Asia

Highlights The odds of a stronger recovery in EM oil demand next year are rising, as vaccines using mRNA technology are manufactured locally and become widely available.1 This will reduce local lock-down risks in economies relying on less efficacious COVID-19 vaccines – or lacking them altogether – thereby increasing mobility, economic activity and oil demand. Our global crude oil balances estimates are little changed to the end of 2023, which leaves our price expectations mostly unchanged: 4Q21 Brent prices are expected to average $70.50/bbl, while 2022 and 2023 prices average $75 and $80/bbl, respectively (Chart of the Week). The balance of risks to the crude oil market remain to the upside in our estimation. In addition to a higher likelihood of better-than-expected EM demand growth, we expect OPEC 2.0 production discipline to hold, and for the price-taking cohort outside the coalition to continue prioritizing investors' interests. We remain long commodity index exposure – S&P GSCI and COMT – and, at tonight's close, will be getting long the DFA Dimensional Emerging Core Equity Market ETF (DFAE) on the back of increasing local mRNA vaccine production in EM economies. Feature As local production of COVID-19 vaccines employing mRNA technology spreads throughout EM economies, the odds of a stronger-than-expected recovery in oil demand next year will increase. The buildout of production and distribution facilities for this technology is progressing quickly in Asia – e.g., Chinese mRNA tech joint ventures are expected to be in production mode in 4Q21 – Latin America, Africa, and the Middle East.2 Accelerated availability of more efficacious vaccines globally will address the "fault lines" identified by the IMF in its July 2021 update. In that report, the Fund notes a major downside risk to its global GDP growth expectation of 6% this year remains slower-than-expected vaccine rollouts to emerging and developing economies.3 The other major risk identified by the Fund is too-rapid a winddown of policy support in DM economies, which would lead to tighter financial conditions globally. Our global demand expectation is driven by GDP estimates from the IMF and World Bank. The implication of that assumption is the powerful recovery in DM oil demand seen this year will slow while EM demand picks up next year (Chart 2). We proxy DM oil demand with OECD oil consumption and EM demand with non-OECD consumption. We continue to expect overall oil demand to recover by just over 5.0mm b/d this year and 4.4mm b/d next year (Table 1). Chart of the WeekOil Forecasts Hold Steady Oil Forecasts Hold Steady Oil Forecasts Hold Steady Chart 2Higher EM Oil Demand Expected in 2022 Higher EM Oil Demand Expected in 2022 Higher EM Oil Demand Expected in 2022 Table 1BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) To Dec23 Upside Price Risk Rises For Crude Upside Price Risk Rises For Crude Global Oil Supply To Remain Steady Hurricane Ida will have removed ~ 30mm barrels of US offshore oil output by the time losses are fully tallied, based on IEA estimates. Even so, in line with the US EIA, we expect offshore US oil production will recover from the damage caused by the storm in 4Q21 and be back at ~ 1.7mm b/d on average over the quarter. This will allow oil prices to ease slightly from current elevated levels over the balance of the year. Inland, US shale-oil output remains on track to average ~ 9.06mm b/d this year, 9.55mmb/d in 2022 and 9.85mmb/d in 2023, in our modeling (Chart 3). We expect production in the Lower 48 states of the US to remain mostly steady going forward. Production from finishing drilled-but-uncompleted (DUCs) shale-oil wells is the lowest it's been since 2013.  Output from these wells will remain relatively low for the rest of the year. This supply was developed during the COVID-19 pandemic, as it was cheaper to bring on than new drilling. For 2022 and 2023 overall, our model points to a slow build-up in US shale-oil output as drilling increases. Going into 2022, we expect continued production discipline from OPEC 2.0, and for the coalition to continue to manage output in line with actual demand it sees from its customers. The 400k b/d being returned monthly to the market over August 2021 to mid-2022 will accommodate demand increases. However, it will be monitored closely in the event demand fails to materialize, as has been OPEC 2.0's wont over the course of the pandemic. Chart 3US Shale-Oil Output Mostly Stable US Shale-Oil Output Mostly Stable US Shale-Oil Output Mostly Stable Oil Markets To Remain Balanced We see markets remaining balanced to the end of 2023, with OPEC 2.0 maintaining its production-management strategy – keeping the level of supply just below the level of demand – and the price-taking cohort led by US shale-oil producers remaining focused on maintaining margins so as to provide competitive returns to investors. On the demand side, EM growth will pick up as DM growth slows. Given our fundamental view, global crude oil balances estimates are little changed to the end of 2023 (Chart 4). This allows inventories to continue to draw this year and next, then to slowly rebuild as production increases toward the end of 2023 (Chart 5). Falling inventories will keep the Brent forward curve backwardated – i.e., prompt-delivery oil will trade higher than deferred-delivery oil. Chart 4Markets Remain Balanced... Markets Remain Balanced... Markets Remain Balanced... Chart 5...And Oil Inventory Continues To Draw ...And Oil Inventory Continues To Draw ...And Oil Inventory Continues To Draw The backwardated forward curve means OPEC 2.0 producers will continue to realize higher delivered prices on their crude oil than the marginal shale-oil producer, which hedges its production 1-2 years forward to stabilize revenue. This is the primary benefit to the member states in the producer coalition: a backwardated curve pricing closer to marginal cost limits the amount of revenue available to shale-oil producers, and thus restrains output to that which is profitable at the margin. Investment Implications Our supply-demand outlook keeps our price expectations mostly unchanged from last month's forecast. We expect 4Q21 Brent prices to average $70.50/bbl, while 2022 and 2023 prices average $75 and $80/bbl, respectively, as can be seen in the Chart of the Week. WTI prices will continue to trade $2-$4/bbl below Brent over this interval. With fundamentals continuing to support a backwardated forward curve in Brent and WTI, we continue to favor long commodity-index exposure, which benefits from this structure.4 Therefore, we remain long the S&P GSCI and the COMT ETF, which is an optimized version of the GSCI that concentrates on positioning in backwardated futures contracts. The upside risk to oil prices resulting from increasing local production of mRNA vaccines in EM economies that had relied on less efficacious vaccines undoubtedly will increase mobility and raise oil demand, if, as appears likely, the impact of this localization is realized in the near term. This also could boost commodity demand generally, if it allows trade and GDP growth to accelerate in EM economies, which supports our long commodity-index view. The rollout of mRNA technology into EM economies also suggests EM GDP growth could increase at the margin with locally produced mRNA vaccines becoming more available. This would redound to the benefit of trade and economic activity generally.5 It also could help unsnarl the movement of goods globally. The wider implications of a successful expansion of locally produced mRNA vaccines leads us to recommend EM equity exposure on a tactical basis. At tonight's close, we will be getting long the DFA Dimensional Emerging Core Equity Market ETF (DFAE). As this is tactical, we will use a tight stop (10%) for this recommendation.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Associate Commodity & Energy Strategy ashwin.shyam@bcaresearch.com Commodities Round-Up Energy: Bullish Natural gas demand is surging globally. Record-breaking heat waves in the US are driving demand for gas-fired generation required to meet space-cooling demand. In addition, in the June-August period, the US saw record LNG exports. Europe and Asia are competing for the fuel as both prepare for winter. Brazil also has been a strong bid for LNG, as drought there has reduced hydropower supplies. In Europe, natural gas inventories were drawn hard this past winter as LNG supplies were bid away to Asia to meet space-heating demand. This is keeping Europe well bid now as winter approaches (Chart 6). The US Climate Prediction Center last week gave 70-80% odds of a second La Niña for the Northern Hemisphere winter. Should it materialize, it could again drive cold artic air into their markets, as it did last winter, and push natgas demand higher. Our recommendation to get long 1Q22 $5.00/MMBtu calls vs short 1Q22 $5.50/MMBtu calls last week was up 17% as of Tuesday's close. We remain long. Base Metals: Bullish The slide in iron ore prices from its ~ $230/MT peak earlier this year can be attributed to weak Chinese demand, and the possibility of its persistence through the winter and into next year (Chart 7). The world’s largest steel-producing nation is aiming to limit steel output to no higher than 2020 levels, in a bid to reduce industrial pollution. According to mining.com, provincial governments have directly asked local steel mills to curb output. Regulation in this sector in China will continue to reduce prices of iron ore, a key raw material in steel production. Precious Metals: Bullish The lower-than-expected reading on the US core CPI earlier this week weighed on the USD, and propelled gold prices above the $1,800/oz mark. While markets expected lower consumer prices for August to diminish the Fed’s resolve to taper asset purchases by year-end, we do not think the lower month-on-month CPI number will delay tapering. The timing of the Fed's initial rate hike – expected by markets to occur after the tapering of the central bank's asset-purchase program – will depend on the US labor force reaching "maximum employment." According to BCA Research's US Bond Strategy, this criterion will be met in late-2022 or early-2023. Low-interest rates, coupled with persistent inflation until then, will be bullish for gold prices. Chart 6 Upside Price Risk Rises For Crude Upside Price Risk Rises For Crude Chart 7 CHINA IMPORTED IRON ORE GOING DOWN CHINA IMPORTED IRON ORE GOING DOWN   Footnotes 1     Please see Everest to bring Canadian biotech's potential Covid shots to China, other markets published on September 13, 2021 by indiatimes.com. 2     Examples of this include Brazil's Eurofarma to make Pfizer COVID-19 shots for Latin America, published by reuters.com; Biovac Institute to be first African company to produce mRNA vaccines, published be devex.com; and mRNA Vaccines Mark a New Era in Medicine, posted by supertrends.com. The latter report also discusses the application of mRNA technology to other diseases like malaria. 3    Please see Fault Lines Widen in the Global Recovery published 27 July 2021 by the Fund. 4    Backwardation is the source of roll yield for long-index exposure.  This is due to the design of these index products, which buy forward then – in backwardated markets – roll out of futures contract as they approach physical delivery at a higher level and re-establish their exposure in a deferred contract. 5    The lower realized efficacy of Sinopharm and Sinovac COVID-19 vaccines and high reinfection rates in economies using these vaccines are one of the key risks to our overall bullish commodity view.  Please see Assessing Risks To Our Commodity Views, which we published on July 8, 2021. It is available at ces.bcaresearch.com.   Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades

Dear Client, Next week, in lieu of our regular weekly report, I will be hosting two webcasts where I will discuss our view on China’s economy and financial markets. I will also address the topics that our clients are most concerned about, including China’s regulatory developments, inflation, and policy direction. The webcasts will be held on Wednesday, September 22 at 10:00 am EDT (English), and Thursday, September 23 at 9:00 am HKT (Mandarin). I look forward to discussing with you during the webcast. We will return to our regular publishing schedule on Wednesday, September 29. Best regards, Jing Sima, China Strategist Highlights China is facing cyclical inflationary pressures more than disinflationary ones. Prices of mining, raw materials and manufacturing goods have been rising at record rates. Chinese manufacturers are operating at close to full production, which suggests that there is little slack in demand. Despite soft headline readings in consumer prices, the costs of goods and services have rebounded to pre-pandemic levels. Prices for home durable goods, fuel and utilities have surged to multiyear highs. Measures to boost domestic demand will be limited as long as inflationary pressures continue and manufacturers produce at close to full capacity. Near-term policy support will likely focus on reducing costs for manufacturers and improving wage growth for lower-income households. We are initiating a trade: long industrial stocks/short A-shares.  Feature China’s Producer Price index (PPI) registered a 13-year high in August, at the time when the domestic economy continued to slow. On the other hand, consumer prices (CPI) - both headline and core CPI - have been lackluster. The acceleration in producer inflation and the demand dynamics raise the question whether China is in a stagflation, a situation in which prices climb but wages and demand do not follow. Consequentially, economy policy faces a dilemma between boosting demand and containing inflation. Inflationary pressures have been driven by pandemic-related factors and the supply-side constraints will likely continue into Q1 next year. These inflationary pressures, and more importantly, undercurrents in the inflation prints, will constrain Chinese policymakers’ efforts to reflate the economy. The recent rebound in Chinese infrastructure stocks is overdone. Material stocks are also vulnerable to price setbacks. Global commodity prices will soften, although from very elevated levels. Meanwhile, we are initiating a trade: long Chinese industrial stocks relative to the A-share market. Despite falling profit growth in recent months, China’s leadership is increasing its support, both cyclically and structurally, to the manufacturing sector. Inflation Or Deflation? The details in both the PPI and CPI readings indicate that China is facing more inflationary pressures than disinflationary ones. Producers are raising prices across the board. Although consumer prices will likely remain well below the PBoC's 3% inflation target for the year mainly due to low food prices, prices in some of the key consumer goods segments are rising at an alarming pace. The inflationary pressures will continue for producers, at least through the first quarter of 2022. The strength in August’s PPI was concentrated in mining and raw materials (Chart 1, top panel). Robust global demand and tight supply conditions supported high oil and base metals prices, while pushing up coal prices. Chart 1Chinese Mining And Manufacturing Goods Prices Accelerated To Record Highs Chinese Mining And Manufacturing Goods Prices Accelerated To Record Highs Chinese Mining And Manufacturing Goods Prices Accelerated To Record Highs Chart 2Commodity Prices Held Up Despite A Slowing China Commodity Prices Held Up Despite A Slowing China Commodity Prices Held Up Despite A Slowing China We do not expect China’s infrastructure investment growth to pick up and support industrial metal prices. However, this year’s unsynchronized recovery in global demand and severe supply shortages have delayed the global commodity market’s price reaction to slowing Chinese demand (Chart 2). Moreover, as China’s environmental policy remains stringent during the upcoming winter, supply-side constraints from production cuts will partially offset the slowdown in China’s demand for mining and raw materials (Chart 3A and 3B). Chart 3ASupply-Side Constraints And Chinese Production Cuts Likely To Continue Into Early 2022 Supply-Side Constraints And Chinese Production Cuts Likely To Continue Into Early 2022 Supply-Side Constraints And Chinese Production Cuts Likely To Continue Into Early 2022 Chart 3BSupply-Side Constraints And Chinese Production Cuts Likely To Continue Into Early 2022 Supply-Side Constraints And Chinese Production Cuts Likely To Continue Into Early 2022 Supply-Side Constraints And Chinese Production Cuts Likely To Continue Into Early 2022 Manufacturing goods inflation registered its topmost annual growth since data collection started in 1996 (Chart 1, bottom panel). Moreover, capacity utilization rates in the industrial and manufacturing sectors are at the highest levels since 2007, well above their means (Chart 4). Changes in manufacturing capacity are highly correlated with China’s export growth and tightly linked to PPI (Chart 5). Therefore, manufacturing goods prices will remain lofty as long as external demand stays robust and China’s manufacturers continue to produce near maximum output. Chart 4Chinese Manufacturers Are Producing Near Their Max Capacity Chinese Manufacturers Are Producing Near Their Max Capacity Chinese Manufacturers Are Producing Near Their Max Capacity Chart 5Robust Exports Have Been Supporting Strong Chinese Manufacturing Output Robust Exports Have Been Supporting Strong Chinese Manufacturing Output Robust Exports Have Been Supporting Strong Chinese Manufacturing Output The PPI’s weakest component has been consumer goods, which inched up by a mere 0.3% from a year ago (Chart 6). However, consumer goods only account for 25% of PPI, whereas industrial and manufacturing producer goods are 75%. In addition, the underlying data shows that among the four sub-components in the PPI’s consumer goods, only food prices have remained below their pre-pandemic levels (Chart 7, top panel). Prices in durable goods have rebounded strongly since March last year and clothing and daily sundry articles have recovered to their end-2019 rate of growth (Chart 7, mid and bottom panels).  Chart 6Producer Prices For Consumer Goods Remain Soft... Producer Prices For Consumer Goods Remain Soft... Producer Prices For Consumer Goods Remain Soft... Chart 7...But Food Prices Have Been The Main Drag ...But Food Prices Have Been The Main Drag ...But Food Prices Have Been The Main Drag The PPI’s price forces are consistent with the CPI, in which food has been the main drag. Core CPI, along with prices for consumer goods and services, have returned to pre-pandemic growth rates (Chart 8). Durable goods prices, such as home appliances, increased to a multiyear high in August. Fuel and utilities costs have also risen. This suggests that despite the soft CPI readings, inflation has flowed from producers to Chinese consumers through manufacturing goods. The passthrough will likely intensify into Q4 when domestic COVID-cases have been largely brought under control and the September – October holiday season will boost consumption for both goods and services. Chart 8Prices For Other Consumer Goods Categories Have Recovered Prices For Other Consumer Goods Categories Have Recovered Prices For Other Consumer Goods Categories Have Recovered Table 1A Look At China’s CPI Basket – Food Dominates Inflation, Deflation, Or Stagflation? Inflation, Deflation, Or Stagflation? We still expect that headline CPI will remain below the PBoC’s 3% inflation target for the year. Consumer durable goods prices are lightly weighted in China’s CPI, therefore, an acceleration in inflation passthroughs in this component is unlikely to significantly push up the CPI aggregates (Table 1). Chart 9Prices For Healthcare And Education Services On A Structural Downshift Prices For Healthcare And Education Services On A Structural Downshift Prices For Healthcare And Education Services On A Structural Downshift In addition, there are some structural headwinds that will affect prices in the education and healthcare and medical services components, which together account for about 15% of the CPI. Healthcare prices have been on a policy-driven structural downshift since late 2017 and recent regulatory changes in the education industry will depress pricing power in that sector (Chart 9). Despite sluggish aggregate consumer prices, climbing prices in consumer durable goods, services and particularly, fuel and utilities, will likely force China’s leadership to take action on policy. Bottom Line: Price pressures for Chinese producers remain intense and consumers will feel the heat of escalating prices in durable goods, fuel and utilities. Inflation is threatening domestic demand, which is already slowing from its peak earlier this year. Implications On Policy Response Inflation readings –even though they are lagging economic indicators –bear significant forward-looking market implications because changes in inflation dynamics herald various policy responses. Despite slower economic growth, higher inflation coupled with accommodative monetary and fiscal policies may indicate that the economy is in a “goldilocks” stage and corporate profits can still benefit (Chart 10). Chinese onshore stocks reached record high recently (Chart 11). Chart 10Are Chinese Corporates In A 'Sweet Spot'? Are Chinese Corporates In A 'Sweet Spot'? Are Chinese Corporates In A 'Sweet Spot'? Chart 11Accommodative Monetary Conditions Propelled Chinese Stock Prices To Highest Since 2015 Accommodative Monetary Conditions Propelled Chinese Stock Prices To Highest Since 2015 Accommodative Monetary Conditions Propelled Chinese Stock Prices To Highest Since 2015 However, underlying trends in China’s producer and consumer inflation prints raise the risks that policymakers may not deliver the ingredients needed for a “just right” scenario. Even though China has kept a loose monetary policy that we expect to extend into next year, inflationary pressures may force policymakers to either delay or reduce the magnitude of stimulus. Recent policy moves show that the authorities are focused on reducing input cost burdens and bumping up support for small- and medium-sized enterprises (SMEs), which are highly concentrated in mid- to downstream manufacturing and services sectors. In our view, the recent rhetoric from policymakers further reduces the odds of any broadly based stimulus to boost demand. Our view is based on the following observations: The elevated global input costs and limited price passthroughs to consumers are depressing Chinese manufacturers’ profit margins and incentives to expand production capacity. Despite strong exports and production, manufacturing investment has lagged that in infrastructure and real estate this year (Chart 12). Consumers, particularly lower-income households, are bearing most of the burdens; rising costs and slow wage growth are weakening their propensity to spend (Chart 13). Chart 12Slower Manufacturing Investment Recovery Than Infrastructure And Real Estate So Far This Year Slower Manufacturing Investment Recovery Than Infrastructure And Real Estate So Far This Year Slower Manufacturing Investment Recovery Than Infrastructure And Real Estate So Far This Year Chart 13Slow Wage Growth Limits The Pace Of Consumption Recovery Slow Wage Growth Limits The Pace Of Consumption Recovery Slow Wage Growth Limits The Pace Of Consumption Recovery The inflation prints came at the time when China’s top leadership shifted its structural policy goals to reduce income inequality and stabilize manufacturing share in the aggregate economy. The structural goals will likely be reflected in policy responses to the cyclical challenge.  Moreover, this year’s manufacturing production volume was growing twice as fast as producer prices, a reversal from 2017 when price increases outpaced production (Chart 14). Price changes are much more important to corporate profits than volume changes. A strong RMB and sharply escalating shipping costs have also reduced exporters’ pricing power and profits (Chart 15). In contrast, mounting prices across various commodities have allowed the upstream industrial sectors, which are dominated by SOEs, to deliver much stronger profits than the downstream and private sector (Chart 16). Chart 14Growth In Manufacturing Output And Prices Starting To Converge Growth In Manufacturing Output And Prices Starting To Converge Growth In Manufacturing Output And Prices Starting To Converge Chart 15Strong RMB And Rising Shipping Costs Have Reduced Chinese Exporters' Profitability Strong RMB And Rising Shipping Costs Have Reduced Chinese Exporters' Profitability Strong RMB And Rising Shipping Costs Have Reduced Chinese Exporters' Profitability   It is unsurprising that authorities are increasing support to the private sector in order to maintain manufacturing share in the economy and keep the export sector competitive (Chart 17). A boost in infrastructure investment, on the other hand, would exacerbate upward pressure on commodity prices and mostly benefit upstream SOEs. Chart 16Upstream Industries Disproportionally Benefited From Surging Commodity Prices Upstream Industries Disproportionally Benefited From Surging Commodity Prices Upstream Industries Disproportionally Benefited From Surging Commodity Prices Chart 17Private Sector: Lower Profit Margin, Higher Costs Private Sector: Lower Profit Margin, Higher Costs Private Sector: Lower Profit Margin, Higher Costs Furthermore, stimulating the traditional sectors would not revive household consumption. The subdued recovery in consumption and prices for consumer staple goods is due to slow growth in lower-income household wages and a disrupted recovery in the services sector. Ramping up infrastructure investment can support headline GDP growth, but will do little to provide jobs and wages since China’s private sector provides 80% of all jobs and 90% of annual job creations. Lower-income households have a higher marginal propensity to consume. We expect the government to accelerate fiscal support measures to fortify wages among lower-income households. Bottom Line: Ongoing inflationary pressures and the underlying forces will likely thwart policymakers from stepping up their efforts to stimulate the old economy sectors. Investment Conclusions Chart 18Rebound In Infrastructure Stocks Should Be Short-Lived Rebound In Infrastructure Stocks Should Be Short-Lived Rebound In Infrastructure Stocks Should Be Short-Lived Chinese onshore stocks in the infrastructure, materials, and industrial sectors recently advanced strongly in the expectation that policymakers will ramp up their fiscal support in the old economy sectors, particularly infrastructure. Although we agree that infrastructure investment will improve, we maintain our view that a sizable rebound is highly unlikely this year. Hence, we do not expect that the rally in infrastructure stocks will be long-lasting (Chart 18).  We are probably too late in the cycle to re-initiate our long material/broad market trade in the onshore and offshore equity markets (Chart 19). We closed the trade in December last year when Chinese policymakers started pulling back stimulus, and in expectations that raw material prices would tumble. However, we underestimated the intensity of China’s de-carbonization efforts and protracted global supply-side constraints. Although global commodity prices will remain elevated into 2022, the price rallies from this year are not sustainable on a cyclical (6- to 12-month) basis. Therefore, we do not recommend material stocks as a cyclical play.  Chart 19Price Rally In Materials Stocks Unlikely To Sustain Price Rally In Materials Stocks Unlikely To Sustain Price Rally In Materials Stocks Unlikely To Sustain Chart 20Industrial Stocks May Be On A Structural Upcycle Industrial Stocks May Be On A Structural Upcycle Industrial Stocks May Be On A Structural Upcycle Instead, we recommend a long industrial/broad A-share market trade (Chart 20). Even though China is in a late business cycle and the upcoming stimulus will be mediocre at best, we think that the industrial sector will benefit from policy support for investment in the manufacturing sector and a faster pace in the sector’s capacity expansion.   Jing Sima China Strategist jings@bcaresearch.com   Footnotes Market/Sector Recommendations Cyclical Investment Stance

Highlights The US Climate Prediction Center gives ~ 70% odds another La Niña will form in the August – October interval and will continue through winter 2021-22. This will be a second-year La Niña if it forms, and will raise the odds of a repeat of last winter's cold weather in the Northern Hemisphere.1 Europe's natural-gas inventory build ahead of the coming winter remains erratic, particularly as Russian flows via Ukraine to the EU have been reduced this year. Russia's Nord Stream 2 could be online by November, but inventories will still be low. China, Japan, South Korea and India  – the four top LNG consumers in Asia  – took in 155 Bcf of the fuel in June. A colder-than-normal winter would boost demand. Higher prices are likely in Europe and Asia (Chart of the Week). US storage levels will be lower going into winter, as power generation demand remains stout, and the lingering effects from Hurricane Ida reduce supplies available for inventory injections. Despite spot prices trading ~ $1.30/MMBtu above last winter's highs – currently ~ $4.60/MMBtu – we are going long 1Q22 NYMEX $5.00/MMBtu natgas calls vs short NYMEX $5.50/MMBtu natgas calls expecting even higher prices. Feature Last winter's La Niña was a doozy. It brought extreme cold to Asia, North America and Europe, which pulled natural gas storage levels sharply lower and drove prices sharply higher as the Chart of the Week shows. Natgas storage in the US and Europe will be tight going into this winter (Chart 2). Europe's La Niña lingered a while into Spring, keeping temps low and space-heating demand high, which delayed the start of re-building inventory for the coming winter.  In the US, cold temps in the Midwest hampered production, boosted demand and caused inventory to draw hard. Chart of the WeekA Return Of La Niña Could Boost Global Natgas Prices A Return Of La Niña Could Boost Global Natgas Prices A Return Of La Niña Could Boost Global Natgas Prices Chart 2Europe, US Gas Stocks Will Be Tight This Winter NatGas: Winter Is Coming NatGas: Winter Is Coming Summer in the US also produced strong natgas demand, particularly out West, as power generators eschewed coal in favor of gas to meet stronger air-conditioning demand. This is partly due to the closing of coal-fired units, leaving more of the load to be picked up by gas-fired generation (Chart 3). The EIA estimates natgas consumption in July was up ~ 4 Bcf/d to just under 76 Bcf/d. Hurricane Ida took ~ 1 bcf/d of demand out of the market, which was less than the ~ 2 Bcf/d hit to US Gulf supply resulting from the storm.  As a result, prices were pushed higher at the margin. Chart 3Generators Prefer Gas To Coal NatGas: Winter Is Coming NatGas: Winter Is Coming US natgas exports (pipeline and LNG) also were strong, at 18.2 Bcf/d in July (Chart 4). We expect US LNG exports, in particular, to resume growth as the world recovers from the COVID-19 pandemic (Chart 5). This strong demand and exports, coupled with slightly lower supply from the Lower 48 states – estimated at ~ 98 Bcf/d by the EIA for July (Chart 6) – pushed prices up by 18% from June to July, "the largest month-on-month percentage change for June to July since 2012, when the price increased 20.3%" according to the EIA. Chart 4US Natgas Exports Remain Strong US Natgas Exports Remain Strong US Natgas Exports Remain Strong Chart 5US LNG Exports Will Resume Growth NatGas: Winter Is Coming NatGas: Winter Is Coming Chart 6US Lower 48 Natgas Production Recovering US Lower 48 Natgas Production Recovering US Lower 48 Natgas Production Recovering Elsewhere in the Americas, Brazil has been a strong bid for US LNG – accounting for 32.3 Bcf of demand in  June – as hydroelectric generation flags due to the prolonged drought in the country. In Asia, demand for LNG remains strong, with the four top consumers – China, Japan, South Korea, and India – taking in 155 Bcf in June, according to the EIA. Gas Infrastructure Ex-US Remains Challenged A combination of extreme cold weather in Northeast Asia, and a lack of gas storage infrastructure in Asia generally, along with shipping constraints and supply issues at LNG export facilities, led to the Asian natural gas price spike in mid-January.2 Very cold weather in Northeast Asia, drove up LNG demand during the winter months. In China, LNG imports for the month of January rose by ~ 53% y-o-y (Chart 7).3 The increase in imports from Asia coincided with issues at major export plants in Australia, Norway and Qatar during that period. Chart 7China's US LNG Exports Surged Last Winter, And Remain Stout Over The Summer NatGas: Winter Is Coming NatGas: Winter Is Coming Substantially higher JKM (Japan-Korea Marker) prices incentivized US exporters to divert LNG cargoes from Europe to Asia last winter. The longer roundtrip times to deliver LNG from the US to Asia – instead of Europe – resulted in a reduction of shipping capacity, which ended up compounding market tightness in Europe. Europe dealt with the switch by drawing ~ 18 bcm more from their storage vs. the previous year, across the November to January period. Countries in Asia - most notably Japan – however, do not have robust natural gas storage facilities, further contributing to price volatility, especially in extreme weather events. These storage constraints remain in place going into the coming winter. In addition, there is a high probability the global weather pattern responsible for the cold spells around the globe that triggered price spikes in key markets globally – i.e., a second La Niña event – will return. A Second-Year La Niña  Event The price spikes and logistical challenges of last winter were the result of atmospheric circulation anomalies that were bolstered by a La Niña event that began in mid-2020.4 The La Niña is characterized by colder sea-surface temperatures that develops over the Pacific equator, which displaces atmospheric and wind circulation and leads to colder temperatures in the Northern Hemisphere (Map 1). Map 1La Niña Raises The Odds Of Colder Temps NatGas: Winter Is Coming NatGas: Winter Is Coming The IEA notes last winter started off without any exceptional deviations from an average early winter, but as the new year opened "natural gas markets experienced severe supply-demand tensions in the opening weeks of 2021, with extremely cold temperature episodes sending spot prices to record levels."5 In its most recent ENSO update, the US Climate Prediction Center raised the odds of another La Niña event for this winter to 70% this month. If similar conditions to those of the 2020-21 winter emerge, US and European inventories could be stretched even thinner than last year, as space-heating demand competes with industrial and commercial demand resulting from the economic recovery. Global Natgas Supplies Will Stay Tight JKM prices and TTF (Dutch Title Transfer Facility) prices are likely to remain elevated going into winter, as seen in the Chart of the Week. Fundamentals have kept markets tight so far. Uncertain Russian supply to Europe will raise the price of the European gas index (TTF). This, along with strong Asian demand, particularly from China, will keep JKM prices high (Chart 8). The global economic recovery is the main short-term driver of higher natgas demand, with China leading the way. For the longer-term, natural gas is considered as the ideal transition fuel to green energy, as it emits less carbon than other fossil fuels. For this reason, demand is expected to grow by 3.4% per annum until 2035, and reach peak consumption later than other fossil fuels, according to McKinsey.6 Chart 8BCAs Brent Forecast Points To Higher JKM Prices BCAs Brent Forecast Points To Higher JKM Prices BCAs Brent Forecast Points To Higher JKM Prices Spillovers from the European natural gas market impact Asian markets, as was demonstrated last winter. Russian supply to Europe – where inventories are at their lowest level in a decade – has dropped over the last few months. This could either be the result of Russia's attempts to support its case for finishing Nord Stream 2 and getting it running as soon as possible, or because it is physically unable to supply natural gas.7 A fire at a condensate plant in Siberia at the beginning of August supports the latter conjecture. The reduced supply from Russia, comes at a time when EU carbon permit prices have been consistently breaking records, making the cost of natural gas competitive compared to more heavy carbon emitting fossil fuels – e.g., coal and oil – despite record breaking prices. With Europe beginning the winter season with significantly lower stock levels vs. previous years, TTF prices will remain volatile. This, and strong demand from China, will support JKM prices. Investment Implications Natural gas prices are elevated, with spot NYMEX futures trading ~ $1.30/MMBtu above last winter's highs – currently ~ $4.60/MMBtu. Our analysis indicates prices are justifiably high, and could – with the slightest unexpected news – move sharply higher. Because natgas is, at the end of the day, a weather market, we favor low-cost/low-risk exposures. In the current market, we recommend going long 1Q22 NYMEX $5.00/MMBtu natgas calls vs short NYMEX $5.50/MMBtu natgas calls expecting even higher prices. This is the trade we recommended on 8 April 2021, at a lower level, which was stopped out on 12 August 2021 with a gain of 188%.   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 Earlier this week, Saudi Aramco lowered its official selling price (OSP) by more than was expected – lowering its premium to the regional benchmark to $1.30/bbl from $1.70/bbl – in what media reports based on interviews with oil traders suggest is an attempt to win back customers electing not to take volumes under long-term contracts. This is a marginal adjustment by Aramco, but still significant, as it shows the company will continue to defend its market share. Pricing to Northwest Europe and the US markets is unchanged. Aramco's majority shareholder, the Kingdom of Saudi Arabia (KSA), is the putative leader of OPEC 2.0 (aka, OPEC+) along with Russia. The producer coalition is in the process of returning 400k b/d to the market every month until it has restored the 5.8mm b/d of production it took off the market to support prices during the COVID-19 pandemic. We expect Brent crude oil prices to average $70/bbl in 2H21, $73/bbl in 2022 and $80/bbl in 2023. Base Metals: Bullish Political uncertainty in Guinea caused aluminum prices to rise to more than a 10-year high this week (Chart 9). A coup in the world’s second largest exporter of bauxite – the main ore source for aluminum – began on Sunday, rattling aluminum markets. While iron ore prices rebounded primarily on the record value of Chinese imports in August, the coup in Guinea – which has the highest level of iron ore reserves – could have also raised questions about supply certainty. This will contribute to iron-ore price volatility. However, we do not believe the coup will impact the supply of commodities as much as markets are factoring, as coup leaders in commodity-exporting countries typically want to keep their source of income intact and functioning. Precious Metals: Bullish Gold settled at a one-month high last Friday, when the US Bureau of Labor Statistics released the August jobs report. The rise in payrolls data was well below analysts’ estimates, and was the lowest gain in seven months. The yellow metal rose on this news as the weak employment data eased fears about Fed tapering, and refocused markets on COVID-19 and the delta variant. Since then, however, the yellow metal has not been able to consolidate gains. After falling to a more than one-month low on Friday, the US dollar rose on Tuesday, weighing on gold prices (Chart 10). Chart 9 Aluminum Prices Recovering Aluminum Prices Recovering Chart 10 Weaker USD Supports Gold Weaker USD Supports Gold       Footnotes 1      Please see the US Climate Prediction Center's ENSO: Recent Evolution, Current Status and Predictions report published on September 6, 2021. 2     Please see Asia LNG Price Spike: Perfect Storm or Structural Failure? Published by Oxford Institute for Energy Studies. 3     Since China LNG import data were reported as a combined January and February value in 2020, we halved the combined value to get the January 2020 amount. 4     Please see The 2020/21 Extremely Cold Winter in China Influenced by the Synergistic Effect of La Niña and Warm Arctic by Zheng, F., and Coauthors (2021), published in Advances in Atmospheric Sciences. 5     Please see the IEA's Gas Market Report, Q2-2021 published in April 2021. 6     Please see Global gas outlook to 2050 | McKinsey on February 26, 2021. 7     Please see ICIS Analyst View: Gazprom’s inability to supply or unwillingness to deliver? published on August 13, 2021.   Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades