjustment Excess reserves are created by central banks “out of thin air” so they do not represent a major constraint. The ratio between broad money supply and excess reserves represents the money multiplier. Chart 8 illustrates there is no strong or constant relationship between Saudi commercial banks’ excess reserves and broad money (M3) creation. The latter could fluctuate, i.e., commercial banks could create more or less new money/deposits for the same level of excess reserves provided by the central bank. Critically, on aggregate, the commercial banking system does not lend out or part with excess reserves when it originates loans or purchases securities, except in cases where the counterpart is the central bank, as we demonstrated in our October 22 and January 16 2020 Special Reports.  Bottom Line: The purchase of debt securities, including government bonds, by commercial banks is nothing more than debt monetization. Hence, any country can finance its fiscal deficit by encouraging domestic commercial banks to purchase local currency government bonds. Ultimate Macro Constraints The ultimate macro constraint for any country when budget deficits are financed by local commercial banks is inflation and/or downward pressure on the currency. Monetization of government debt could eventually be problematic in Saudi Arabia because the country pegs its currency to the US dollar. The risks to the exchange rate peg due to mushrooming money supply will ultimately limit the government’s ability to rely on commercial banks to finance its budget deficits (Chart 9). Chart 9Saudi Arabia: Divergence Between Broad Money And FX Reserves Will Continue For Now Saudi Arabia: Oil And Macro Adjustment Saudi Arabia: Oil And Macro Adjustment Another Achilles’ heel of this economy is its dependence on imports. Structurally, the economy is plagued by low productivity and a lack of domestic productive capacity. Consequently, any boost to domestic demand from fiscal spending will translate into higher imports as well as increased remittance outflows from foreign workers who dominate Saudi Arabia’s workforce. Ultimately, pressure on the current account balance will build as the expansion in domestic demand leads to US dollar outflows. Both FDI and portfolio inflows have been meager and will stay depressed if oil prices remain low, since foreign investors will be hesitant to invest in this petro-dependent economy. Amid a deteriorating balance of payments, the only way to defend the currency peg will be for the central bank to sell its foreign exchange reserves. Chart 10 (top panel) shows that the central bank’s foreign reserves have been shrinking while broad money supply has been expanding rapidly. Chart 10The FX Reserves-To-Broad Money Supply Ratio Will Fall Close To 0.5 In 2022 Saudi Arabia: Oil And Macro Adjustment Saudi Arabia: Oil And Macro Adjustment Such dynamics will persist in the coming years. As a result, the foreign exchange reserves-to-broad money ratio will drop from 0.85 today to 0.68 by the end of 2021 and 0.53 by the end of 2022 (Chart 10, bottom panel). There is no threshold for this ratio or any other financial and economic variable to gauge when the peg will have to be adjusted. In the case of Saudi Arabia, de-pegging or devaluing the currency carries major political implications. Authorities will be reluctant to do it before Crown Prince Mohammed bin Salman becomes king. Nevertheless, long-term currency forwards could start pricing a probability of such currency adjustments earlier than it eventually occurs. The Risk Premium In Currency Forwards The risk premium in the long-term currency forwards will widen as (1) oil prices stay low for longer (Chart 11), (2) Saudi Arabia engages in some form of covert debt monetization, and (3) the traditional pillars of US-Saudi relations gradually erode. Chart 11Bet On A Rising Probability Of Devaluation Saudi Arabia: Oil And Macro Adjustment Saudi Arabia: Oil And Macro Adjustment Chart 12Underweight Saudi Versus EM Equities Saudi Arabia: Oil And Macro Adjustment Saudi Arabia: Oil And Macro Adjustment US-Saudi relations will likely sour in the coming years stemming from the Biden administration’s engagement with Iran. Having reached self-sufficiency in energy production, the US will, in the long run, have less incentive to be involved in the region and defend its allies. Together, these factors could raise the geopolitical risk premium in the Saudi riyal forwards. Poor domestic growth, as well as a rising risk premium due to devaluation, bodes ill for equities. Investors should consider underweighting Saudi stocks within an EM equity portfolio (Chart 12). For credit investors, we recommend underweighting both Saudi sovereign and corporate spreads in an EM credit portfolio. Lower oil prices will force more borrowing and start eroding the balance sheet of the government and corporates. Andrija Vesic Associate Editor andrijav@bcaresearch.com Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com Footnotes 1 The global index is constructed based on data from 25 developed and developing countries, including India but excluding China.

Highlights The Beirut blast calls attention to instability in the Shia Crescent. A turbulent push for political change will now ensue in Lebanon. Hezbollah’s and Iran’s political capital in Lebanon will suffer significantly. Lebanon is a red herring, but Iraq is a Black Swan. It is at risk of social unrest contagion. Iran’s financial troubles are weighing on its ability to maintain its sphere of influence. It is adopting a strategy of measured sabotage and deterrence against US interests in Iraq. The double whammy of low oil prices and pandemic is weighing on Saudi Arabia’s finances. Nevertheless it is prioritizing a cooperative relationship with Iraq. Iran could stage a major attack or President Trump’s poor election prospects could force him to “wag the dog.” Massive excess oil capacity will mute the oil market impact of a supply shortfall in Iraq. However, the risk becomes more relevant as demand recovers and markets rebalance in the second half of the year. Stay long Brent crude oil and gold. Feature The August 4 explosion at the Port of Beirut was devastating. It killed more than 220, wounded over 6000, left 300,000 homeless, and damaged buildings as far away as 9km from the site of the explosion. The blast added insult to injury to the country’s already troubled finances. Estimates for the cost of repair range anywhere between $5 billion and $15 billion. Global investors can largely write off the incident as an idiosyncratic shock. Even though emigration is likely to pick up, Lebanon’s population is only a third of Syria’s prior to its civil war. Assuming that a third of Lebanese become displaced abroad – a generous assumption more suitable to Syrian-style civil war than Lebanon’s situation – about 2 million Lebanese will be displaced, half of which will make their way to Europe or elsewhere outside the Middle East. As long as an antagonistic Turkey upholds its agreement with the EU, a mass exodus from Lebanon does not risk an unmanageable migrant crisis for Europe (Chart 1). Political tensions will rise and potentially lead to a populist backlash, given Europe’s battered economy. But Lebanon alone is not enough. The risk is broader Middle Eastern instability, which is a credible risk. Chart 1Middle Eastern Instability Could Fuel European Populism Middle Eastern Instability Could Fuel European Populism Middle Eastern Instability Could Fuel European Populism Thus Lebanon in itself is a red herring, but it is a bellwether for further unrest in the Middle East in countries that are not red herrings (Map 1). Map 1Lebanon Is A Red Herring; Iraq And Saudi Arabia Are Relevant From The Arab Spring To The Shia Crackup From The Arab Spring To The Shia Crackup A major conflict in Iraq is an underrated risk to global oil supply. The catastrophe calls attention to instability the Shia Crescent – a region in a tug of war between rival sectarian and geopolitical interests. Whereas the 2008 crisis led to the largely Sunni Arab states in the so-called Arab Spring, the 2020 crisis is piling pressure onto already unstable Shia states and regions: Iran, Iraq, Lebanon, Syria, and possibly eastern Saudi Arabia. Of particular significance is the fate of Iraq. Popular grievances are eerily similar to Lebanon’s. Baghdad is on shaky ground, yet the ramp up in US-Iran tensions going into the November US elections makes the threat of instability in Iraq more acute. As OPEC’s second ranked oil producer, a major conflict in Iraq poses an underrated risk to global oil supply. Supply losses are a tailwind to oil prices when market conditions are tight. However OPEC 2.0’s 8.3mm b/d of voluntary cuts means massive spare capacity is available globally to offset potential losses in Iraq, reducing the potential upside to oil prices. Nevertheless, this risk becomes more relevant as markets tighten on the back of a demand-side recovery, i.e. as balance is restored to the oil market and as excess spare capacity is eliminated. With oil markets likely rebalancing in 3Q20, unrest in Iraq poses an upside risk to our Commodity & Energy Strategy service’s expectation that 2H20 Brent prices will average $44/bbl and 2021 prices will average $65/bbl (Chart 2). Even though gold has already rallied 30% since mid-March, geopolitical risks including US-Iran tensions suggest any near-term selloff is a buying opportunity (Chart 3). The bullish gold narrative – geopolitical risks, falling dollar, and low real interest rates for the foreseeable future – remain intact even as the downturn gives way to a cyclical recovery. We continue to recommend gold on a strategic time horizon. Chart 2Oil Price Rally Remains Intact Oil Price Rally Remains Intact Oil Price Rally Remains Intact Chart 3Gold Is Due For A Breather Gold Is Due For A Breather Gold Is Due For A Breather Lebanon’s economic collapse highlights risks to other regional economies tied to the oil dependent Arab economies of the Persian Gulf. As the latter grapple with record low oil prices, production cuts, and the pandemic-induced recession, second-order effects will reverberate throughout the region, hitting economies such as Egypt and Jordan whose economic as well as political structures are intimately intertwined with Gulf Cooperation Council finances and policies. Lebanon’s Collapse Was Inevitable Lebanon was already going through an economic and financial meltdown before the explosion (Chart 4). Aside from the humanitarian loss, the economic impact is also profound. The country – highly dependent on imports of basic goods and suffering from food insecurity – must now contend with the loss of its main port and most of its grain reserves, destroyed in the explosion. As the dust settles, grief is morphing into anger on the streets. Regardless of whether the blast was due to happenstance or malice, the immediate cause was 2,750 tons of ammonium nitrate in storage for six years. The government was warned about the risks of the explosive chemicals at least four times this year – with the latest being on the day of the blast. Chart 4Beirut Port Explosion Accelerated Lebanon’s Collapse From The Arab Spring To The Shia Crackup From The Arab Spring To The Shia Crackup Mass protests are already taking place, calling on the government to be held accountable for criminal negligence. A controversial petition to return Lebanon to French mandate has gained more than 60,000 signatures. Prime Minister Hassan Diab’s seven-month-old cabinet has resigned. (It was put in place last year amid an earlier bout of unrest.) Official incompetence and neglect are in fact the best-case explanations for the explosion. Many questions remain unanswered. For instance, what triggered the fire? Israel swiftly denied any connection and offered humanitarian aid, while Hezbollah’s leader Hassan Nasrallah claimed to know more about the Port of Haifa than about Beirut Port. Early parliamentary elections and the cabinet’s resignation will not appease the protesters. Photos of Nasrallah, President Aoun, Speaker of Parliament Nabih Berri, and former Prime Minister Saad Hariri were among those hung by protesters in gallows in Martyrs’ Square over the weekend. Berri and Gebran Bassil are known to be the source of the cabinet’s decision-making power.1 They have veto over all decisions, large and small. During the mass protests in October 2019, Nasrallah stated that Hezbollah has two red lines:     Aoun must finish his term, which expires in 2022;     No early elections will be held, i.e. the speaker of the house will not be changed. While early elections have now been promised, these red lines highlight that corruption runs deep in Lebanon and opposition groups face an uphill battle against the establishment. A turbulent push for political change will now ensue. Hezbollah’s and Iran’s political capital in Lebanon will suffer significantly. Another Israeli confrontation with Hezbollah is not the base case but it could occur. Bottom Line: Lebanon is a failed state. As with the Arab Spring, the question is whether popular anger will prove contagious and spread to more market-relevant neighboring countries. The rally in the Israeli shekel in trade weighted terms since mid-March has already started to fizzle and may be tested further as turmoil in Lebanon raises the risk of confrontation. Contagion? In order for a geopolitical event in the Middle East to warrant investors’ attention, it must affect at least two of the following factors : (1) global oil supply, (2) geography of existential significance to a regional power, or (3) sectarian conflict which could lead to contagion. In this context, Lebanon is a red herring, but Iraq is not – therefore investors should watch to see if anything causes destabilization in Iraq. A decline in Iranian funds will weaken Tehran’s sphere of influence. Like Lebanon, Iraq is dominated by a highly corrupt sectarian system that has been plundering the wealth; people are suffering from rising rates of unemployment; and the regime is in the crosshairs of competing foreign agendas (Chart 5). Chart 5Iraqis And Lebanese Suffer Similar Grievances From The Arab Spring To The Shia Crackup From The Arab Spring To The Shia Crackup Iraq is in Iran’s sights because it aspires to establish a land bridge to the Mediterranean through a friendly “Shia Crescent” (Map 2). Iran’s modus operandi is to establish a presence in its neighbors’ domestic politics through Iran-backed factions. Map 2Iraq Essential To Iran’s Aspirational ‘Land Bridge’ To The Mediterranean From The Arab Spring To The Shia Crackup From The Arab Spring To The Shia Crackup Given the current state of Iran’s economy, it is not far-fetched to envision a significant drop in the funding of its foreign proxies (Chart 6). Historically these funds have followed the ebbs and flows of oil prices. For instance, in 2009, when faced with declining oil prices and US sanctions Iran’s funds to Hezbollah were estimated to have fallen by 40%. This happened again in 2014-16 and is not too different from today. Thus Iraq is at risk of contagion. Iran’s financial troubles are weighing on its ability to maintain its sphere of influence. Syrian fighters have reported paychecks being slashed, Iranian projects in Syria have stalled, and Hezbollah employees report to have missed paychecks and lost other benefits. Tehran’s finances are essential for Hezbollah’s survival.2 Iran’s proxies in Iraq are facing a similar fate.3 Chart 6Iran Suffering Under "Maximum Pressure" Iran Suffering Under "Maximum Pressure" Iran Suffering Under "Maximum Pressure" Bottom Line: Iraq faces an uptick in social unrest due to the poor living conditions and possible contagion from Lebanon. Meanwhile, Iran-backed groups there face a decline in funds from Tehran, which will send them searching for replacement funds. If Lebanon falters the world can usually ignore it but if Iraq falters the world will have to take notice. Saudi Arabia Prioritizes Revenue Over Growth Beirut’s foreign policy stances in recent years have been seen as appeasing Iran at the expense of Gulf Arab states.4 This trend coincides with a decline in Gulf Cooperation Council financing to Lebanon. Now the collapse in oil prices and pandemic have weighed on Saudi Arabia’s budget, which still depends on the energy sector for most of its revenues despite efforts to diversify. State revenues were down 49% year-on-year in Q2 pulling the budget deficit down to $29 billion (Chart 7). Riyadh is reassessing its priorities. Opting for revenue at the expense of growth, Riyadh has tightened the screws on its citizens. The government has had to pare back some of the benefits Saudis have long been accustomed to. The value-added-tax rate tripled from 5% to 15%, and a bonus cost-of-living allowance of $266 for public sector employees ended. The kingdom also announced plans to reduce spending on major projects by $26 billion – including some of those associated with Crown Prince Mohammed bin Salman’s reform agenda, Vision 2030. Chart 7Saudi Arabia Under Pressure From Double Whammy Saudi Arabia Under Pressure From Double Whammy Saudi Arabia Under Pressure From Double Whammy Severe economic turmoil poses a risk to the Saudi social contract in which citizens pledge allegiance to the ruling class in exchange for financial and social guarantees. The risk now is that the fiscal challenges dent Saudi citizens’ pocketbooks and thus impact social and political stability. However, oil prices are recovering to levels consistent with the kingdom’s fiscal breakeven oil price next year. The global economic recovery will begin to support the kingdom’s economy in the second half of this year (Chart 8). This will ease pressure on the budget and hence households. Moreover the slowdown is likely to hit foreign workers hardest and thus hasten the Saudization process. Foreign workers are the lowest hanging fruit and will be the first to find themselves jobless. In that sense the crisis is expediting some of Riyadh’s long-term reform targets. That said, there is still some risk of internal instability or even a palace coup. Tehran could incite sectarian tensions in the kingdom’s Eastern Province where an estimated 30-50% of the population is believed to be Shia. This is relevant given that nearly all Saudi oil production is located there. Chart 8KSA Benefits From EM GDP Growth ... KSA Benefits From EM GDP Growth ... KSA Benefits From EM GDP Growth ... Regarding the possibility of a palace coup, Crown Prince Mohammed bin Salman has spent this year cracking down on potential dissidents. Former Crown Prince Mohammed bin Nayef and King Salman’s only surviving full-brother Prince Ahmed bin Abdulaziz – both influential and well-liked – were among those detained in March. The kingdom’s contradictory policies – reform through repression – may eventually culminate in an overt political crisis. Though such a crisis may not occur until the time of royal succession. These economic and political challenges may force Saudi Arabia to adopt an inward stance. Its foreign interventions to date have been costly and come with little benefit – judging by the war in Yemen. It is also possible that Saudi Arabia, which is already the third largest defense spender globally, will try to strengthen its position vis-à-vis Iran. Crown Prince Mohammed bin Salman has already stated that the kingdom will pursue a nuclear program if Iran develops a nuclear bomb. This is relevant in today’s context with Iran no longer complying with restrictions to its nuclear program (Table 1). Saudi Arabia, like Iran, claims its nuclear program is for peaceful purposes – in order to generate nuclear power as part of efforts to diversify its economy.5 Table 1Iran No Longer Complying With 2015 Nuclear Deal From The Arab Spring To The Shia Crackup From The Arab Spring To The Shia Crackup Still, low oil prices tend to discourage petro states from engaging in conflict (Chart 9). Arab petro states may show restraint, at least until oil markets recover. Chart 9Low Oil Prices Discourage Petro States From Engaging In Conflict From The Arab Spring To The Shia Crackup From The Arab Spring To The Shia Crackup Overall weakness in oil-producing economies will hurt various countries that rely on remittances (Chart 10). The downturn will also hurt countries dependent on remittances from petro states in the region such as Egypt and Jordan. Bottom Line: The collapse in oil prices is forcing Saudi Arabia to reconsider its priorities and is expediting some long-term reforms. For now, it is adopting a pro-revenue rather than a pro-growth stance. This is likely to result in a focus inward for the kingdom. The implication is that countries that are leveraged to the petro-economies of the Gulf for remittances, bilateral aid, and capital flows will take a hit. These include Lebanon, Egypt, and Jordan. Chart 10Egypt And Jordan Also Vulnerable To Petro State Weakness Egypt And Jordan Also Vulnerable To Petro State Weakness Egypt And Jordan Also Vulnerable To Petro State Weakness Iraq Is The Prize Not unlike Lebanon, Iraq’s political class has been suffering a legitimacy crisis since protests erupted there last October resulting in the resignation of then-Prime Minister Adel Abdul Mahdi. However unlike Lebanon, Iraq is a significant geography for global investors. It is a major OPEC producer – second only to Saudi Arabia – accounting for 16% of the cartel’s production last year. The Iraqi oil minister’s first foreign trip was to the Saudi capital. This is not surprising. Iraq not only seeks Saudi leniency in OPEC 2.0 cuts, but also needs financial assistance to develop a natural gas field that will allow it to reduce dependence on Iran. Saudi Arabia also hopes to reduce Iraq’s dependence on Iranian natural gas and coax it into its sphere of influence. When it comes to crude oil, the additional 1mm b/d of voluntary cuts in June announced unilaterally by Saudi Arabia beyond its agreed OPEC 2.0 commitments are also a sign of Saudi willingness to accommodate Iraq and its non-compliance  (Chart 11).6 Saudi Arabia does not want to see Iraq’s newly elected government failing on the back of budgetary strain. In fact, al-Kadhimi is an opportunity for the Saudis. Formerly the director the National Intelligence Service with warm ties to the US, he is a champion of Iraqi sovereignty. Even though Iraq is being forced to compensate for past overproduction of oil in August and September, it was cajoled by the promise of a $500 million “bridging” loan from Saudi Arabia, to be repaid when oil markets recover. While financial assistance shows the kingdom’s commitment to Iraq, more significantly it reflects Riyadh’s desperation to revive oil markets and bring prices closer to its fiscal breakeven oil price amid the still uncertain demand outlook. Chart 11Saudi Arabia Willing To Accommodate Iraq From The Arab Spring To The Shia Crackup From The Arab Spring To The Shia Crackup Neither Saudi Arabia’s nor al-Kadhimi’s efforts are guaranteed to succeed in pulling Iraq out of Iran’s sphere. The prime minister received a rude awakening upon his arrest of 14 Kata’ib Hezbollah fighters in June on grounds of a plan to launch a rocket attack on US interest in Baghdad. They were swiftly released, and the case against them dropped. It is hard to curb Iranian influence. For its part, Iran stood behind al-Kadhimi’s nomination despite him being perceived as pro-Western. Tehran needed to avoid an anti-Iranian backlash on the streets of Baghdad if it had stood against him. Instead, Iran’s calculus was that it is in its best interest to swallow the pill and work with the new government at a time when Iraqi anger was targeted against US involvement rather than at Iranian interference. Prior to the US assassination of Qassem al-Suleimani and Abu Mahdi al-Muhandis on Iraqi soil, Iraqis were rebelling against Iran’s influence. That being said, Iran will maintain pressure on Iraq through continued attacks on US interests there (Table A1 in Appendix). This is also reflected in the July assassination of top Iraqi security expert Hisham al-Hashimi, who had previously advised the government on how to curb Iranian control. Iran was looking to make it to the US election in November without an escalation in tensions, hoping the US elections will result in a more dovish Democratic Party leadership averse to conflict with Iran. However, recent cyber-attacks on key Iranian infrastructure raise the likelihood that tensions will escalate ahead of the elections. The US is also threatening to maintain maximum sanctions even if the United Nations Security Council disagrees. As always, Iraq will find itself in the crossfire of any deterioration in relations. Bottom Line: Maintaining a cooperative relationship with Iraq aligns with both of Saudi Arabia’s interests there: limiting Iranian interference and supporting global oil markets through supply-side discipline. Iran will maintain pressure on Iraq’s new government through continued attacks on US interests. However, these attacks are supposed to fall short of killing US citizens and giving President Trump a reason to launch air strikes that could give him a patriotic boost in opinion polls. Nevertheless, tensions in the Gulf could escalate if Iran stages a major attack or if President Trump’s poor election prospects force him to “wag the dog.” In that case Iraqi oil supply would be disrupted. Investment Implications The Shia Crescent remains at heightened risk of instability on the back of Iran’s economic deterioration. Massive excess oil capacity will mute the oil market impact of a supply shortfall in Iraq. However, the risk becomes more relevant as demand recovers and markets rebalance in the second half of the year. Given that the Saudi loan will ensure Iraq’s commitment to compensatory production cuts in August and September, supply-side risks are a tailwind to oil prices in H2. The elevated risk of an escalation in US-Iran tensions also favors holding gold. President Trump’s polling has bottomed, yet he remains the underdog in the election – we maintain his odds of winning reelection are 35%. This raises the risk that he adopts a “war president” posture. Iran could become a target as the financial price of confronting Iran is negligible for Trump, whereas a major China confrontation could sink the stock market. The collapse in oil prices and pandemic have weighed on Saudi Arabia’s budget. It has adopted a revenue over growth posture. While this could be a risk to domestic stability, our base case is that it accelerates the kingdom’s long-term reforms. The oil market rout and economic downturn will hurt other countries in the region that are leveraged to Arab petro states – chiefly Egypt and Jordan. Investors should monitor risks to state stability in the coming years. Lebanon’s crisis will incentivize emigration, but given the relatively small size of its population, the major risk to Europe comes from any broader state failures and Middle Eastern instability rather than from Lebanon’s failure alone. If the Democratic Party wins the US election, as expected, then the US-Iran strategic détente will resume and Iran will get a lifeline. But the immediate transition will still be rocky given the Israeli and Saudi desire to exploit Iran’s extreme vulnerability and build leverage with Washington. The COVID-19 crisis heralds another round of Middle Eastern crisis, much as the 2008 crisis led to the Arab Spring. Stay strategically long Brent crude oil and gold. Also, in the wake of yesterday’s 15% pullback in silver, go strategically long silver (XAGUSD), which will continue benefiting from the same structural trends favoring gold but also outperform gold as the global economy recovers, given its greater industrial utility.     Roukaya Ibrahim Editor/Strategist Geopolitical Strategy RoukayaI@bcaresearch.com       Appendix Table A1Iran Adopting Deterrence Strategy In Iraq From The Arab Spring To The Shia Crackup From The Arab Spring To The Shia Crackup   Footnotes 1     Berri is of the Hezbollah-allied Amal Movement and has been parliamentary speaker since 1992, while Bassil is President Aoun’s son-in-law and president of the Free Patriotic Movement, which has the most seats in parliament. 2     Hezbollah gains legitimacy at home through its charity work that plugs the gap in services normally provided for by the government. 3    According to a commander of an Iran-backed paramilitary group in Iraq, Iran slashed its monthly funding to the top four militias by nearly half this year. Please see “Coronavirus and sanctions hit Iran’s support of proxies in Iraq,” Reuters, July 2, 2020. 4    Hezbollah has gained control over the foreign policy and Lebanon has recently taken stances that are seen as bowing to Iranian pressure. Lebanon did not attend a March 22, 2018 extraordinary Arab League meeting discussing violations committed by Iran. Prior to that, Beirut did not condemn Iranian attacks on a Saudi diplomatic mission in Tehran. 5    However an undisclosed facility for processing uranium ore in the northeast of the kingdom has recently appeared. 6    This is not unlike the US’s decision to extend sanction waivers by four months, allowing Baghdad to import Iranian energy in order to ensure that the new government of Prime Minister Mustafa al-Kadhimi can stand on its own and is not overly dependent on Iran.

Highlights The EU’s €750 billion fiscal package, along with another round of US stimulus likely exceeding $1 trillion, will support global oil demand. On the supply side, OPEC 2.0’s production discipline likely holds, and US shale output will remain depressed. These fundamentals, along with a weakening USD, will continue to support Brent prices, which are up 129% from their lows in April. China’s record-setting crude-oil-import surge during the COVID-19 pandemic – averaging 12.7mm b/d in 1H20, up 28.5% y/y – is at risk of slowing in 2H20, as domestic storage fills. Supply-side risks are acute: Massive OPEC 2.0 spare capacity – which could exceed 6mm b/d into 2021 – will tempt producers eager to monetize these to boost revenue. On the demand side, COVID-19 infection rates are surging in the US. Progress on vaccines notwithstanding, politically intolerable public-health risks in big consuming markets could usher in demand-crushing lockdowns again. Economic policy uncertainty remains elevated globally, but the balance of risks continues to favor the upside: We expect 2H20 Brent prices to average $44/bbl, and 2021 prices to average $65/bbl, unchanged from last month’s forecast. Feature We are marginally lifting our forecast of average 2020 Brent prices to $43/bbl, with 2H20 expected to average $44/bbl, and $65/bbl next year, unchanged from June. Marginal improvements to preliminary supply and demand estimates earlier in the COVID-19 pandemic support the thesis that fundamentals will not derail the massive oil-price rally that lifted Brent 129% from its April 21 low of $19.30/bbl. A weakening US dollar, and the expectation this trend will continue, also is supportive to commodities in general, oil in particular. As a result, we are marginally lifting our forecast of average 2020 Brent prices to $43/bbl, with 2H20 expected to average $44/bbl, and $65/bbl next year, unchanged from June (Chart of the Week). The three principal oil-market data providers – the US EIA, IEA and OPEC – raised demand estimates at the margin for 1H20, particularly for 2Q20, the nadir for global oil consumption. The EIA’s estimate for 2Q20 demand shows an upward revision of 550k b/d from last month’s estimate. On the supply side, the EIA estimates global output fell -8.1mm b/d in 2Q20, a -300k b/d downward revision vs. its estimate from last month (Chart 2). Chart of the WeekOil Price Rally Remains Intact Oil Price Rally Remains Intact Oil Price Rally Remains Intact Chart 2OPEC 2.0, US Shale Production Cuts Deepen OPEC 2.0, US Shale Production Cuts Deepen OPEC 2.0, US Shale Production Cuts Deepen We continue to expect the drawdown in storage levels to flatten – and then backwardate – the forward curves for Brent and WTI. After accounting for this better-than-expected fundamental performance, we now expect global supply to fall 5.9mm b/d in 2020 and to increase 4.2mm b/d in 2021. On the demand side, we now expect 2020 demand to fall 8.1mm b/d vs. 8.9mm b/d last month, and for 2021 demand to rise 7.8mm b/d vs 8.5mm b/d in June (Chart 3). This will keep the physical deficit we’ve been forecasting for 2H20 and 2021 in place, allowing OECD storage to fall to 3,026mm barrels by year-end and to 2,766mm barrels by the end of next year (Chart 4). Chart 3Supply-Demand Balances Tighten ... Supply-Demand Balances Tighten ... Supply-Demand Balances Tighten ... Chart 4... Leading To Deeper Storage Draws ... ... Leading To Deeper Storage Draws ... ... Leading To Deeper Storage Draws ... We continue to expect the drawdown in storage levels to flatten – and then backwardate – the forward curves for Brent and WTI (Chart 5). One caveat, though: We are watching floating storage levels closely, particularly in Asia: The current structure of the Brent forwards does not support carrying floating inventory, but it’s been slow moving lower (Chart 6). This could reflect a slowing in China’s crude-oil import surge, which hit record levels in May and June. Chart 5... And More Backwardation In Brent And WTI Forwards ... ... And More Backwardation In Brent And WTI Forwards ... ... And More Backwardation In Brent And WTI Forwards ... Chart 6… Even As Floating Storage In Asia Remains Elevated Balance Of Oil-Price Risk Remains To The Upside Balance Of Oil-Price Risk Remains To The Upside China’s Crude-Import Binge Ending? There is a non-trivial risk China’s crude-buying binge during the COVID-19 pandemic, which supported prices during the brief Saudi-Russian market-share war in March and the collapse in global demand in 2Q20, may have run its course (Chart 7).1 At the depths of the global pandemic in 2Q20, China’s year-on-year (y/y) crude imports surged 15%. According to Reuters, China’s crude oil imports totaled 12.9mm b/d in June, a record level for the second month in a row.2 Much of this was converted to refined products – chiefly gasoline and diesel fuel – as China’s demand recovered from the global pandemic (Chart 8). China’s 208 refineries can process 22.3mm b/d of crude, according to the Baker Institute at Rice University in Houston.3 Refinery runs in June were estimated at just over 14mm b/d by Reuters. Chart 7China's Crude Import Binge Stalls China's Crude Import Binge Stalls China's Crude Import Binge Stalls Chart 8China's Refiners Lift Runs As Imports Surge China's Refiners Lift Runs As Imports Surge China's Refiners Lift Runs As Imports Surge A reduction in China’s crude imports would force barrels to either remain on the water until refiners find a need for it, or demand for refined products increases in the region. China imports its oil into 59 port facilities, which can process ~ 16mm b/d. Storage is comprised of 74 crude oil facilities holding ~ 706mm barrels, and 213 refined-product facilities with capacity to hold ~ 357mm barrels of products (Map 1). By Reuters’s count, ~ 2mm b/d of crude went into storage in the January-May period, while close to 2.8mm b/d was stored in June. Official storage data is a state secret, so it is not possible to determine whether China’s crude and product storage is full. However, if crude oil imports remain subdued – and floating storage in Asia remains elevated – we would surmise the Chinese storage facilities are close to full. Additionally, any sharp and sustained increase in refined product exports would indicate storage is brimming. Map 1Baker Institute China Oil Map Balance Of Oil-Price Risk Remains To The Upside Balance Of Oil-Price Risk Remains To The Upside A reduction in China’s crude imports would force barrels to either remain on the water until refiners find a need for it, or demand for refined products increases in the region. We expect the latter condition to obtain, in line with our expectation of a global recovery in demand, even though China remains out of sync with the rest of the world presently. China was the first state to confront the pandemic and first to emerge out of it; its trading partners still are in various stages of recovery (Chart 9). Chart 9China's Demand Recovery Likely Will Be Choppy China's Demand Recovery Likely Will Be Choppy China's Demand Recovery Likely Will Be Choppy OPEC 2.0’s Remains Sensitive To Demand Fluctuations OPEC 2.0’s leaders – the Kingdom of Saudi Arabia (KSA) and Russia – also managed to secure additional “compensation” cuts from members that have missed their targets in previous months. The asynchronous recovery in global oil demand poses a unique problem for OPEC 2.0 this year and next. OPEC 2.0 will be easing production curtailments to 7.7mm b/d beginning in August from 9.6mm b/d in July, on the advice of its Joint Ministerial Monitoring Committee (JMMC). This is a decision that will be closely monitored, amid rising concern over the speed of demand recovery in the US and EM economies, due to mounting COVID-19 cases (Chart 10). The surge in US infections relative to its trading partners is of particular concern, given the size of US oil demand (Chart 11). In 2H20, we expect US demand will account for close to 20% of global demand, much the same level it was prior to the pandemic (Table 1). Chart 10COVID-19 Infections Surge In The US Balance Of Oil-Price Risk Remains To The Upside Balance Of Oil-Price Risk Remains To The Upside Chart 11US COVID-19 Infections Are A Risk To Global Commodity Demand Balance Of Oil-Price Risk Remains To The Upside Balance Of Oil-Price Risk Remains To The Upside Table 1BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) Balance Of Oil-Price Risk Remains To The Upside Balance Of Oil-Price Risk Remains To The Upside OPEC 2.0’s leaders – the Kingdom of Saudi Arabia (KSA) and Russia – also managed to secure additional “compensation” cuts from members that have missed their targets in previous months, bringing the actual increase in production closer to 1-1.5mm b/d. Together, Iraq, Nigeria, Kazakhstan, and Angola, over-produced versus their May and June targets by ~ 760k b/d. In our balances estimates, as is our normal practice, we haircut these estimates and use a lower compliance level that those stated in the official OPEC 2.0 agreement. In the case of these producers, we assume they will compensate for ~ 70% of their overproduction, bringing the adjusted cuts to ~ 8.3mm b/d. This should be sufficient to maintain the current supply deficit in oil markets that continues to support Brent prices above $40/bbl. However, the reliance on laggards’ extra cuts to balance markets adds instability. There is a lot of supply on the sidelines from the OPEC 2.0 cuts and the restart of the Neutral Zone shared by Saudi Arabia and Kuwait. The JMMC is continually assessing supply-demand balances and remains focused on making sure the totality of the cuts does not fall on a small group of countries. It reiterated its position that “achieving 100% conformity from all participating Countries is not only fair, but vital for the ongoing rebalancing efforts and to help deliver long term oil market stability.” In June, OPEC 2.0’s overall compliance was 107% – mostly reflecting over-compliance from KSA, the UAE, and Kuwait.4 There is a lot of supply on the sidelines from the OPEC 2.0 cuts and the restart of the Neutral Zone shared by Saudi Arabia and Kuwait. The US EIA estimates that within the original OPEC cartel spare capacity will average close to 6mm b/d this year, the first time since 2002 that it has exceeded 5mm b/d. On top of this, there’s the looming downside risk of a new Iran deal if Democrats win the White House and Congress in US elections in November, and a possible restart of Libyan exports this year. Watch The DUCs In The US With WTI prices averaging $41/bbl so far in July, we continue to expect part of previously shut-in US production to come back on line in July, August and September. Nonetheless, the negative effect of the multi-year low rig count will be felt heavily in 4Q20 and 1Q21 and will push production lower. The rig count appears to be bottoming but is not expected to increase meaningfully until WTI prices move closer to $45-50/bbl. On average it takes somewhere between 9-12 months for the signal from higher prices to result in new oil production flowing to market in the US. As the rig count moves back up in 2021, its effect on production will be apparent only in late-2021. However, the massive inventory of drilled-but-uncompleted (DUC) wells in the main US tight-oil basins will provide a source of cheaper new supply, if WTI prices remain above $40/bbl. DUCs are 30-40% cheaper to complete compared to drilling a new well from start. We expect DUCs completion will begin adding to US crude output in 1Q21, and that this will continue to be a source of supply beyond 2021. Bottom line: Global economic policy uncertainty remains elevated, albeit off its recent highs (Chart 12). We expect this uncertainty to continue to wane, which will allow the USD to continue to weaken. This will spur global oil demand, and will augment the fiscal and monetary stimulus to the COVID-19 pandemic undertaken globally. Chart 12Global Policy Uncertainty Remains High, Which Could Support USD Demand Balance Of Oil-Price Risk Remains To The Upside Balance Of Oil-Price Risk Remains To The Upside Nonetheless, the global recovery remains out of sync, which complicates OPEC 2.0’s production management, and markets’ estimation of supply-demand balances. Uneven success in combating the pandemic keeps the risk of lockdowns on the radar in the US. Policy is driving oil production at present, and, given the temptation to monetize spare capacity, the supply side remains a risk to prices. We continue to see upside risk dominating the evolution of prices and are maintaining our expectation Brent prices will average $44/bbl in 2H20 – lifting the overall 2020 average to $43/bbl – and $65/bbl next year. Our expectation WTI will trade $2-$4/bbl below Brent also remains intact.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Hugo Bélanger Associate Editor Commodity & Energy Strategy HugoB@bcaresearch.com Fernando Crupi Research Associate Commodity & Energy Strategy FernandoC@bcaresearch.com     Commodities Round-Up Energy: Overweight Canadian oil production averaged 4.6mm b/d in 2Q20 vs. 5.5mm b/d in 2Q19, based on EIA estimates. The lack of demand from US refiners – crude imports from Canada fell by 420k b/d y/y during the quarter – and close to maxed-out local storage facilities pushed prices below cash costs, forcing the shut-ins of more than 1mm b/d of crude production. Canadian energy companies started releasing their 2Q20 earnings this week and analysts expect the results to be one of the worst ever recorded, reflecting the extent of the pain producers felt during the COVID-19 shock. Base Metals: Neutral High-grade iron ore prices (65% Fe) were trading above $120/MT this week, on the back of forward guidance from the commodity’s top exporter, Brazilian miner Vale, which suggested exports will be lower than had been previously estimated this year, according to Fastmarkets MB, a sister service of BCA Research. This is in line with an Australian Department of Industry, Science, Energy and Resources analysis in June, which noted, “The COVID-19 pandemic appears to have affected both sides of the iron ore market: demand disruptions have run up against supply problems localised in Brazil, where COVID-19-related lockdowns have derailed efforts to recover from shutdowns in the wake of the Brumadinho tailings dam collapse” (Chart 13). Precious Metals: Neutral Our long silver position is up 17.5% since it was recommended July 2. We are placing a stop-loss on the position at $21/oz, our earlier target, given the metal was trading ~ $22/oz as we went to press. The factors supporting gold prices – chiefly low real rates in the US, a weakening dollar and global monetary accommodation, also support silver prices. However, silver also will benefit from the recovery in industrial activity and incomes we anticipate in the wake of global fiscal and monetary stimulus, which will drive demand for consumer products (Chart 14). Ags/Softs:  Underweight Lumber prices have more than doubled since April lows. The uncertainty brought by the COVID-19 health emergency altered the perception of future housing demand and, by extension, lumber demand, to the point that mills responded by substantially decreasing capacity utilization rates. However, in the wake of global monetary and fiscal stimulus, housing weathered the storm better than expected. Furthermore, a surge in DIY projects from individuals working from home at a time of reduced supply contributed to the current state of market shortage. Chart 13Lower Supply Supports Iron Ore Prices Lower Supply Supports Iron Ore Prices Lower Supply Supports Iron Ore Prices Chart 14Silver Favored Over Gold Silver Favored Over Gold Silver Favored Over Gold         Footnotes 1     In our reckoning, a non-trivial risk is something greater than Russian roulette odds – i.e., a 1-in-6 chance of an event occuring. Re the ever-so-brief Saudi-Russian market-share war, please see KSA, Russia Will Be Forced To Quit Market-Share War, which we published March 19, 2020. It is available at ces.bcaresearch.com. 2     Please see COLUMN-China's record crude oil storage flies under the radar: Russell published by reuters.com July 20, 2020. 3    The Baker Institute’s Open-Source Mapping of China's Oil Infrastructure was last updated in March 2020. The map is “a beta version and is likely missing some pieces of existing infrastructure. The challenge of China’s geographic expanse — it is roughly the same area as the U.S. Lower 48 — is compounded by a lack of transparency on the part of China’s government,” according to the Baker Institute. 4    In our supply-side estimates, we used IEA estimates of cuts for June this month. This doesn’t change the overall estimate of cuts from our earlier analysis; however, it slightly changes how the 9.7mm b/d was split between OPEC 2.0 members. the official eased cuts are 7.7mm b/d from 9.7mm b/d in May-June-July, but it actually is closer to 8.3mm b/d accounting for the compensation from the countries mentioned above.   Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Trade Recommendation Performance In 2020 Q2 Balance Of Oil-Price Risk Remains To The Upside Balance Of Oil-Price Risk Remains To The Upside Commodity Prices and Plays Reference Table Trades Closed in 2020 Summary of Closed Trades Balance Of Oil-Price Risk Remains To The Upside Balance Of Oil-Price Risk Remains To The Upside

Highlights If the current low oil price environment is transitory, temporary fiscal tightening can be used to preserve the exchange rate peg. In our view, low oil prices are structural - crude prices will likely average $40 and lower in the coming years. In such a scenario, fiscal tightening cannot be a solution because it will unleash eternal economic malaise. Hence, currency devaluation will become necessary. Even though Saudi Arabia’s currency devaluation is not imminent, the risk-reward of selling the SAR/USD in the forward market is attractive. We recommend investors sell Saudi Arabian riyals in the forward market as a long-term bet. Feature The plunge in oil prices has revived the debate on the sustainability of the Saudi currency peg. This report argues that currency devaluation is not imminent, given that Saudi authorities have sufficient foreign currency reserves to fund balance of payment (BoP) deficits for some time. Beyond that, if oil prices average $40 and lower, Saudi’s exchange rate peg will come under pressure. Depleting Foreign Exchange Reserves Chart I-1Saudi Arabia: Oil Prices And Balance Of Payments Saudi Arabia: Oil Prices And Balance Of Payments Saudi Arabia: Oil Prices And Balance Of Payments In this section, we estimate how oil prices will impact the level of Saudi Arabia’s gross foreign exchange (FX) reserves. Odds are that oil prices have experienced a structural breakdown and will average no more than $40 per barrel in the next three years.1 To preserve the riyal’s peg to the US dollar, the Saudi authorities will have to plug the gap in foreign funding requirements (FFR). We define the FFR as the sum of the current account balance and the capital account balance without taking into account government external borrowing. The nation’s current account balance and FFR along with oil prices are shown in Chart I-1. For the purpose of this simulation, we assume an average oil price of $40, $40, and $35 a barrel in 2020, 2021 and 2022, respectively. Our full set of assumptions for Table I-1 are provided in Box I-1. Our findings from the simulation are as follows: Saudi Arabia’s FFR deficits will amount to $94 billion in 2020, $96 billion in 2021 and $82 billion in 2022 (Table I-1, row G). We assume the government’s external (US dollar) borrowing will cover 50% of FFR in 2020, 2021, and 2022. The rest will be financed by drawdowns from the Saudi Arabian Monetary Authority’s (SAMA) gross FX reserves. The latter will decline by $47 billion in 2020, $48 billion in 2021 and $41 billion in 2022. Indeed, over the first three months of this year, the monetary authorities’ FX reserves have already dropped by around $26 billion. Hence, our forecasts for annual change in the central bank’s FX reserves are reasonable. Saudi Arabia’s gross FX reserves will drop to $360 billion by the end of 2022 from the current $471 billion (Table I-1, row J). This roughly represents a 23% decline. In terms of fiscal dynamics, the fiscal balance will register deficits of 14%, 16% and 17% of GDP in 2020, 2021 and 2022, respectively (Table I-1, row C). Assuming the government decides to fund 75% of the deficits by issuing bonds and the other 25% by drawing on FX reserves at SAMA, the public debt-to-GDP ratio will rise from around 23% currently to 61% by the end of 2022 (Table I-1, row D). Box I-1Simulation: Estimating Potential Drawdowns In Foreign Currency Reserves Saudi Riyal Devaluation: Not Imminent But Necessary Saudi Riyal Devaluation: Not Imminent But Necessary The Money Supply Coverage Ratio The Saudi Currency Law of 1959 stipulates that currency issued by SAMA must be backed by foreign currencies and gold. Indeed, Chart I-2 reveals that SAMA is in compliance with that law. Its holdings of gold and foreign currencies closely track the sum of currency in circulation and the cash stored in SAMA’s and banks’ vaults. This monetary construct made sense in the 1960s when much of the money supply was made up of cash currency, meaning that electronic money/bank deposits were still too small to matter. Odds are that oil prices have experienced a structural breakdown and will average no more than $40 per barrel in the next three years. Currently, currency in circulation makes up only 11% of the broad local currency money supply, hereafter referred to as the broad money supply. The latter is calculated as M3 minus foreign currency deposits and includes cash in circulation and all local currency deposits (electronic money). Demand deposits make up 63% of the broad money supply, while savings and time deposits account for 25% (Chart I-3). In a nutshell, the currency in circulation amounts to SAR 199 billion, while the broad money supply stands at SAR 1866 billion. Chart I-2The Monetary Rule That SAMA Follows The Monetary Rule That SAMA Follows The Monetary Rule That SAMA Follows Chart I-3Composition Of Broad Money Supply Composition Of Broad Money Supply Composition Of Broad Money Supply   Individuals, companies and foreigners can use the entire broad money supply - cash in circulation and all local currency deposits (electronic money) - to buy foreign currency in Saudi Arabia. In nutshell, time and savings deposits can be converted into demand deposits upon the expiration of their term or immediately after the payment of a penalty. Therefore, the proper formula for calculating the international FX reserves-to-money supply coverage ratio is as follows: Money coverage ratio = (central bank’s foreign exchange reserves) / (broad local currency money supply). For the reasons elaborated above, the denominator should be the broad money supply, not just the amount of currency in circulation. To calculate the Saudi Arabia’s money coverage ratio, we use not only SAMA’s holdings of gold and foreign currencies, but also all its foreign currency securities, including bonds, stocks and other foreign assets, including private equity investments. The top panel of Chart I-4 illustrates that the broad money supply is now equal to the central bank’s gross foreign exchange reserves, i.e., the nation’s money coverage ratio is currently close to one. Hence, in short, the level of FX reserves is currently adequate. Chart I-4Saudi Arabia: FX Reserves And Broad Money Supply Saudi Arabia: FX Reserves And Broad Money Supply Saudi Arabia: FX Reserves And Broad Money Supply Crucially, if SAMA chooses to maintain the economy’s broad money supply such that it is equal to its holdings of gross international FX reserves, then it will have to shrink the money supply substantially as its foreign exchange reserves are depleted considerably over the course of the next three years. Our projections in Table I-1 suggest that SAMA’s gross foreign exchange reserves will likely drop by about 25% between January 1, 2020 and the end of 2022. If Saudi authorities attempt to maintain the money coverage ratio at around one, the broad money supply will also have to shrink by the same order of magnitude. We reckon that it will be very painful economically and, thereby, socially and politically undesirable to follow a monetary regime that requires a 25% contraction in the nominal broad money supply over the next three years. Money supply will likely be allowed to exceed the authorities’ gross foreign exchange reserves. This will prompt doubts about the sustainability of the exchange rate peg. For instance, in 2015-2016, the broad money supply in Saudi Arabia actually expanded by 6% over a two year period even though gross international FX reserves declined by 27% (please refer to Chart I-5 on page 7). The difference between then and now is that gross international reserves in the 2015-2016 period were greater than the broad money supply, which means that the money coverage ratio was well above one (Chart I-4, bottom panel). Chart I-5Bank Credit/Money Growth Can Diverge From FX Reserves Bank Credit/Money Growth Can Diverge From FX Reserves Bank Credit/Money Growth Can Diverge From FX Reserves In brief, in 2015-16, SAMA had leeway to tolerate a major drop in its gross foreign exchange reserves without needing to shrink the broad money supply. However now with the money coverage ratio close to one, SAMA does not have that much room to maneuver. Odds are that the money supply will not be allowed to drop as low as the forthcoming drop in the central bank’s gross foreign exchange reserves given the enormous deflationary pressures that would be unleashed. Consequently, the nation’s money coverage ratio will likely drop well below one. This will likely prompt doubts about the sustainability of Saudi Arabia’s exchange rate peg. Bottom Line: Attempts by SAMA to maintain the money coverage ratio at or close to one – to ensure a solid currency peg –will entail a substantial shrinkage in the broad money supply. The latter will herald immense contractionary and deflationary pressures in the real economy. This scenario is economically, socially and politically unviable. Hence, money supply will likely be allowed to exceed the authorities’ gross foreign exchange reserves. This will prompt doubts about the sustainability of the exchange rate peg. A New Era Of Higher Currency Risk Premiums The simulation in Table I-1 projects that KSA’s foreign exchange reserves will drop by about 25% by the end of 2022. If the broad money supply grows even 5% per annum over the next three years (the current annual growth rate being 11%), the money coverage ratio will drop from its current 0.95 to about 0.61. As Saudi Arabia’s foreign exchange reserves increasingly fall short of its broad money supply, the currency peg will enter a new era where doubts about the currency peg’s sustainability will begin to grow. Consequently, currency forwards will start pricing in higher chances of devaluation. Given that a central bank’s sale of international FX reserves to non-banks shrinks the banks’ excess reserves and broad money supply,2 a pertinent question is: how and why can broad money supply still grow? The broad money supply can still expand even when the central bank sells its foreign exchange reserves. The local currency money supply expands when the central bank or commercial banks lend to or purchase assets from non-bank entities. This includes their purchases of government bonds on both the primary and secondary markets. Chart I-5 reveals that broad money supply growth in Saudi Arabia correlates with commercial banks’ assets and is not always aligned with SAMA’s gross FX reserves. Chart I-6Money Multiplier = Broad Money Supply / Banks' Excess Reserves Money Multiplier = Broad Money Supply / Banks' Excess Reserves Money Multiplier = Broad Money Supply / Banks' Excess Reserves Overall, it is possible for the broad money supply to expand in Saudi Arabia even if SAMA depletes its FX reserves to fund BoP deficits. For this to occur, banks and/or SAMA need to lend to or purchase securities from non-banks (including from the government) in greater amounts than SAMA’s sales of its FX reserves. Besides, the central bank may or may not need to provide funding (excess reserves) to the banking system to accommodate an expanding money supply (Chart I-6). Going forward, KSA’s broad money supply will be shaped by the following dynamics. On the one hand, sales of SAMA’s foreign exchange reserves will reduce its broad money supply. On the other hand, commercial banks’ lending to non-banks, alongside their purchase of government securities, will expand the money supply. In aggregate, the money supply might grow modestly even as the country’s foreign currency reserves plummet. However, this implies that the FX reserves-to-money supply coverage ratio will drop well below one. This is unlikely to break the currency peg in the medium term. There is no theory or historical precedent to indicate the level at which the money coverage ratio causes the peg to crumble. It is often much more about confidence in the exchange rate regime than about the precise level of this ratio. Chart I-7 illustrates the money coverage ratio for different economies. KSA has the highest money coverage ratio among emerging markets. Chart I-7The Money Coverage Ratio: A Cross-Country Perspective Saudi Riyal Devaluation: Not Imminent But Necessary Saudi Riyal Devaluation: Not Imminent But Necessary However, there are several reasons why this ratio should structurally be higher in Saudi Arabia than in other EM economies: First, unlike the majority of EMs, KSA runs a currency peg and the latter warrants different standards regarding the money coverage ratio. Foreign exchange reserves falling well below the broad money supply will gradually undermine the integrity of its monetary regime and shake confidence in its sustainability. Chart I-8Saudi Arabia: FX Reserves And Interest Rates Saudi Arabia: FX Reserves And Interest Rates Saudi Arabia: FX Reserves And Interest Rates Second, the Impossible Trinity thesis suggests that in an economy with an open capital account, the central bank is forced to choose between controlling either the currency or interest rates. Since there are no capital controls in Saudi Arabia and the central bank fixes the riyal to the US dollar, SAMA has little control over interest rates. The country is therefore forced to import US interest rates. Provided US interest rates are now close to zero and the plunge in oil revenues has unleashed a recession in Saudi Arabia, the very low interest rates that Saudi Arabia imports from the US are currently adequate. This, however, does not mean that Saudi interest rates cannot deviate from US ones. Chart I-8 illustrates that SAMA’s sales of FX reserve assets could lead to a rise in local interbank rates in absolute terms or relative to US ones. This is because when the central bank is selling US dollars, it tends also to shrink the banking system’s excess reserves, which forces commercial banks to bid the price of inter-bank liquidity higher. Third, a central bank cannot simultaneously control the exchange rate and the quantity of monetary aggregates. In other words, SAMA cannot both peg the currency to the US dollar and have control over the level of money supply. This constraint is similar but not identical to the above point about the relationship between exchange and interest rates. To illustrate this trade-off: when SAMA draws down its international reserves to fund a BoP deficit, the money supply will shrink. If the authorities simultaneously encourage and allow the banks to lend to or purchase securities from non-banks, including the government, the money supply will expand. This newly created money could find its way to the currency market (in the form of greater imports or capital outflows) and could bid up the price of the US dollar versus SAR. To defend the peg, SAMA will have to sell more of its foreign currency reserves and purchase SAR, thereby, contracting the money supply again. In short, because of the currency peg, SAMA might not be able to simultaneously control the level of money supply and defend the peg. Finally, unlike many other EM economies, KSA has little domestic productive capacity and relies heavily on imports to satisfy domestic demand for goods and services. Given the nation’s high propensity to import, new riyals created by the banking system have a higher chance of flowing to the foreign exchange market, weighing on the value of the currency and jeopardizing the peg. In Saudi Arabia, fiscal policy is of paramount importance to upholding the currency peg when oil revenues plunge. Other EM economies like the Brazilian or Russian ones do not face such a constraint because they do not have pegged currency regimes. Other economies such as China’s and Korea’s have substantial domestic productive capacity to meet new domestic demand. So, in the latter economies only a small portion of new money creation flows to the foreign exchange market. Bottom Line: Given that it is operating a fixed exchange rate regime, KSA’s money coverage ratio should structurally be higher than that of many other emerging economies. As this ratio drops well below one in the next couple of years, the risk premium in SAR forwards will rise as the market moves to price a higher probability of devaluation. Fiscal-Monetary Nexus In Saudi Arabia, fiscal policy is of paramount importance to upholding the currency peg when oil revenues plunge (Chart I-9). The basis for this is the fact that in Saudi Arabia fiscal policy plays a larger role than monetary policy in driving domestic demand. Chart I-10 demonstrates that government spending amounts to 36% of GDP annually while new annual credit origination is only about 4% of GDP. Chart I-9Oil Prices And Government Spending Oil Prices And Government Spending Oil Prices And Government Spending Chart I-10Fiscal Spending Is Much More Important Than Credit Creation Fiscal Spending Is Much More Important Than Credit Creation Fiscal Spending Is Much More Important Than Credit Creation   Even though the government has already embarked on a considerable fiscal austerity program, the nation will continue to face very large fiscal deficits. Our simulation forecasts fiscal deficits of 14% of GDP in 2020, 16% in 2021 and 17% of GDP in 2022 (please refer to row C in Table I-1 on page 3). Chart I-11Fiscal Spending Drives Imports Fiscal Spending Drives Imports Fiscal Spending Drives Imports Saudi imports are very sensitive to government spending while government revenues correlate with exports (Chart I-11). Swelling fiscal deficits can be funded by issuing both foreign and local currency bonds. However, each type of borrowing has different implications for the exchange rate, interest rates and the money supply. There are several ways in which the fiscal-monetary nexus can play out in Saudi Arabia.3 The government can draw down on its FX reserves at SAMA to fund the fiscal deficit. This will quickly erode the central bank’s gross FX reserves and, consequently, undermine confidence in the currency peg. The government can borrow externally (in foreign currency) to cover both the budget and BoP deficits. However, in this case, the government’s foreign currency debt will mushroom and the nation’s sovereign credit risk and, thereby, cost of external borrowing will rise.  The fiscal deficit can be funded by issuing local currency bonds sold to non-banks only. Given the sheer size of required government funding over the next couple of years, local interest rates will rise significantly as the government competes to attract a limited amount of existing deposits. Overall, this will crowd out the private sector which will have negative ramifications on the economy. However, the currency peg will not be jeopardized as the money supply will shrink dramatically in this scenario. The government can fund itself by borrowing from domestic commercial banks, i.e., by issuing local currency paper to be bought by banks. The government will get new local currency deposits and will not compete for existing deposits. This will not produce a crowding out effect and interest rates will not rise. As we have discussed in past reports, commercial banks do not require deposits or savings to lend money or to purchase securities. Everywhere, commercial banks – with regulatory forbearance and shareholder consent – can purchase literally an unlimited amount of government bonds thereby financing the nation’s large fiscal deficits. Critically, when commercial banks buy local currency government bonds, they create new local currency deposits “out of thin air”. This scenario would be equivalent to the monetization of public debt. Money supply will expand briskly and the money coverage ratio will drop. The outcome will produce downward pressure on the currency’s value as new money/deposits created by commercial banks will end up eating into the country’s finite foreign exchange reserves via imports and capital outflows, as discussed above. While commercial banks can easily fund the fiscal deficit by creating money “out of thin air”, the former will likely bolster demand for dollars and endanger the currency peg. Bottom Line: The Saudi government will likely resort to all four mechanisms to fund itself. Given the large size of its fiscal deficit, financing it entirely via external borrowing or the depletion of FX reserves is unattainable. Therefore, issuance of local bonds will continue at a rapid pace, with the following implications: If local bonds are bought by non-banks, local interest rates will be pushed higher, crowding out the private sector with negative ramifications for the economy; or If local bonds are bought by commercial banks, the money supply will expand meaningfully, thereby drastically reducing the money coverage ratio and exerting substantial pressure on the currency peg. Neither of these scenarios can be sustained in the long run. Investment Conclusions Chart I-12SAR/USD Forwards And Oil Prices SAR/USD Forwards And Oil Prices SAR/USD Forwards And Oil Prices If the era of low oil prices is transitory, temporary fiscal tightening can be used to preserve the peg. In our view, low oil prices are structural – crude prices will likely average at most $40 per barrel in the coming years. In such a scenario, fiscal tightening cannot be a solution because it will unleash eternal economic malaise. Hence, currency devaluation will be unavoidable. Critically, the longer the authorities preserve the peg in the face of lower oil prices, the larger the devaluation will ultimately be. Based on historical experiences of other economies that delayed their own currency adjustments, the devaluations that they eventually faced were between 30-50%. Despite the collapse in oil prices, the SAR/USD long-term forwards are underpricing the risk of devaluation (Chart I-12). If the downshift in oil prices is more permanent than the one in 2015 – as we believe it will be – the SAR/USD long-term forwards offer a good opportunity. As a structural trade, we recommend investors to sell the 3-year SAR/USD forward. The current entry point is attractive. Ayman Kawtharani Editor/Strategist ayman@bcaresearch.com Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com   Footnotes   1  This is the view of BCA’s Emerging Markets Strategy service and it differs from the view of BCA’s Commodities and Energy Strategy service. 2  Commercial banks’ excess reserves are not part of the broad money supply. This applies to all economies, regardless of their exchange rate regime. 3  By that we mean the interplay between government financing/borrowing and the resulting changes in money supply, interest rates and the exchange rate.  

Highlights If the current low oil price environment is transitory, temporary fiscal tightening can be used to preserve the exchange rate peg. In our view, low oil prices are structural - crude prices will likely average $40 and lower in the coming years. In such a scenario, fiscal tightening cannot be a solution because it will unleash eternal economic malaise. Hence, currency devaluation will become necessary. Even though Saudi Arabia’s currency devaluation is not imminent, the risk-reward of selling the SAR/USD in the forward market is attractive. We recommend investors sell Saudi Arabian riyals in the forward market as a long-term bet. Feature The plunge in oil prices has revived the debate on the sustainability of the Saudi currency peg. This report argues that currency devaluation is not imminent, given that Saudi authorities have sufficient foreign currency reserves to fund balance of payment (BoP) deficits for some time. Beyond that, if oil prices average $40 and lower, Saudi’s exchange rate peg will come under pressure. Depleting Foreign Exchange Reserves Chart I-1Saudi Arabia: Oil Prices And Balance Of Payments Saudi Arabia: Oil Prices And Balance Of Payments Saudi Arabia: Oil Prices And Balance Of Payments In this section, we estimate how oil prices will impact the level of Saudi Arabia’s gross foreign exchange (FX) reserves. Odds are that oil prices have experienced a structural breakdown and will average no more than $40 per barrel in the next three years.1 To preserve the riyal’s peg to the US dollar, the Saudi authorities will have to plug the gap in foreign funding requirements (FFR). We define the FFR as the sum of the current account balance and the capital account balance without taking into account government external borrowing. The nation’s current account balance and FFR along with oil prices are shown in Chart I-1. For the purpose of this simulation, we assume an average oil price of $40, $40, and $35 a barrel in 2020, 2021 and 2022, respectively. Our full set of assumptions for Table I-1 are provided in Box I-1. Our findings from the simulation are as follows: Saudi Arabia’s FFR deficits will amount to $94 billion in 2020, $96 billion in 2021 and $82 billion in 2022 (Table I-1, row G). We assume the government’s external (US dollar) borrowing will cover 50% of FFR in 2020, 2021, and 2022. The rest will be financed by drawdowns from the Saudi Arabian Monetary Authority’s (SAMA) gross FX reserves. The latter will decline by $47 billion in 2020, $48 billion in 2021 and $41 billion in 2022. Indeed, over the first three months of this year, the monetary authorities’ FX reserves have already dropped by around $26 billion. Hence, our forecasts for annual change in the central bank’s FX reserves are reasonable. Saudi Arabia’s gross FX reserves will drop to $360 billion by the end of 2022 from the current $471 billion (Table I-1, row J). This roughly represents a 23% decline. In terms of fiscal dynamics, the fiscal balance will register deficits of 14%, 16% and 17% of GDP in 2020, 2021 and 2022, respectively (Table I-1, row C). Assuming the government decides to fund 75% of the deficits by issuing bonds and the other 25% by drawing on FX reserves at SAMA, the public debt-to-GDP ratio will rise from around 23% currently to 61% by the end of 2022 (Table I-1, row D). Box I-1Simulation: Estimating Potential Drawdowns In Foreign Currency Reserves Saudi Riyal Devaluation: Not Imminent But Necessary Saudi Riyal Devaluation: Not Imminent But Necessary The Money Supply Coverage Ratio The Saudi Currency Law of 1959 stipulates that currency issued by SAMA must be backed by foreign currencies and gold. Indeed, Chart I-2 reveals that SAMA is in compliance with that law. Its holdings of gold and foreign currencies closely track the sum of currency in circulation and the cash stored in SAMA’s and banks’ vaults. This monetary construct made sense in the 1960s when much of the money supply was made up of cash currency, meaning that electronic money/bank deposits were still too small to matter. Odds are that oil prices have experienced a structural breakdown and will average no more than $40 per barrel in the next three years. Currently, currency in circulation makes up only 11% of the broad local currency money supply, hereafter referred to as the broad money supply. The latter is calculated as M3 minus foreign currency deposits and includes cash in circulation and all local currency deposits (electronic money). Demand deposits make up 63% of the broad money supply, while savings and time deposits account for 25% (Chart I-3). In a nutshell, the currency in circulation amounts to SAR 199 billion, while the broad money supply stands at SAR 1866 billion. Chart I-2The Monetary Rule That SAMA Follows The Monetary Rule That SAMA Follows The Monetary Rule That SAMA Follows Chart I-3Composition Of Broad Money Supply Composition Of Broad Money Supply Composition Of Broad Money Supply   Individuals, companies and foreigners can use the entire broad money supply - cash in circulation and all local currency deposits (electronic money) - to buy foreign currency in Saudi Arabia. In nutshell, time and savings deposits can be converted into demand deposits upon the expiration of their term or immediately after the payment of a penalty. Therefore, the proper formula for calculating the international FX reserves-to-money supply coverage ratio is as follows: Money coverage ratio = (central bank’s foreign exchange reserves) / (broad local currency money supply). For the reasons elaborated above, the denominator should be the broad money supply, not just the amount of currency in circulation. To calculate the Saudi Arabia’s money coverage ratio, we use not only SAMA’s holdings of gold and foreign currencies, but also all its foreign currency securities, including bonds, stocks and other foreign assets, including private equity investments. The top panel of Chart I-4 illustrates that the broad money supply is now equal to the central bank’s gross foreign exchange reserves, i.e., the nation’s money coverage ratio is currently close to one. Hence, in short, the level of FX reserves is currently adequate. Chart I-4Saudi Arabia: FX Reserves And Broad Money Supply Saudi Arabia: FX Reserves And Broad Money Supply Saudi Arabia: FX Reserves And Broad Money Supply Crucially, if SAMA chooses to maintain the economy’s broad money supply such that it is equal to its holdings of gross international FX reserves, then it will have to shrink the money supply substantially as its foreign exchange reserves are depleted considerably over the course of the next three years. Our projections in Table I-1 suggest that SAMA’s gross foreign exchange reserves will likely drop by about 25% between January 1, 2020 and the end of 2022. If Saudi authorities attempt to maintain the money coverage ratio at around one, the broad money supply will also have to shrink by the same order of magnitude. We reckon that it will be very painful economically and, thereby, socially and politically undesirable to follow a monetary regime that requires a 25% contraction in the nominal broad money supply over the next three years. Money supply will likely be allowed to exceed the authorities’ gross foreign exchange reserves. This will prompt doubts about the sustainability of the exchange rate peg. For instance, in 2015-2016, the broad money supply in Saudi Arabia actually expanded by 6% over a two year period even though gross international FX reserves declined by 27% (please refer to Chart I-5 on page 7). The difference between then and now is that gross international reserves in the 2015-2016 period were greater than the broad money supply, which means that the money coverage ratio was well above one (Chart I-4, bottom panel). Chart I-5Bank Credit/Money Growth Can Diverge From FX Reserves Bank Credit/Money Growth Can Diverge From FX Reserves Bank Credit/Money Growth Can Diverge From FX Reserves In brief, in 2015-16, SAMA had leeway to tolerate a major drop in its gross foreign exchange reserves without needing to shrink the broad money supply. However now with the money coverage ratio close to one, SAMA does not have that much room to maneuver. Odds are that the money supply will not be allowed to drop as low as the forthcoming drop in the central bank’s gross foreign exchange reserves given the enormous deflationary pressures that would be unleashed. Consequently, the nation’s money coverage ratio will likely drop well below one. This will likely prompt doubts about the sustainability of Saudi Arabia’s exchange rate peg. Bottom Line: Attempts by SAMA to maintain the money coverage ratio at or close to one – to ensure a solid currency peg –will entail a substantial shrinkage in the broad money supply. The latter will herald immense contractionary and deflationary pressures in the real economy. This scenario is economically, socially and politically unviable. Hence, money supply will likely be allowed to exceed the authorities’ gross foreign exchange reserves. This will prompt doubts about the sustainability of the exchange rate peg. A New Era Of Higher Currency Risk Premiums The simulation in Table I-1 projects that KSA’s foreign exchange reserves will drop by about 25% by the end of 2022. If the broad money supply grows even 5% per annum over the next three years (the current annual growth rate being 11%), the money coverage ratio will drop from its current 0.95 to about 0.61. As Saudi Arabia’s foreign exchange reserves increasingly fall short of its broad money supply, the currency peg will enter a new era where doubts about the currency peg’s sustainability will begin to grow. Consequently, currency forwards will start pricing in higher chances of devaluation. Given that a central bank’s sale of international FX reserves to non-banks shrinks the banks’ excess reserves and broad money supply,2 a pertinent question is: how and why can broad money supply still grow? The broad money supply can still expand even when the central bank sells its foreign exchange reserves. The local currency money supply expands when the central bank or commercial banks lend to or purchase assets from non-bank entities. This includes their purchases of government bonds on both the primary and secondary markets. Chart I-5 reveals that broad money supply growth in Saudi Arabia correlates with commercial banks’ assets and is not always aligned with SAMA’s gross FX reserves. Chart I-6Money Multiplier = Broad Money Supply / Banks' Excess Reserves Money Multiplier = Broad Money Supply / Banks' Excess Reserves Money Multiplier = Broad Money Supply / Banks' Excess Reserves Overall, it is possible for the broad money supply to expand in Saudi Arabia even if SAMA depletes its FX reserves to fund BoP deficits. For this to occur, banks and/or SAMA need to lend to or purchase securities from non-banks (including from the government) in greater amounts than SAMA’s sales of its FX reserves. Besides, the central bank may or may not need to provide funding (excess reserves) to the banking system to accommodate an expanding money supply (Chart I-6). Going forward, KSA’s broad money supply will be shaped by the following dynamics. On the one hand, sales of SAMA’s foreign exchange reserves will reduce its broad money supply. On the other hand, commercial banks’ lending to non-banks, alongside their purchase of government securities, will expand the money supply. In aggregate, the money supply might grow modestly even as the country’s foreign currency reserves plummet. However, this implies that the FX reserves-to-money supply coverage ratio will drop well below one. This is unlikely to break the currency peg in the medium term. There is no theory or historical precedent to indicate the level at which the money coverage ratio causes the peg to crumble. It is often much more about confidence in the exchange rate regime than about the precise level of this ratio. Chart I-7 illustrates the money coverage ratio for different economies. KSA has the highest money coverage ratio among emerging markets. Chart I-7The Money Coverage Ratio: A Cross-Country Perspective Saudi Riyal Devaluation: Not Imminent But Necessary Saudi Riyal Devaluation: Not Imminent But Necessary However, there are several reasons why this ratio should structurally be higher in Saudi Arabia than in other EM economies: First, unlike the majority of EMs, KSA runs a currency peg and the latter warrants different standards regarding the money coverage ratio. Foreign exchange reserves falling well below the broad money supply will gradually undermine the integrity of its monetary regime and shake confidence in its sustainability. Chart I-8Saudi Arabia: FX Reserves And Interest Rates Saudi Arabia: FX Reserves And Interest Rates Saudi Arabia: FX Reserves And Interest Rates Second, the Impossible Trinity thesis suggests that in an economy with an open capital account, the central bank is forced to choose between controlling either the currency or interest rates. Since there are no capital controls in Saudi Arabia and the central bank fixes the riyal to the US dollar, SAMA has little control over interest rates. The country is therefore forced to import US interest rates. Provided US interest rates are now close to zero and the plunge in oil revenues has unleashed a recession in Saudi Arabia, the very low interest rates that Saudi Arabia imports from the US are currently adequate. This, however, does not mean that Saudi interest rates cannot deviate from US ones. Chart I-8 illustrates that SAMA’s sales of FX reserve assets could lead to a rise in local interbank rates in absolute terms or relative to US ones. This is because when the central bank is selling US dollars, it tends also to shrink the banking system’s excess reserves, which forces commercial banks to bid the price of inter-bank liquidity higher. Third, a central bank cannot simultaneously control the exchange rate and the quantity of monetary aggregates. In other words, SAMA cannot both peg the currency to the US dollar and have control over the level of money supply. This constraint is similar but not identical to the above point about the relationship between exchange and interest rates. To illustrate this trade-off: when SAMA draws down its international reserves to fund a BoP deficit, the money supply will shrink. If the authorities simultaneously encourage and allow the banks to lend to or purchase securities from non-banks, including the government, the money supply will expand. This newly created money could find its way to the currency market (in the form of greater imports or capital outflows) and could bid up the price of the US dollar versus SAR. To defend the peg, SAMA will have to sell more of its foreign currency reserves and purchase SAR, thereby, contracting the money supply again. In short, because of the currency peg, SAMA might not be able to simultaneously control the level of money supply and defend the peg. Finally, unlike many other EM economies, KSA has little domestic productive capacity and relies heavily on imports to satisfy domestic demand for goods and services. Given the nation’s high propensity to import, new riyals created by the banking system have a higher chance of flowing to the foreign exchange market, weighing on the value of the currency and jeopardizing the peg. In Saudi Arabia, fiscal policy is of paramount importance to upholding the currency peg when oil revenues plunge. Other EM economies like the Brazilian or Russian ones do not face such a constraint because they do not have pegged currency regimes. Other economies such as China’s and Korea’s have substantial domestic productive capacity to meet new domestic demand. So, in the latter economies only a small portion of new money creation flows to the foreign exchange market. Bottom Line: Given that it is operating a fixed exchange rate regime, KSA’s money coverage ratio should structurally be higher than that of many other emerging economies. As this ratio drops well below one in the next couple of years, the risk premium in SAR forwards will rise as the market moves to price a higher probability of devaluation. Fiscal-Monetary Nexus In Saudi Arabia, fiscal policy is of paramount importance to upholding the currency peg when oil revenues plunge (Chart I-9). The basis for this is the fact that in Saudi Arabia fiscal policy plays a larger role than monetary policy in driving domestic demand. Chart I-10 demonstrates that government spending amounts to 36% of GDP annually while new annual credit origination is only about 4% of GDP. Chart I-9Oil Prices And Government Spending Oil Prices And Government Spending Oil Prices And Government Spending Chart I-10Fiscal Spending Is Much More Important Than Credit Creation Fiscal Spending Is Much More Important Than Credit Creation Fiscal Spending Is Much More Important Than Credit Creation   Even though the government has already embarked on a considerable fiscal austerity program, the nation will continue to face very large fiscal deficits. Our simulation forecasts fiscal deficits of 14% of GDP in 2020, 16% in 2021 and 17% of GDP in 2022 (please refer to row C in Table I-1 on page 3). Chart I-11Fiscal Spending Drives Imports Fiscal Spending Drives Imports Fiscal Spending Drives Imports Saudi imports are very sensitive to government spending while government revenues correlate with exports (Chart I-11). Swelling fiscal deficits can be funded by issuing both foreign and local currency bonds. However, each type of borrowing has different implications for the exchange rate, interest rates and the money supply. There are several ways in which the fiscal-monetary nexus can play out in Saudi Arabia.3 The government can draw down on its FX reserves at SAMA to fund the fiscal deficit. This will quickly erode the central bank’s gross FX reserves and, consequently, undermine confidence in the currency peg. The government can borrow externally (in foreign currency) to cover both the budget and BoP deficits. However, in this case, the government’s foreign currency debt will mushroom and the nation’s sovereign credit risk and, thereby, cost of external borrowing will rise.  The fiscal deficit can be funded by issuing local currency bonds sold to non-banks only. Given the sheer size of required government funding over the next couple of years, local interest rates will rise significantly as the government competes to attract a limited amount of existing deposits. Overall, this will crowd out the private sector which will have negative ramifications on the economy. However, the currency peg will not be jeopardized as the money supply will shrink dramatically in this scenario. The government can fund itself by borrowing from domestic commercial banks, i.e., by issuing local currency paper to be bought by banks. The government will get new local currency deposits and will not compete for existing deposits. This will not produce a crowding out effect and interest rates will not rise. As we have discussed in past reports, commercial banks do not require deposits or savings to lend money or to purchase securities. Everywhere, commercial banks – with regulatory forbearance and shareholder consent – can purchase literally an unlimited amount of government bonds thereby financing the nation’s large fiscal deficits. Critically, when commercial banks buy local currency government bonds, they create new local currency deposits “out of thin air”. This scenario would be equivalent to the monetization of public debt. Money supply will expand briskly and the money coverage ratio will drop. The outcome will produce downward pressure on the currency’s value as new money/deposits created by commercial banks will end up eating into the country’s finite foreign exchange reserves via imports and capital outflows, as discussed above. While commercial banks can easily fund the fiscal deficit by creating money “out of thin air”, the former will likely bolster demand for dollars and endanger the currency peg. Bottom Line: The Saudi government will likely resort to all four mechanisms to fund itself. Given the large size of its fiscal deficit, financing it entirely via external borrowing or the depletion of FX reserves is unattainable. Therefore, issuance of local bonds will continue at a rapid pace, with the following implications: If local bonds are bought by non-banks, local interest rates will be pushed higher, crowding out the private sector with negative ramifications for the economy; or If local bonds are bought by commercial banks, the money supply will expand meaningfully, thereby drastically reducing the money coverage ratio and exerting substantial pressure on the currency peg. Neither of these scenarios can be sustained in the long run. Investment Conclusions Chart I-12SAR/USD Forwards And Oil Prices SAR/USD Forwards And Oil Prices SAR/USD Forwards And Oil Prices If the era of low oil prices is transitory, temporary fiscal tightening can be used to preserve the peg. In our view, low oil prices are structural – crude prices will likely average at most $40 per barrel in the coming years. In such a scenario, fiscal tightening cannot be a solution because it will unleash eternal economic malaise. Hence, currency devaluation will be unavoidable. Critically, the longer the authorities preserve the peg in the face of lower oil prices, the larger the devaluation will ultimately be. Based on historical experiences of other economies that delayed their own currency adjustments, the devaluations that they eventually faced were between 30-50%. Despite the collapse in oil prices, the SAR/USD long-term forwards are underpricing the risk of devaluation (Chart I-12). If the downshift in oil prices is more permanent than the one in 2015 – as we believe it will be – the SAR/USD long-term forwards offer a good opportunity. As a structural trade, we recommend investors to sell the 3-year SAR/USD forward. The current entry point is attractive. Ayman Kawtharani Editor/Strategist ayman@bcaresearch.com Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com   Footnotes   1  This is the view of BCA’s Emerging Markets Strategy service and it differs from the view of BCA’s Commodities and Energy Strategy service. 2  Commercial banks’ excess reserves are not part of the broad money supply. This applies to all economies, regardless of their exchange rate regime. 3  By that we mean the interplay between government financing/borrowing and the resulting changes in money supply, interest rates and the exchange rate.  

Highlights A World Organization of the Petroleum Exporting Countries (WOPEC) looks set to emerge after today’s OPEC 2.0 video conference to discuss production cuts in the wake of the COVID-19 pandemic, and the market-share war between the leaders of the coalition led by the Kingdom of Saudi Arabia (KSA) and Russia. WOPEC will not be memorialized by a Declaration of Cooperation as OPEC 2.0 was.  Oil exporters globally will cooperate on harmonizing policy to meet demand. In our latest scenario concentrating on likely supply responses, we show cuts of ~ 8mm b/d will be sufficient to clear the storage overhang caused by COVID-19-induced demand destruction of close to 4mm b/d this year. Based on this modeling, we see Brent prices averaging $36/bbl and $64/bbl this year and next, with WTI trading $2-$6/bbl lower, depending on US Gulf storage availability. This is roughly in line with our previous scenario (Chart of the Week).1 Demand destruction over 4mm b/d would require additional production cuts. Feature The 2020 oil price collapse brought on by COVID-19 – and super-charged by the market-share war declared by Russia following the breakdown of OPEC 2.0’s March 6 meeting – has spurred oil-producing states globally to action. Chart of the WeekExpect A Sharp Oil Price Recovery Expect A Sharp Oil Price Recovery Expect A Sharp Oil Price Recovery Chart 2The Oil-Price Collapse Of 2020 The Oil-Price Collapse Of 2020 The Oil-Price Collapse Of 2020 WOPEC is bigger than OPEC 3.0 – an unofficial grouping we hypothesized at the end of March to encompass the expected future cooperation of KSA, Russia and the Texas Railroad Commission (RRC) – our shorthand for US oil-producing interests – succeeding OPEC 2.0. Today’s OPEC 2.0 video conference originally was called by KSA for Monday, but was moved to today – presumably – to give member states time to agree production cuts. The conference most likely was delayed by the acrimonious public exchange between its leaders this past weekend.2 On the heels of the OPEC 2.0 video conference comes a hastily called video conference on Friday of G20 energy ministers to discuss energy security. The G20 is led by KSA this year.3 The 2020 oil price collapse brought on by COVID-19 – and super-charged by the market-share war declared by Russia following the breakdown of OPEC 2.0’s March 6 meeting – has spurred oil-producing states globally to action (Chart 2). KSA, Russia and their respective OPEC 2.0 allies all are fully invested in this meeting, as are producers in the US, Canada, Norway and Brazil.4 Supply Destruction Vs.Production Cuts Oil producers face a stark choice: Either cut production voluntarily to counter the global demand destruction of a pandemic, or have the market do it for them by driving prices through cash costs toward zero (i.e., $0.00/bbl), as global crude oil and product storage fills. Prices in some basins have fallen close to zero after accounting for the basis differentials to benchmark prices and transport costs (e.g., WTI-Midland), which, in the US has begun to force shut-ins (Chart 3).5 Continued weak pricing close to zero risks shutting older, high-cost landlocked production in permanently, and many states simply cannot afford to lose the critical revenue provided by oil exports. Chief among these states are the non-Gulf members of OPEC, excluding Russia, US onshore, and Canada, which we identify as “The Other Guys” (Chart 4).6 Chart 3Some Crude Grades Priced Close To $0.00/bbl Some Crude Grades Priced Close to $0.00/bbl Some Crude Grades Priced Close to $0.00/bbl Chart 4"The Other Guys" Production Declines Would Moderate With OPEC 2.0 Deal The "Other Guys" Production Declines Would Moderate With OPEC 2.0 Deal The "Other Guys" Production Declines Would Moderate With OPEC 2.0 Deal We expect The Other Guys in OPEC 2.0 will lose 700k b/d, with 400k b/d of that realized over the course of 2021. The chief contribution of The Other Guys to the OPEC 2.0 coalition’s production-management scheme is their managed production decline. These states were only starting to recover from the Global Financial Crisis (GFC) beginning in 2010 when the OPEC market-share war of 2014-16 was declared. The COVID-19 price collapse, coupled with the knock-on effects of the 2020 KSA-Russia market-share war likely accelerates the rate of production decline for the Other Guys, as capital continues to avoid developing their resources. We expect The Other Guys in OPEC 2.0 will lose 700k b/d, with 400k b/d of that realized over the course of 2021. Core OPEC and Russia can increase (and decrease) production, and we expect they will deliver the largest part of the OPEC 2.0 production cuts. In this week’s simulation, we project KSA will cut 2mm b/d, from their April level of from 12mm b/d; and Russia will cut 1.1mm b/d, down from 11.6mm b/d. We then project Iraq will cut 460k b/d; Kuwait 280k b/d; and the UAE 315k b/d. Outside OPEC 2.0, a lot of the production we expect will be cut is out of necessity. Canada, for example, will be forced to either shut in high-cost tar-sands production or go back to pro-rating production as it did last year, owing to a lack of storage in Alberta and pipeline takeaway capacity to move their crude south to US refiners. We expect Canada to cut 350k b/d this year, as a result. Brazil’s Petrobras already has shut in 100k b/d, and US producers have begun shutting in shale-oil production.7 US Production Cuts Some of the more efficient producers in The Great State of Texas have been calling for pro-rationing of up to 20%, which would push the cuts in Texas’s Permian and Eagle Ford shale basins alone to 1.23mm b/d. Production cuts most likely will be focused on the US, as this is the most easy-to-adjust output in the world. It also still is higher up the global cost curve, although, as we have noted earlier, this will change in the event bankruptcies pick up.8 In the US, production cuts already have begun. They are and will continue to be focused on the shales. We continue to project cuts in the US shales of ~ 1.5 mm b/d this year. However, this number could be higher: If producers respond to the collapse in prices by not sending any new rigs to the field in the next 12 months, production will fall by 2.9mm b/d from production declines alone. Just to keep production flat, the US shales will need an average of ~ 520 rigs per month (assuming no drilled-uncompleted wells are finished). The risk on our rig-count estimates are straightforward: If rig counts go much lower, we could see a large decline in shale production in the coming months (Chart 5). Chart 5US Shale Output Falls This Year And Next The Birth Of WOPEC The Birth Of WOPEC Some of the more efficient producers in The Great State of Texas have been calling for pro-rationing of up to 20%, which would push the cuts in Texas’s Permian and Eagle Ford shale basins alone to 1.23mm b/d. Including the Anadarko Basin, most of which is in Oklahoma, which also permits pro-rationing, 20% pro-rationing would push TX-OK cuts to ~ 1.33mm b/d. As we have been writing over the past month, we could see a return of pro-rationing in the states of Texas and Oklahoma. In the Great State, producers have filed a petition before the Texas RRC asking the Commission to reprise its 1928-73 production-management role.9 The Texas RRC will hold a video conference Tuesday, April 14, to consider this petition. We’re expecting this petition to be granted, and for pro-rationing to begin in the near future. On the demand side, we are staying with the scenario we presented March 30, with 2Q20 demand falling ~ 12mm b/d (y/y vs. 2Q19). In 2H20, we project demand to grow at a rate of 800k b/d by 4Q20. For all of 2020, we model average demand losses equal to 3.8mm b/d. For 2021, massive fiscal and monetary stimulus globally will lift demand 5.3mm b/d. With the supply cuts projected above and our demand view, we see balances tightening over the course of the year and moving into a physical deficit in 4Q20 (Chart 6). While near-term oversupply will force inventories to grow sharply, we expect them to draw as sharply beginning by September and continuing into next year (Chart 7). Chart 6Supply-Demand Imbalance Will Tighten Into 2021 Supply-Demand Imbalance Will Tighten Into 2021 Supply-Demand Imbalance Will Tighten Into 2021 Chart 7Inventories Will Build Sharply, Then Draw Sharply in 2021 Inventories Will Build Sharply, Then Draw Sharply in 2021 Inventories Will Build Sharply, Then Draw Sharply in 2021 Investment Implications Our projections for supply presented this week and our demand scenario presented at the end of March are evolving into our base case for oil and gas. We still do not know with certainty the OPEC 2.0 coalition will agree to production cuts today, or whether the Texas RRC will return to the business of pro-rationing. If either or both of these outcomes does not materialize, markets will take over and savagely destroy supply. This will be extremely volatile. For our part, we expect OPEC 2.0, the Other Guys outside the coalition, and the US shales to deliver something that looks like voluntary cuts. This will occur via voluntary cuts, “managed” declines, and pro-rationing and shut-ins. Unlike many of our economist colleagues who argue against such jointly coordinated policies – invoking a free-market, pure-competition paradigm that has not existed for any meaningful period in the modern history of the oil market – we believe producers are intelligently pursuing their interests by jointly coordinating the boom-bust mayhem of unfettered oil markets. Similarly, we believe consumers are better served by diversified sources of energy vs. an over-reliance on large concentrated supplies who can use their low-cost endowment to monopolize supply and set up barrier to entry to competition. Given our view, we remain constructive to the oil market, expecting a rally that will look a lot like the Chart of the Week and the balances we show in Chart 7. As a result, we are getting long 2H21 Brent vs. short 2H22 Brent futures.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Hugo Bélanger Associate Editor Commodity & Energy Strategy HugoB@bcaresearch.com Fernando Crupi Research Associate Commodity & Energy Strategy FernandoC@bcaresearch.com   Commodities Round-Up Energy: Overweight Defying the global rush to cut oil production, Mexico apparently is moving toward increasing production. Petroleos Mexicanos (PEMEX) is looking to drill 423 wells this year, according to Bloomberg. A March 26 Journal of Petroleum Technology survey suggests capex by E&P companies will fall by up to 35% this year. Base Metals: Neutral This week Japan’s Nippon Steel became the latest producer to idle blast furnaces, halting about 15% of the company’s total capacity. More generally an iron ore surplus in other parts of Asia and in Europe is expected as steel mills idle furnaces amidst lower demand for their output. However, diminished activities in mines – severely impacted by lockdowns – will offset some of the demand loss. COVID-19 induced shutdown in South Africa, Iran, India and Canada have curtailed exports from those countries until late April. Additionally, bad weather in Brazil led iron ore exports to fall on a yoy basis for the third month in a row in March. A decline of ~ 2% vs. last year’s already depressed – following the Vale dam incident – levels. China’s anticipated infrastructure stimulus will support iron ore demand, drawing down inventories and pushing up prices, but it, too, will be tempered by the pace of the recovery in its export markets. Precious Metals: Neutral A strong US dollar remains an important risk for precious metals. The dollar rose 1.6% since March 28 despite the Fed’s actions to calm the global dollar liquidity squeeze. This signals the funding crisis has not been thoroughly controlled and that swap lines will have to be extended to additional EM central banks. However, a large share of outstanding foreign exchange swaps/forwards resides in non-bank financial corporations and institutions with limited access to dollar funding via central bank swap lines. Over the short-term, our gold price recommendation remains vulnerable to deterioration, due to uncertain liquidity conditions (Chart 8). Ags/Softs:  Underweight This week we begin tracking the lumber market. Lumber consumption fell sharply as the coronavirus spread in the United States, pushing front-month futures down 44% from February highs. With housing starts already weak in February – down 1.5% month on month – and expected to be even weaker in March (Chart 9), continued lumber supply curtailments will stabilize prices in the short term and eventually push prices up once lower interest rates kick in and demand resumes. Chart 8 Global USD Squeeze Could Threaten Gold Again Global USD Squeeze Could Threaten Gold Again Chart 9 Lumber Hammered As COVID-19 Pounds Housing Starts Lumber Hammered As COVID-19 Pounds Housing Starts       1     Please see OPEC 3.0 In the Offing?, published March 30, 2020, which focused on demand destruction. 2     Please see OPEC+ meeting delayed as Saudi Arabia and Russia row over oil price collapse: sources, and G20 energy ministers to hold video conference on Friday: document published by reuters.com April 4 and April 7, 2020. 3    The G20 consists of Argentina, Australia, Brazil, Canada, China, Germany, France, India, Indonesia, Italy, Japan, Mexico, the Russian Federation, Saudi Arabia, South Africa, South Korea, Turkey, the UK, the US and the EU. 4    Please see A look at the major players in this week’s “OPEC++” meeting, a Bloomberg analysis published by worldoil.com April 7, 2020. 5    Please see Can the world agree a deal to boost oil prices? Published by Wood MacKenzie April 3, 2020.  6    The Other Guys is our moniker for all producers excluding core-OPEC, US shale, Russia and Canada. Production from this group of producers has been falling as a share of global production for years, due to a lack of domestic and foreign direct investment in their energy sectors. 7     In its latest Short-Term Energy Forecast, the EIA estimates US crude oil production will fall 500k b/d this year and 700k b/d next year, driven by market forces. 8    For a discussion, please see How Long Will The Oil-Price Rout Last?, a Special Report we published with BCA Research’s Geopolitical Strategy March 9, 2020. It is available at ces.bcaresearch.com. 9    Please see Oil Prorationing in the Spotlight at Texas Railroad Commission, published by Baker Botts, a Texas law firm, on March 30, 2020.   Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Trade Recommendation Performance In 2019 Q4 The Birth Of WOPEC The Birth Of WOPEC Commodity Prices and Plays Reference Table Trades Closed in 2020 Summary of Closed Trades The Birth Of WOPEC The Birth Of WOPEC

Highlights The odds of an emergency meeting of OPEC 2.0 to get supply under control are growing, based on the repeated overtures from Russian officials providing the Kingdom of Saudi Arabia (KSA) an opening to resume talks on their production-management regime. We have developed a not-unreasonable scenario in which global oil consumption falls by ~ 20% y/y in April to assess the COVID-19-induced price impact. Even an aggressive 3.5mm b/d cut from OPEC 2.0 – presuming a rapprochement between KSA and Russia – and an additional 200k b/d market-induced cut by North American producers still sees Brent prices bottoming over the next two months at ~ $18/bbl. OECD inventories surge, reaching ~ 3.6 billion by June 2020, before production cuts and demand restoration start to drain them. Comments from Texas Railroad Commission (RRC) leadership indicate they could be back in the business of pro-rating production in the Lone Star state. If a new OPEC 3.0 described here can move quickly enough, Brent prices could revive to ~ $45/bbl by year end, and clear $60/bbl by 2Q21.  We are getting long Dec20 Brent and WTI at tonight’s close. Feature Refiners worldwide are reducing runs as the COVID-19 pandemic continues to cut through oil demand like a scythe through wheat.1 Refiners’ inability to sell gasoline, diesel and jet fuel, and a host of other products, is forcing crude oil to back up globally in storage facilities, pipelines and, soon, on ships (Chart 1).2  This is occurring while KSA and Russia wage a global market-share war, targeting each others’ refinery customers with lower and lower prices. Without a concerted effort by OPEC 2.0 – the coalition led by KSA and Russia – and the US shales to rein in production, the global supply of storage will be exhausted and oil prices will push well below $20/bbl to force output to shut in.  Indeed, numerous grades of crude oil worldwide already are trading below $20/bbl after factoring in their spreads vs. Brent crude oil as regional takeaway and storage infrastructure are overwhelmed (Chart 2). Chart 1Even With Production Cuts Oil Inventories Will Surge Even With Production Cuts Oil Inventories Will Surge Even With Production Cuts Oil Inventories Will Surge Chart 2Global Crude Prices Trading Below $20/bbl Global Crude Prices Trading Below $20/bbl Global Crude Prices Trading Below $20/bbl Chart 3“The Other Guys” Production Declines Will Accelerate "The Other Guys" Production Declines Will Accelerate "The Other Guys" Production Declines Will Accelerate The consequences for oil producers outside core-OPEC will be disastrous, as they were following the last market-share war led by OPEC in 2014-16.  The producer group we’ve dubbed “The Other Guys” – producers outside core-OPEC – will continue to see production falling, most likely at an accelerating rate, if the market-share war persists (Chart 3).  Even within core-OPEC – principally the GCC states – governments will be required to cut spending on public works, salaries for workers, and services.3 Sovereign wealth funds and foreign reserves will have to be drawn down to fill holes in budgets, as happened during the last market-share war of 2014-16 launched by OPEC.  The IMF last week noted the world economy is in recession, and that EM economies in particular will see growth fall sharply as a result of the COVID-19 pandemic.4 “We are in an unprecedented situation where a global health pandemic has turned into an economic and financial crisis. With a sudden stop in economic activity, global output will contract in 2020. … emerging market and developing countries, especially low-income countries, will be particularly hard hit by a combination of a health crisis, a sudden reversal of capital flows and, for some, a sharp drop in commodity prices. Many of these countries need help to strengthen their crisis response and restore jobs and growth, given foreign exchange liquidity shortages in emerging market economies and high debt burdens in many low-income countries.”  For commodity markets, this means the principal source of demand growth is being severely hobbled. The Oil Demand Hit … Estimating the demand destruction caused by COVID-19 is fraught with uncertainty.  Instead of attempting such an estimate, we simulate a sharp drop in oil demand of close to 20% y/y in April 2020, which is consistent with the lockdowns that are bringing the global economy to a standstill.  Specifically, we have 2Q20 demand falling ~ 12mm b/d (y/y vs. 2Q19).  Thereafter, demand picks up rapidly in 2H20, reaching a growth rate of 800k b/d by 4Q20.  For all of 2020, we model average demand losses equal to 3.8mm b/d.  For next year, we expect the combination of massive fiscal and monetary stimulus hitting markets globally will lift demand 5.3mm b/d. Net, we view the COVID-19 demand shock as transitory.  But it leaves a huge amount of unrefined crude oil in storage and massive amounts of unsold products in inventory. Left unaddressed, crude oil will continue to fill storage globally, as will unsold refined products.  This will leave oil producers and refiners in an untenable situation, even after demand returns to normal following the pandemic. Strategists in Riyadh, Moscow and Austin, Texas, know this. … Requires A Supply Offset KSA is forcing its competitors to endure what John Rockefeller, one of the founders of Standard Oil Co., once called a “good sweating.”5  A good sweating was a price-cutting strategy designed to drive competitors out of business and force them to sell to Rockefeller’s company.  This occurred in 2014-16 and in 1986, when KSA had to rein in fellow OPEC members that were free-riding on its production discipline. We believe KSA is well aware it cannot endure a years-long market-share war, nor does it want to.  Its primary goal in the current circumstances is to remind oil producers globally that it can, when it choses, take as much market share as it deems necessary.  After flooding global markets in April 2020 we expect the core-OPEC producers in the Gulf (Kuwait, the UAE, Iraq and, of course, KSA) to reduce production by ~ 2.5mm b/d starting in May 2020, and hold these cuts until 2021 (around the time inventories are drawn down to their 5-year average).  In 2021, we have the group increasing production by 2.5mm b/d in 1Q21. As for Russia, we have them increasing production in April 2020 – contributing to the surge in inventories globally.  However, beginning in May, we believe Russia and its non-OPEC allies will agree to remove ~ 1mm b/d , in line with the cuts we expect from core-OPEC. Russia faces political and geopolitical constraints that work against maintaining the market-share war. First, President Vladimir Putin has already been forced to shift his national strategy over the past three years to address growing concerns with domestic discontent due to the recession caused by the 2014 oil shock and the economic austerity policies his government pursued afterwards. These policies give Putin policy room to fight today’s market-share war, but they also portend another massive blow to the livelihood and wellbeing of the nation. Second, Putin is in the midst of arranging an extension of his term in office through 2036, which requires the constitutional court to approve of constitutional changes as well as a popular referendum. The referendum has been delayed due to the pandemic and need for an emergency response. While Putin is generally popular and has underhanded means of orchestrating the referendum, it would be extremely dangerous for him to compound the pandemic and global recession with an oil market-share war that makes matters even worse for the Russian people while simultaneously preparing for a plebiscite.   Third, internationally, Putin cannot ultimately defeat the Saudis or US shale in terms of market share. Therefore the domestic risks posed above are not compensated by an improvement in Russia’s international standing – neither in oil markets nor in broader strategic influence, given that an economic recession hurts Russia’s ability to maintain and modernize its military and security forces. In the US shales, we are modeling a sharp fall-off in production starting as early as May 2020.  For the rest of 2020, production will gradually decline naturally from low rig counts. In 2H20 – probably in 4Q20 – we expect the Texas Railroad Commission to once again regulate oil production in the state, provided other state regulators (e.g., in North Dakota) and producing countries, (e.g., Russia and KSA) also sign on to take on a similar role.6 In addition to the market-driven shut-ins between now and 4Q20, we expect the RRC to secure production cuts of up to 1.5mm b/d by Dec 2020. As prices pick up next year, shale production will stabilize and slowly move up. The supply-demand assumptions we make in this scenario produce a physical surplus for the better part of 2020 (Chart 4). Chart 4Supply-Demand Imbalance Leads to Physical Surplus Supply-Demand Imbalance Leads to Physical Surplus Supply-Demand Imbalance Leads to Physical Surplus Prices Could Fall Further, Then Take Off Even if we see OPEC 2.0 cut, and sharp drops in US shale output followed by renewed pro-rationing by state regulators in the US led by Texas, the fact that they’ve all increased production for April means storage will inevitably rise drastically in the coming months (Chart 5).  As inventory skyrockets in the wake of both the massive demand and supply shocks in 1Q20 and April 2020, prices will fall to $20/bbl (Chart 6). Chart 5Inventories Swell on Demand Shock, Then Drain on Supply Cuts Inventories Swell on Demand Shock, Then Drain on Supply Cuts Inventories Swell on Demand Shock, Then Drain on Supply Cuts Chart 6Brent Prices Forced Lower, Then Move Above $60/bbl Brent Prices Forced Lower, Then Move Above $60/bbl Brent Prices Forced Lower, Then Move Above $60/bbl Once the large-scale OPEC 2.0 cuts start, prices rebound rapidly. Demand also starts picking up this summer, which also will lift prices. For 2020, we expect Brent prices to average $35/bbl, while in 2021 we expect Brent to average $66/bbl. Over this period, WTI will trade $2-$4/bbl below Brent.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Matt Gertken Geopolitical Strategist mattg@bcaresearch.com     Footnotes 1     Please see Global oil refiners shut down as coronavirus destroys demand published by reuters.com March 26, 2020, and S&P Global Platts report Refinery margin tracker: Global refining margins take a severe hit on falling gasoline demand published March 23. 2     This appears to be happening now, as pipeline operators ask shippers to reduce the rate at which they fill the lines.  Please see Pipelines ask U.S. drillers to slow output as storage capacity dwindles published by worldoil.com March 30, 2020.  3    Prominently among the GCC states, KSA cuts public spending 5% and introduced fiscal measures meant to cushion the blow of the COVID-19 shock and to offset the low prices resulting from its market-share war with Russia.  Please see Saudi Arabia announces $32 billion in emergency funds to mitigate oil, coronavirus impact published by cnbc.com March 20, 2020. 4     Please see the Joint Statement by the Chair of International Monetary and Financial Committee and the Managing Director of the International Monetary Fund issued by International Monetary and Financial Committee Chair Lesetja Kganyago and International Monetary Fund Managing Director Kristalina Georgieva March 27, 2020. 5     Please see Daniel Yergin’s The Prize: The Epic Quest for Oil, Money & Power, published by Simon & Schuster in 1990, particularly Chapter 2 for a discussion of Rockefeller’s “good sweating,” in which competitors were driven out of business by low prices engineered by Rockefeller if they refused to sell out to Standard Oil. 6     The tone of remarks from TRR Chairman Wayne Christian has become more agreeable to having the TRR Commission return to pro-rating oil production in the Lone Star state.  His recent editorial for worldoil.com notes, “Any action taken by Texas must be done in lockstep with other oil producing states and nations, ensuring that they cut production at similar times and in similar amounts.”  Please see  Christian’s editorial, Texas RRC Chairman Wayne Christian: We must stabilize worldwide oil markets, published by worldoil.com March 25, 2020.