Oil

Highlights As the global economy moves toward shut-down, the Kingdom of Saudi Arabia (KSA) and Russia will be forced to end their market-share war and focus on shoring up their economies and tending to their populations’ welfare. Governments worldwide are rolling out fiscal- and monetary-policy responses to the COVID-19 pandemic. They also are imposing seldom-seen freedom-of-movement and -gathering restrictions on their populations to contain the spread of the virus. A surge in bankruptcies among US shale-oil companies is expected as demand and supply shocks push Brent and WTI below producers’ breakeven prices. In our base case, benchmark prices are pushed toward $20/bbl this year, which will keep volatility elevated. Prices recover in 4Q20 and 2021, as the pandemic recedes, and economies respond to fiscal and monetary stimulus. We have reduced our oil-price forecasts in the wake of the deterioration in fundamentals, expecting Brent to average $36/bbl in 2020, and $55/bbl in 2021. WTI will trade ~ $3-$4/bbl lower. COVID-19 is transitory. Therefore price risk is to the upside in 2021, given the global stimulus being deployed. Feature Brent and WTI prices are down 61.4% and 66.6% since the start of the year (Chart of the Week), taking front-month futures to their lowest levels since 2002. Oil markets are in a fundamental disequilibrium – the expected global supply curve is moving further to the right with each passing day, as the KSA and Russia market-share rhetoric escalates. Global demand curves are moving further to the left on an hourly basis, as governments worldwide impose freedom-of-movement restrictions and lock-downs to contain the spread of COVID-19 seen only during times of war and natural devastation.  These effects combine to swell inventories globally, as rising supply fails to be absorbed by demand. The collapse in crude oil prices since the beginning of this year is lifting volatility to levels not seen since the Gulf War of 1990-91. Chart of the WeekBenchmark Crude Prices Collapse Toward Cash Costs Chart 2Oil-Price Volatility Surges To Wartime Levels Prices, as can be expected under such circumstances, are plunging toward cash costs – i.e., the level at which only operating costs are covered – which are below $20/bbl. The collapse in crude oil prices since the beginning of this year is lifting volatility to levels not seen since the Gulf War of 1990-91 launched by the US and its allies following Iraq’s invasion of Kuwait (Chart 2). As inventories rise, the supply of storage globally falls, and prices are forced below cash costs to drive surplus crude oil production from the market. The rapid evolution from backwardation (prompt prices exceed deferred prices) to steep contango (prompt prices at a discount) in the benchmark crudes is how markets signal the supply of storage is falling (Chart 3). Chart 3Markets' Violent Move From Backwardation To Contango Chart 4Storage Constraints Drive Price Volatility This strain on global inventory capacity will keep volatility elevated: As physical constraints on storage intensify, only price can adjust to clear the market, which results in massive price moves as markets respond in real time to supply-demand imbalance (Chart 4). Shales Lead US Output Lower At this point, massive increases in supply are not required to keep benchmark oil prices below $30/bbl. Markets are seeing and anticipating a sharp contraction in demand in the near term, with storage building as consumers “shelter in place” around the world. Production is set to increase in April, in the midst of a global exogenous shock to demand. As these fundamentals are worked into prices volatility will remain high. In our updated forecasts, our base case assumes KSA and its allies, and Russia raise production by 1.3mm b/d in 2Q20 and 3Q20.  KSA's and Russia's output increase to ~ 11mm b/d and 11.7mm b/d, respectively. We expect the reality of low prices and a slowing world economy to force these states back to the negotiating table in 2H20, with production cuts being realized in 4Q20 and 2021 (see below). With less capital made available to shale drillers, production growth in the shales literally is forced to slow. While KSA’s and Russia’s budgets almost surely will bear enormous strain in such an environment, we believe it is the US shales that take the hardest hit over the short run, if KSA and Russia maintain their avowed production intensions. The growth in US shale output – Russia’s presumed target – is expected to slow sharply this year under current circumstances, increasing at a rate of just 650k b/d over 2019’s level. Next year, we expect shale production in the US to fall ~ 1.3mm b/d to 7.7mm b/d. Part of this is driven by the on-going reluctance of capital markets to fund shale drillers and hydrocarbon-based energy companies generally, which can be seen in the blowout in high-yield bond spreads dominated by shale issuers (Chart 5). With less capital made available to shale drillers, production growth in the shales literally is forced to slow. Chart 5Low Price Force US Shale Cutbacks With funding limited and domestic oil prices well below breakevens – and cash costs – more shale-oil producers will be pushed into bankruptcy or into sharp slowdowns in drilling activity (Charts 6A and 6B). These constraints will force total US output to contract by 1.3mm b/d next year, based on our modeling. This will take US lower 48 output this year and next to 10.5mm b/d and 9.2mm b/d, respectively (Chart 7). Chart 6ALow Prices Force US Shale CutbacksChart 6BLow Price Force US Shale Cutbacks Capital markets will not tolerate unprofitable production. When the dust settles next year, US shale-oil output is expected to take the biggest supply hit globally, based on our current assumptions and modeling results. Worthwhile remembering, however, shale-oil production is highly likely to emerge a leaner more efficient sector, as they did in the OPEC-led market-share war of 2014-16.1 Also worthwhile remembering, for shale operators, is capital markets will not tolerate unprofitable production. So, net, a stronger, more disciplined shale-oil producer cohort emerges from the wreckage of the COVID-19 demand shock coupled with the KSA-Russia market-share war of 2020. Chart 7US Shale Contraction Leads US Output Lower In 2021 Demand Uncertainty Is Huge We are modeling a shock that reduces global demand – a highly unusual occurrence – by 150k b/d this year versus 2019 levels (Table 1). Most of this shock occurs in 1H20, where a large EM contraction originating in China set the pace. We expect China’s demand to begin recovering in 2Q20. The demand contraction moves into OECD states in 2Q20, which are expected to follow a similar trajectory in demand shedding seen elsewhere (Chart 8). In 2H20, we expect global demand to begin recovering, and, barring another outbreak of COVID-19 (or another novel coronavirus) next winter, for global demand growth to re-accelerate to ~ 1.7mm b/d in 2021. Table 1BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) The uncertainty around our demand modeling is large. Expectations from the large data providers are all over the map: The EIA expects demand to grow 360k b/d this year, while the IEA and OPEC expect -90k and 60k b/d. In addition, some banks and forecasters make a case for demand falling by 1mm b/d or more in 2020, a scenario we do not expect. Sorting through the evolution of demand this year – i.e., tracking the recovery from China and EM through to DM – will be difficult, particularly as Western states go into lock-down mode and the global economy remains moribund. This makes our forecasts for supply-demand balances and prices highly tentative, and subject to revision. Chart 8Demand Shock + Market-Share War = Imbalance Market-Share War: What Is It Good For? As we argue above, the US shale-oil producers will, for a variety of reasons, be forced by capital and trading markets to retrench, and to cut production sharply. They lost favor with markets prior to the breakdown of OPEC 2.0, and this will not change. At this point, it is unlikely KSA and Russia can alter this evolution by increasing or decreasing production – investors already have shown they have little interest in funding their further growth and development. The KSA-Russia market-share war reinforces investors’ predispositions, and decidedly accelerates this retrenchment by the shale producers. As the global economy moves toward shut-down, KSA and Russia will be forced to turn their attention to shoring up their economies and tending to their populations’ welfare. The strain of a global shut-down will absorb governments’ resources worldwide, and self-inflicted wounds – which, at this point, a market-share war amounts to – will only make domestic conditions worse in KSA, Russia and their respective allies. The income elasticity of supply for these producers is such that small adjustments – positive or negative – on the supply side have profound effects on oil producers’ revenues (Table 2). Both KSA and Russia are aware of this. Russia burns through its $150 billion national wealth fund in ~ three years in a market-share war, while KSA burns through ~ 10% of its foreign reserves, when export prices fall $30/bbl and Russia's exports rise 200k b/d and KSA's rise 2mm b/d.2 In a world where demand destruction is accelerating revenue losses, and storage limitations threaten to collapse oil prices below cash costs, production management – even if that means extending the 1Q20 cuts of 1.7mm b/d for the balance of 2020 – is necessary to avoid larger, longer-term economic damage (Chart 9). Table 2Market-Share War Vs. Revenue Chart 9Global Inventories Could Surge We believe the leadership in both of these states have sufficient reason to return to the negotiating table to figure out a way to re-start their production-management accord, if only to preserve funds to cover imports while global demand recovers. It may take a month or two of unchecked production to make this point clear, however, so volatility can be expected to remain elevated. These fundamental and political assessments compel us to reduce our oil-price forecasts in the wake of the deterioration in fundamentals, expecting Brent to average ~ $36/bbl in 2020, and $55/bbl in 2021. WTI will trade ~ $3-$4/bbl lower. Price risk is to the upside in 2021, given the global fiscal and monetary stimulus being deployed. Bottom Line: The confluence of a true global demand shock and a market-share war on the supply side has pushed benchmark crude oil prices close to cash costs for many producers. The damage to states highly dependent on oil revenues is just now becoming apparent. We expect KSA and Russia to return to the negotiating table, to hammer out a production-management accord that allows them to control as much of the economic damage to their economies as is possible. Capital markets already are imposing a harsh discipline on US shales – Russia’s presumptive target in the market-share war. The consequences of the COVID-19 vis-a-vis demand destruction are of far greater moment for KSA and Russia than their market-share war. They need to shore up their economies and get in the best possible position to benefit from a global economic rebound, not destroy themselves seeking a Pyrrhic victory that devastates both of them.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Hugo Bélanger Associate Editor Commodity & Energy Strategy HugoB@bcaresearch.com   Commodities Round-Up Energy: Overweight Chinese refiner Sinochem International Oil (Singapore) turned down an offer of crude-oil cargoes for May-June deliver from Russian oil company Rosneft PJSC, which is under US sanctions, according to Bloomberg. Sinochem refuses cargoes from Iran, Syria, Venezuela, and Kurdistan, which also are under sanction or are commercially aligned with sanctioned entities. Base Metals: Neutral The downward trend in base metal prices remains,  as the spread of the coronavirus intensifies outside of China, and governments worldwide impose freedom-of-movement restrictions on their populations to contain further spread. Persistent US dollar strength – supported by inflows to safe assets amid the elevated global economic uncertainty – pressures EM economies’ base metal demand. As a result, the LME index is down 18% YTD, reaching its 2016 lows. We were stopped out of our long LMEX recommendation on March 17, 2020 for a 12% loss. Precious Metals: Neutral Gold and silver are caught up in a global selloff of assets that have performed well over the past year as safe havens, as market participants raise cash for liquidity reasons or margin calls. We are waiting for an opportunity to go long gold again after being stopped out earlier in the sell-off. Silver will recover with industrial-commodity demand, which we expect to occur in 4Q20, when the COVID-19 threat recedes, and consumers worldwide are responding to the globally fiscal and monetary stimulus being rolled out now. We are staying on the sidelines for now, as volatility is extremely high for metals (Chart 10). Ags/Softs:  Underweight CBOT May Corn futures were down 3% Tuesday, reaching 18-month lows, driving mostly by high USD levels, which make US exports less competitive. Supplies from South America, where a large harvest is ongoing in Argentina and Brazil, are taking market share. Furthermore, according to a report from the University of Illinois, lower gasoline consumption resulting from the COVID-19 pandemic will reduce the amount of corn needed for ethanol production; demand could fall 120mm to 170mm bushels. Soybeans and wheat futures ended the day slightly higher on the back of bargain buying, after falling to multi-month lows on Monday. USD strength remains a headwind on ags, encouraging production ex-US at the margin and contributing to stifling demand for US exports (Chart 11). Chart 10Gold Is Experiencing Extremely High Volatility Chart 11USD Strength Remains A Headwind On AGS   Footnotes 1     Please see How Long Will The Oil-Price Rout Last?, a Special Report we published March 9, 2020, which discussed US bankruptcy law and the re-cycling of assets. 2     Please see Russia's Supply Shock To Oil Markets and Russia Regrets Market-Share War?, which we published March 6 and March 12, 2020, for additional discussion. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades TRADE RECOMMENDATION PERFORMANCE IN 2019 Q4 Commodity Prices and Plays Reference Table Trades Closed in 2020 Summary of Closed Trades

Highlights Our short EM equity index recommendation has reached our target and we are booking profits on this trade. The halt to economic activity will produce a global recession that will be worse than the one that took place in late 2008. We continue to recommend short positions in a basket of EM currencies versus the US dollar. In EM fixed-income markets, the duration of the ongoing selloff has been short, and large losses will trigger more outflows ensuring further carnage. Stay defensive for now. Russia is unlikely to make a deal with Saudi Arabia to restrain oil output for now. Feature The global economy is experiencing a sudden, jarring halt. The only comparison for such a sudden stop is the one that occurred in the fall of 2008, following Lehman’s bankruptcy. In our opinion, the global economic impact of the current sudden stop is shaping up to be worse than the one that occurred in 2008. That said, we are taking profits on our short position in EM equities. This position – recommended on January 30, 2020 – has produced a 30% gain.   EM share prices have reached the long-term support that acted as the ultimate floor during the bear markets in 1997-‘98, 2001-‘02, 2007-‘08 and 2015. Our decision to take profits reflects investment discipline. The MSCI EM stock index in US dollar terms has reached our target. In addition, this decision is consistent with two important indicators that we follow and respect: 1. EM stocks have become meaningfully cheap. Chart I-1 illustrates that our cyclically-adjusted P/E (CAPE) ratio for EM equities is about one standard deviation below its fair value – the same level when the EM equity market bottomed in 1998, 2008 and 2015. Chart I-1EM Equities Are Cheap According To The Cyclically-Adjusted P/E Ratio For this EM CAPE ratio to reach 1.5 standard deviations below its fair value – the level that is consistent with EM’s 2001-02 lows – EM share prices need to drop another 15%. 2. In term of the next technical support, EM share prices have reached the long-term support that acted as the ultimate floor during the bear markets in 1997-‘98, 2001-‘02, 2007-‘08 and 2015 (Chart I-2). Chart I-2EM Share Prices Are At Their Long-Term Support While share prices are likely to undershoot, it is risky to bet on a further decline amid current extremely elevated uncertainty and market volatility. The Global Downturn Will Be Worse Than In Late 2008 Odds are that the current global downturn is shaping up to be worse than the one that occurred in late 2008. From a global business cycle perspective, the current sudden halt is beginning from a weaker starting point. Global trade growth was positive back in August-September 2008 – just prior to the Lehman bankruptcy – despite the ongoing US recession (Chart I-3A). In comparison, global trade was shrinking in December 2019, before the COVID-19 outbreak (Chart I-3B). Chart I-3AGlobal Trade Growth Was Positive In September 2008… Chart I-3B…But Was Negative In December 2019   This is because growth in EM and Chinese economies was still very robust in the middle of 2008. Moreover, the economies of EM and China were structurally very healthy and were anchored by solid fundamentals. Still, the blow to confidence emanating from the crash in global financial markets and plunge in US domestic demand in the fall of 2008 produced major shockwaves in EM/Chinese financial markets. Provided the ongoing negative confidence shock and lingering uncertainty persist, odds are that the risk premium will initially overshoot before settling down. Consistently, risk markets will undershoot in the interim. This is in contrast with current cyclical growth conditions and structural economic health, both of which are very poor in EM/China going into this sudden stop.   In China, economic growth in January-February 2020 was much worse than at the trough of the Lehman crisis in the fourth quarter of 2008. Chart I-4 reveals that industrial production, auto sales and retail sales volumes all contracted in January-February 2020 from a year ago. The same variables held up much better in the fourth quarter of 2008 (Chart I-4). Business activity in China is recovering in March, but from very low levels. Reports and evidence from the ground suggest that many companies are operating well below their ordinary capacity – the level of economic activity remains well below March 2019 levels. US real GDP, consumer spending and capital expenditure shrunk by 4%, 2.5% and 17% at the trough of 2008 recession (Chart I-5). Odds are that these variables will plunge by an even greater magnitude in the coming months as the US reinforces lockdowns and public health safety measures. Chart I-4China Business Cycle Was Much Stronger In Q4 2008 Than Now Chart I-5US Growth At Trough Of 2008 Recession   Chart I-6US Small Caps: Overlay Of 2008 And 2020 About 50% of consumer spending in the US is attributed to people over 55 years of age. Provided COVID-19’s fatality rate is high among the elderly, odds are this cohort will not risk going out and spending. How bad will domestic demand in the US be? It is impossible to forecast with any certainty, but our sense is that it will plunge by more than it did in the late 2008-early-2009 period, i.e., by more than 4% (Chart I-5, bottom panel). Interestingly, the crash in US small-cap stocks resembles the one that occurred in the wake of the Lehman bankruptcy (Chart I-6). If US small-cap stocks follow their Q4 2008 - Q1 2009 trajectory, potential declines from current levels will be in the 10%-18% range. Bottom Line: The current halt in economic activity and impending global recession will be worse than the one that took place in late 2008. Reasons Not To Jump Into The Water…Yet Even though EM equities have become cheap and oversold and we are booking profits on our short position in EM stocks, conditions for a sustainable rally do not exist yet: So long as EM corporate US dollar bond yields are rising, EM share prices will remain under selling pressure (Chart I-7). Corporate bond yields are shown inverted in this chart. Chart I-7EM Stocks Fall When EM Corporate Bond Yields Rise Chart I-8Chinese And Emerging Asian Corporate Bond Yields Are Spiking The selloff in both global and EM credit markets began only a few weeks ago from very overbought levels. Many investors have probably not yet trimmed their positions. Hence, EM sovereign and corporate credit spreads and yields will likely rise further as liquidation in the global and EM credit markets persists. Consistently, bond yields for Chinese offshore corporates as well as emerging Asian high-yield and investment-grade corporates are rising (Chart I-8). EM local currency bond yields have also spiked recently as rapidly depreciating EM currencies have triggered an exodus of foreign investors. Rising local currency bond yields are not conducive for EM share prices (Chart I-9). Chart I-9EM Equities Drop When EM Local Bond Yields Rise EM ex-China currencies correlate with commodities prices (Chart I-10). Both industrial commodities and oil prices have broken down and have further downside. The path of least resistance for oil prices is down, given anemic global demand and our expectation that Russia and Saudi Arabia will not reach any oil production cutting agreement for several months (please refer to our discussion on this topic below). Finally, our Risk-On/Safe-Haven currency ratio1 is in free fall and will likely reach its 2015 lows before troughing (Chart I-11). This ratio tightly correlates with EM share prices, and the latter remains vulnerable to further downside as long as this ratio is falling. Chart I-10EM Currencies Move In Tandem With Commodities Prices Chart I-11More Downside In Risk-On/ Safe-Haven Currency Ratio   Bottom Line: Although we are taking profits on the short EM equity position, we continue to recommend short positions in a basket of EM currencies – BRL, CLP, ZAR, IDR, PHP and KRW – versus the US dollar. Liquidation in EM fixed-income markets has been sharp, but the duration has been short –only a few weeks. Large losses will trigger more outflows from EM fixed-income markets. Stay defensive for now. What We Do Know And What We Cannot Know Amid such extreme uncertainty, it is critical for investors to distinguish between what we know and what we cannot know. What we cannot know: With regards to COVID-19: The speed of its spread, the ultimate number of victims it claims and – finally – its impact on consumer and business confidence and psyche. Related to lockdowns: Their duration in key economies. These questions will largely determine this year’s economic growth trajectory: Will it be V-, U-, W-, or L-shaped? Unfortunately, no one knows the answers to the above questions to have any certainty in projecting this year’s global growth. The key factor that gives Russia an advantage over Saudi Arabia in terms of its ability to deal with a negative terms-of-trade shock is not only its better fiscal position but also its ability to depreciate its currency. What we do know: Authorities in all countries will stimulate aggressively so long as financial markets are rioting. Nonetheless, these stimulus measures will not boost growth immediately. With entire countries locked down and plunging consumer and business confidence, stimulus will not have much impact on growth in the near term. In brief, all policy stimulus will boost growth only when worries about the pandemic subside and the economy begins to function again. Both are not imminent. Hence, we are looking at an air pocket with respect to near-term global economic growth. As we argued in our March 11 report titled, Unraveling Of The Policy Put, the pre-coronavirus financial market paradigm – where stocks and credit markets were priced to perfection because of the notion that policymakers would not allow asset prices to drop – has unravelled.   In recent weeks, policymakers around the world have announced plans to deploy massive amounts of stimulus, yet the reaction of financial markets has been underwhelming. The reason is two-fold: Both demand shrinkage and production shutdowns have just started, and they will run their due course regardless of announced policy stimulus measures. Equity and credit markets were priced for perfection before this selloff, and investors are in the process of recalibrating risk premiums. Provided the ongoing negative confidence shock and lingering uncertainty persist, odds are that the risk premium will initially overshoot before settling down. Consistently, risk markets will undershoot in the interim. Bottom Line: DM’s domestic demand downturn is still in its initial phase, and there is little foresight in terms of the pandemic’s evolution. These are natural forces, and any stimulus policymakers enact are unlikely to preclude them from occurring. Reflecting the economic contraction and heightened uncertainty, the selloff in risk assets will likely continue for now. Do Not Bet On An Early Resuscitation Of OPEC 2.0 As we argued in our March 11 report, Russia is unlikely to make a deal with Saudi Arabia to restrain oil output in the immediate term. Russia may agree to restart negotiations, but it will not agree to reverse its position for some time. Both nations will be increasing crude output (Chart I-12). As a result, a full-fledged oil market share war is underway. Consistently, crude prices have experienced a structural breakdown (Chart I-13).  Chart I-12The Largest Oil Producers Are Ramping Up Output Chart I-13Structural Breakdown In Oil Prices   The key factor that gives Russia an advantage over Saudi Arabia in terms of its ability to deal with a negative terms-of-trade shock is not only its better fiscal position but also its ability to depreciate its currency. Russia has a flexible exchange rate, which will allow the currency to depreciate in order to soften the blow from lower oil prices on the real economy and fiscal accounts. The Russian economy and financial system have learned to operate with recurring major currency depreciations. Saudi Arabia has been running a fixed exchange rate regime since 1986 and cannot use currency depreciation to mitigate the negative terms-of-trade shock on its end. Even though Russia’s fiscal budget break-even oil price is much lower than that of Saudi Arabia’s, it is not the most important variable to consider in this confrontation. The fiscal situation in both Russia and Saudi Arabia will not be a major problem for now. Both governments can issue local currency and US dollar bonds, and there will be sufficient demand for these bonds from foreign and local investors. This is especially true with DM interest rates sitting at the zero-negative territory. Falling oil prices and downward pressure on exchange rates will trigger capital outflows in both countries. Russia has learned to live with persistent capital flight. In the meantime, capital outflows will stress Saudi Arabia’s financial system and, eventually, its real economy. This is in fact the country’s key vulnerability. We will be publishing a Special Report on Saudi Arabia in the coming weeks.  Bottom Line: Do not expect a quick recovery in oil prices. Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com   Footnotes 1     Average of CAD, AUD, NZD, BRL, RUB, CLP, MXN & ZAR total return indices relative to average of CHF & JPY total returns.   Equities Recommendations Currencies, Credit And Fixed-Income Recommendations

Highlights While not exactly conciliatory, Russian officials are signaling they will re-consider the declaration of a market-share war with the Kingdom of Saudi Arabia (KSA). KSA upped its shock-and-awe rhetoric promising to lift maximum sustainable capacity to 13mm b/d, which has kept prices under pressure (Chart of the Week) and will resonate into 3Q20, even if a market-share war is averted. Failure to stop a market-share war will fill global oil storage, and Brent prices again will trade with a $20 handle by year-end. Demand forecasts by the IEA and prominent banks are tilting toward the first contraction in global oil demand since the Global Financial Crisis (GFC). Central banks and governments are rolling out fiscal and monetary stimulus to counter the expected hit to global aggregate demand in the wake of COVID-19. Given the extraordinary uncertainty surrounding global oil supply and demand, our balances and prices forecasts are highly tentative. We are reducing our 2020 Brent forecasts to $40/bbl for 2Q-3Q20, and $50/bbl for 4Q20. For 2021, we are expecting Brent to average $60/bbl. WTI trades $3-$4/bbl below Brent in our estimates. Feature Russian officials appear to be seeking a resumption of talks with OPEC. Since the declaration of a market-share war following the breakdown of OPEC 2.0 negotiations to agree a production cut to balance global oil markets, Russian officials appear to be seeking a resumption of talks with OPEC.1 Putting such a meeting together before the expiration of OPEC 2.0’s 1.7mm b/d production-cutting deal at the end of this month will be a herculean lift for the coalition, but it can be done. All the same, it may require a quarter or so of re-opened floodgates from KSA and its GCC allies to focus everyone’s attention on the consequences of market-share wars. To that end, the Kingdom announced it will lift production above 12mm b/d, and supply markets out of strategically placed storage around the world. It was joined by the UAE with a pledge to raise output to 4mm b/d. Chart of the WeekMessy OPEC 2.0 Breakdown Crashes Benchmark Crude Prices Assessing Uncertain Fundamentals While the dramatis personae on the supply side maneuver for advantage, markets still are trying to form expectations on the level of demand destruction in EM and DM wrought by COVID-19. Given the elevated uncertainty around this issue, modeling our ensemble forecast has become more complicated. On the demand side, we are modeling three scenarios for 2020: Global demand growth falls 200k b/d y/y, flat growth, and growth of 600k b/d. Our previous expectations had growth increasing 1mm b/d in 2020 and 1.7mm b/d in 2021. We maintain the rate of growth for next year – 1.7mm b/d – but note it is coming off a lower 2020 base for consumption. On the supply side, it’s a bit more complicated. We have three scenarios: In Scenario 1, we model the OPEC 2.0 breakdown, i.e., OPEC 2.0 gradually increases production by 2.5mm b/d between Apr20 and Dec20. Compared to our previous estimates it also removes the 600k b/d we previously expected would be added to the cuts in 2Q20, which produces a supply increase of 2.5mm b/d + expectation of 600k b/d vs. our previous balances. In Scenario 2, we run our previous balances expectation, which cuts production by a total of 2.3mm b/d in 2Q20, 1.7mm b/d in 2H20, and 1.2mm b/d in 2021.2 Scenario 3 models the additional cuts as recommended by OPEC last in week in Vienna of 1.5mm b/d on top of the 1.7mm b/d already agreed on for 1Q20. These cuts are realized gradually, moving to 2.3mmm b/d in 2Q20 and 3.2mm b/d in 2H20. For 2021, our supply assumptions revert to the OPEC 2.0 production cuts of 1.2mm b/d that prevailed last year. The price expectations generated by these scenarios can be seen in Table 1 and in Charts 2A, 2B, and  2C, which show our supply-side scenarios with the three demand-side scenarios above. We show our balances estimates given these different scenarios in Charts 3A, 3B, and 3C, and our inventory estimates in Charts 4A,  4B, and  4C. Table 1Unstable Brent Price Forecasts It may require a quarter or so of re-opened floodgates from KSA and its GCC allies to focus everyone’s attention on the consequences of market-share wars. Chart 2AOil Price Scenarios Driver: OPEC vs. Russia Price War Chart 2BOil Price Scenarios Driver: Pre-OPEC 2.0 Breakdown Chart 2COil Price Scenarios Driver: Proposed OPEC Cuts Chart 3AOil Balances Scenarios Driver: OPEC vs. Russia Price War Chart 3BOil Balances Scenarios Driver: Pre-OPEC 2.0 Breakdown Chart 3COil Balances Scenarios Driver: Proposed OPEC Cuts Chart 4AOECD Inventory Scenarios Driver: OPEC vs. Russia Price War Chart 4BOECD Inventory Scenarios Driver: Pre-OPEC 2.0 Breakdown Chart 4COECD Inventory Scenarios Driver: Proposed OPEC Cuts Given all of the moving parts in our forecast this month, we will only be publishing a summary of these estimates (Table 1). We will publish our global balances table next week after we have had time to process the EIA’s and OPEC’s historical demand estimates. Given the dynamics of supply-demand and storage adjustments these different scenarios produce, we use them to roughly estimate forecasts for 2Q and 3Q20, 4Q20 and 2021. We are reducing our 2020 Brent forecasts to $40/bbl for 2Q-3Q20, and $50/bbl for 4Q20. For 2021, we are expecting Brent to average $60/bbl. WTI trades $3-$4/bbl below Brent in our estimates. The implicit assumption here is COVID-19 is contained by 3Q20 and is in the market’s rear-view mirror by 4Q20. Obviously, such an assumption is fraught with uncertainty. Russia May Be Re-Thinking Strategy I cannot forecast to you the action of Russia. It is a riddle, wrapped in a mystery, inside an enigma; but perhaps there is a key. That key is Russian national interest. Winston Churchill, BBC Broadcast, October 1, 1939.3 Russia appears to be sending up trial balloons to indicate to OPEC it would not be averse to renewing the OPEC 2.0 dialogue. It is worthwhile noting Russian officials immediately responded to KSA’s first mention of sharply higher output – going to 12.3mm bd from 9.7mm b/d – with their own assertion they will lift current output of ~ 11.4mm b/d by 200k – 300k b/d, and ultimately take that to +500k b/d. Of course, as Churchill’s observation makes plain, it is difficult to interpret Russia’s overtures in this regard, particularly in light of the growing popular dissatisfaction with President Vladimir Putin’s regime within Russia itself. At the outset, it seems to us that the cause of the breakdown in OPEC 2.0 was the collapse in demand from China following the COVID-19 outbreak in Wuhan Province, and Putin’s attempt to secure a longer stay in power.4 The former focused Russia’s oil oligarchs on shoring up market share, and focused Putin on maintaining the support of these important oligarchs. The basis for Russo-Saudi cooperation under the OPEC 2.0 umbrella was rising oil demand, and the simple fact that both sides had exhausted their ability to sustain low prices brought on by the 2014-16 oil-price collapse ushered in by OPEC’s previous market-share war amid the global manufacturing downturn. The slowdown in global demand due to China’s slow-down and the Sino-US trade war in 2019 weakened Russian commitment to OPEC 2.0 by end of year. Putin faced domestic popular discontent and grumbling among the oligarchs (e.g. Igor Sechin, the head of Rosneft), just as he was preparing to extend his term in power. The possibility of a drastic loss of Russian influence over global oil markets – and hence of its own economic independence – emerged at a time when Putin still has the ability to maneuver ahead of the 2021 Duma election and 2024 presidential election which are essential to his maintenance of power. Going into 2020, Russia also had gained monetary and fiscal ammunition over preceding three years that would allow them to challenge KSA within OPEC 2.0, while KSA’s reserves stagnated (Chart 5). The Wuhan Coronavirus pushed things over the edge by hitting Chinese oil demand directly in the gut. Putin gave into the oil sector’s demands for prioritizing market share. As is apparent, this is the critical issue for him and the oligarchs running Russia’s oil and gas companies. Chart 5Foreign Exchange Reserves Russia’s US Focus The fact that US President Donald Trump and Iran are harmed by the oil price collapse is secondary. The Russians may have known that the US and Iran would suffer collateral damage, but their primary objective was not to unseat Trump and definitely not to increase the chances of regime collapse in Iran. It is not unthinkable that President Putin would attempt to upset the US election yet again. Regardless of the relationship between Putin and Trump, Russia benefits from promoting US polarization in general. And the Democrats will impose stricter regulations on US resource industries (including shale). All the same, Russia will suffer from Democrats taking power and strengthening NATO and the trans-Atlantic alliance. A knock on shale is a short-term benefit to Russia, but the loss of Trump as a president who increases geopolitical “multipolarity,” which is good for Russia, would be a long-term loss. President Putin would not have triggered the conflict with Saudi over such a mixed combination. The breakdown of OPEC 2.0 happened after Super Tuesday, so it was clear Biden was leading the US Democratic Party’s bid for the Oval Office come November. Biden is hawkish on Russia and is more likely than Trump to get the Europeans to reduce their energy dependence on Russia. Also, it is possible Trump will benefit from lower oil prices anyway, since it will reduce prices at the pump by November and also help China recover – thus allowing it to boost global demand and follow through on Phase 1 of the Sino-US trade deal. As noted above, market share is primary. The US election, if it is relevant at all, is subsidiary. The Trump administration is furious because the turmoil threatens to upset the US election. As for Iran, Russia does at least consider its position, but is driven by its own needs and, as usual, threw Iran under the bus when necessary. Russia will continue to support the Iranian regime in other ways. And if the consequence of the market-share war is government change in the US, then Iran has its reward. Clearly President Putin was willing to throw President Trump under the bus, as well. It was not surprising to see US officials singling out Russia when discussing the oil-price collapse last week and earlier this week, when US Treasury Secretary Steve Mnuchin and Russia’s foreign minister, Anatoly Antonov, met in Washington. This blame game is consistent with what we think we know: Russia wavered on the deal presented by OPEC. Saudi Arabia was not the instigator.5 Saudi Arabia massively reacted to retaliate against Russia’s declared price war, but it was Russia that refused to agree to more cuts.6 The Trump administration is furious because the turmoil threatens to upset the US election. From Trump’s perspective, oil and gasoline prices weren’t too high, but, now that they are lower, the risk of higher unemployment in key electoral states – even Texas – is elevated. Trump wanted more oil production but not oil market chaos.  Trump wanted more oil production but not oil market chaos. This short-term thinking is likely to drive US policy in advance of the election, although from a long-term point of view the US has little reason to regret Russia’s actions as Russia is ultimately shooting itself in the foot. From an international point of view, the breakdown shows that Russia and KSA are fundamentally competitive, not cooperative, and the fanfare over improving relations was dependent on stronger oil demand, not vice versa. Russia’s strategy for decades – in the Middle East and elsewhere – has been to take calculated risks, not to undertake reckless adventures that expose its military and economic weaknesses relative to the United States and Europe. This strategic logic applies to the market-share war as well as to Russia’s various conflicts with the West. The oil price collapse is bad for Russia’s economy and internal stability and hence the door to talks is still open. The immediate risk to both KSA and Russia is a forward oil curve that stays lower for longer, regardless of what the Russian Finance Ministry says. A reconciliation between KSA and Russia to restore the production-management deal would limit the negative fallout. The immediate risk to both KSA and Russia is a forward oil curve that stays lower for longer, regardless of what the Russian Finance Ministry says.7 Bottom Line: The COVID-19 pandemic and the breakdown of OPEC 2.0 last week in Vienna dramatically heightened uncertainty and volatility in oil markets. Although it appears Russian officials are trying to walk back the market-share war declared at the end of last week, events already in train could keep oil prices lower for longer. We lowered our oil-price forecasts for 2020 to reflect the demand destruction and a possible supply surge this year. The underlying assumption of our modeling on the demand side is the COVID-19 pandemic will be contained and the global economy will be back in working order by 4Q20. On the supply side, nothing is certain, but we are leaning to a re-formation of OPEC 2.0, which ultimately restores the production-management regime that prevailed until last week. Both of these assumptions are highly unstable. We lowered our 2020 Brent forecasts to $40/bbl for 2Q-3Q20, and to $50/bbl for 4Q20. For 2021, we are expecting Brent to average $60/bbl. WTI trades $3-$4/bbl below Brent in our estimates. These forecasts will be constantly reviewed as new information becomes available. Commodities Round-Up Energy: Overweight Total stocks of crude oil and products in the US drew another 7.6mm barrels in the week ended March 6, 2020, led by distillates, the EIA reported. Crude and product inventories finished the week at close to 1.3 billion barrels (ex SPR barrels). Total product demand – what the EIA called “Product Supplied” – was up close to 600k b/d, led by distillates (e.g., heating oil, diesel, jet and marine gasoil). Commercial crude oil inventories rose by 7.7mm barrels (Chart 6). Base Metals: Neutral After falling almost to the daily downside limit early on Monday, Singapore ferrous futures staged a recovery on Tuesday when iron ore jumped 33%, as declining inventories of the steelmaking material sparked supply concerns among investors. SteelHome Consultancy reported this week Chinese port-side iron ore stocks dropped to 126.25mm MT, down 3.4% for the year. In addition, China’s General Administration of Customs reported iron ore imports rose 1.5% in the January and February relative to the same period a year ago. The decreasing number of new COVID-19 cases in China should help iron ore and steel going forward as construction and infrastructure projects resume. Precious Metals: Neutral Gold prices are up 9% YTD, supported by accommodative monetary policy globally in the wake of the rapid spread of COVID-19 cases outside of China. Fixed income markets are pricing in 80bps cuts in the Fed funds rate over the next 12 months. Additionally, negative-yielding debt globally – which is highly correlated with gold prices – increased 26% since January 2020. Continued elevated uncertainty stemming from the spread of the coronavirus keeps demand for safe assets buoyant. We estimate the risk premium in gold prices related to this persistent uncertainty is ~$140/oz (Chart 7). Nonetheless, positioning and technical signal it is overbought and vulnerable to a short-term pullback. Ags/Softs:  Underweight In its World Agricultural Supply and Demand Estimates (WASDE), the USDA lowered its season-average price expectations for the current crop year for corn to $3.80/bu, down 5 cents, and for soybeans to $8.70/bu, a decrease of 5 cents. The USDA kept its expectation for wheat at $4.55/bu. The Department estimates global soybean production will increase 2.4mm MT, with most of this stemming from increases in Argentina and Brazil. CONAB, Brazil’s USDA equivalent, confirmed this projected increase, saying the country’s soybean output is poised to rise 8% to a record 124.2 Mn Tons this year. May soybean futures were up slightly, as were corn and wheat on Tuesday. Chart 6 Chart 7   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Matt Gertken Geopolitical Strategist mattg@bcaresearch.com Hugo Bélanger Associate Editor Commodity & Energy Strategy HugoB@bcaresearch.com   Footnotes 1     Please see Russia keeps door open for OPEC amid threats to raise output, published by worldoil.com; Russian ministry, oil firms to meet after OPEC talks collapse -sources, published by reuters.com March 10, 2020, and Russia says it can deal with pain of a Saudi oil price war published by ft.com March 9, 2020. 2     For non-OPEC 2.0 countries, we also included downward adjustments to Libya and US shale production vs. our previous balances 3    Please see “The Russian Enigma,” published by The Churchill Society. See also Kitchen, Martin (1987), “Winston Churchill and the Soviet Union during the Second World War,” The Historical Journal, Vol. 30, No. 2), pp. 415-436. 4    We also would observe Russian producers never fully abided by the output cuts voluntarily in every instance. Often, compliance was due to (1) seasonal maintenance; (2) extreme temperatures in the winter, and (3) the pipeline contamination incident. Thus, producers were probably close to full capacity most of the time OPEC 2.0's production cuts were in place. This implies that for a minor voluntary production cut, Russia enjoyed prices close to $70/bbl, vs. mid $30s currently. This begs the question why they would provoke a market-share war when they would have been better off continuing to flaut their quotas instead of collapsing prices. 5    Please see Mnuchin wants ‘orderly’ oil markets in talk with Russian ambassador published by worldoil.com March 9, 2020. 6    One could argue that while the Saudis reacted quickly and threatened a massive response, they may have been less fearful of a breakdown given the recognition that it could seriously damage Iran’s economy. 7     The Financial Times noted Russia’s confidence that its National Wealth Fund of ~ $150 billion, equivalent to ~ 9% of GDP, which officials believe allows it “to remain competitive at any predicted price range and keep its market share” – i.e., the state will draw down the fund to cover any difference between low oil prices and domestic oil company’s breakeven prices. Energy Minister Alexander Novak said Russia would “pay special attention to providing the domestic market with a stable supply of oil products and protecting the sector’s investment potential.” Please see Russia says it candDeal with the pain of a Saudi price war, published by ft.com March 9, 2020.  

Highlights Bear markets occur in phases, and their narrative can mutate. What began as a selloff caused by the coronavirus outbreak could well mutate into an oil crash-led selloff, and then mutate again into a selloff due to policy omnipotence, or something else. We are reiterating our short positions in the EM equity index and a basket of EM currencies versus the US dollar as well as our defensive positioning in EM domestic bonds and credit markets. We are taking profits on our long gold/short oil and copper trade. Oil prices may stabilize, but risks are still skewed to the downside. We are also booking gains on our long Russian domestic bonds/short oil position. Feature Chart I-1A Record Low Currency VOL Is Followed By Major Market Disturbances Global financial markets are witnessing the unwinding of the policy put. For the past several years, the consensus in the global investment community was that risk assets could not go down because of policy puts from the Federal Reserve, the US Treasury and President Trump, the European Central Bank and the Chinese authorities. Similarly, crude oil prices had been supported by OPEC 2.0’s put from December 2016 until recently. The latest panic and broad-based liquidation of risk assets has been due not only to fear and uncertainty related to the rapid escalation in COVID-19 cases around the world, but also to investor realization that these policy puts are ineffectual. The Fed’s 50-basis-point intra-meeting rate cut proved incapable of stabilizing global risk assets. Investors have begun to doubt the efficacy of policy puts and have thrown in the proverbial towel. Crucially, the high-speed and intensity of the selloff was due to widespread complacency and overbought conditions in risk assets. In our January 23 report, we quoted Bob Prince, co-CIO of Bridgewater, who stated in Davos that “…we have probably seen the end of the boom-bust cycle.” This comment was consistent with prevalent complacency in global financial markets, reflected in very tight credit spreads worldwide, high US equity multiples and record-low implied volatility in various asset classes. In the same January 23 report, we wrote: “Any time an influential person has made a similar declaration in the past, it marked a major turning point in financial markets. Remarkably, implied volatility for the US dollar has plummeted to a record low, as it has for EM currencies and a wide range of equity markets. Chart I-1 illustrates the implied volatility for EM currencies and the US dollar. Such low levels of implied currency market volatility historically preceded major moves in currency markets and often led to a material selloff in broad EM financial markets.” In that same report , we recommended going long implied EM currency volatility. Since then JP Morgan’s EM currency volatility has risen from 6% to 10%. What began as a selloff caused by the coronavirus outbreak could well mutate into an oil crash-led selloff, and then mutate again into a selloff due to policy omnipotence, or something else. Consistent with this thesis, we reinstated our short EM equity index recommendation in the following week’s report – on January 30. The MSCI EM stock index is down 11% since then. Our target is 800, which is 18% below current levels (Chart I-2, top panel). Chart I-2EM Stocks: A Breakdown In The Making Market Narratives Mutate Chart I-3VIX Surge In Early 2018 Was A Trigger Not Cause Of Selloff Narratives of all large market moves are always expounded in retrospect. Only after a selloff is well-advanced do investors and commentators come up with reasons for it and build a plausible narrative describing it. Critically, bear markets occur in phases, and their narrative can evolve. What began as a selloff caused by the coronavirus outbreak could well mutate into an oil crash-led selloff, and then mutate again into a selloff due to policy omnipotence, or something else. For example, the early 2018 selloff in global equities and industrial commodities was at the time attributed to the spike in US equity volatility (Chart I-3, top and middle panels). In retrospect, January 2018 marked a major top in the global business cycle (Chart I-3, bottom line). Hence, the true reason for the late-January 2018 top in global stocks and industrial commodities was a downturn in global manufacturing and trade and not the surge in the VIX. The key question investors are currently wrestling with is the following: How deep will this selloff be, and how long will it last? Our view is that the selloff in EM and global risk assets is not yet over. As such, we are reiterating our short positions in the EM equity index and a basket of EM currencies versus the US dollar, as well as our defensive positioning in EM domestic bonds and credit markets. Gauging The Downside There is no doubt that global growth will be affected by the spread of COVID-19 and the precautionary measures taken by the authorities, companies and households around the world to contain the outbreak.   Further, growth visibility is extremely low, and that uncertainty is raising the risk premiums that investors demand. The latter is weighing on risk assets in general and global share prices in particular.  Presently, precise forecasts for GDP growth and a potential trajectory of COVID-19 cases are not credible, and hence cannot be relied upon to formulate a sound investment strategy. If the current bloodbath in risk assets persists, a market bottom could be reached well before bad economic data are released or COVID-19 infection cases peak. Given the uncertainty related to both the global growth trajectory and the Covid-19 epidemic, the only way for investors to gauge a market bottom is to continuously examine valuations, technicals and market internals. With respect to valuations and technicals, we have the following observations: The EM equity index seems to breaking below its major support lines. If this breakdowns transpires, there is an air pocket until the index reaches its next technical support, which is 18% below its current level (please refer to the top panel of Chart I-2 on page 3). If the EM MSCI equity index drops to this support range, it would be trading at 11 times its trailing earnings (please refer to the bottom panel of Chart I-2 on page 3). At those levels, the EM equity index would be discounting a lot of bad news, making it immune to dismal economic data and general uncertainty. For the S&P 500, if the current defense line – which held been during 2011, 2015 and 2018 selloffs – is violated, the next long-term technical support is around 2400-2500 (Chart I-4). Inflows to EM fixed-income funds were enormous in 2019. Meanwhile, EM corporate and sovereign spreads have broken out (Chart I-5). Provided this selloff commenced from very overbought and expensive levels, the odds are that liquidation forces will not abate right now and that the selloff in EM fixed income has further to go. Chart I-4S&P 500: Where Technical Support Lies? Chart I-5EM Sovereign And Corporate Spreads Have Broken Out   In a nutshell, we suspect that EM local currency bonds and credit markets received a lot of inflows from European investors in recent years because yields were negative across European fixed-income markets. A weak euro was a boon for European investors investing in EM. That, however, is reversing. Since the recent sharp appreciation in the euro and the nosedive in EM currencies, EM financial market returns in euros have collapsed. This will likely prompt an exodus of European investors from EM financial markets. Chart I-6A Major Breakdown In This Cyclical Indicator Even though the EM equity index is not expensive or overbought, rising EM USD and local currency bond yields herald lower share prices, as we discussed at length in last week’s report. Our Risk-On/Safe-Haven currency ratio1  has plummeted below its major technical support and the next level is significantly lower. In other words, this indicator is also in an air pocket (Chart I-6). Given it is extremely well-correlated with EM share prices, the latter will not bottom until this indicator stabilizes. Technical configurations of high-beta and cyclical segments of the global equity universe are consistent with failed breakouts. Such a profile is typically not followed by a correction, but by a major drawdown. These include the European aggregate equity index, the Nikkei, global industrials and US high-beta stocks (Chart I-7). Chart I-7AFailed Breakouts Are Often Followed By Large Drawdowns Chart I-7BFailed Breakouts Are Often Followed By Large Drawdowns Chart I-8The Global Stocks-To-Bonds Ratio Is Back To 2011 Levels Finally, the global stock-to-bond ratio has decisively broken below the upward sloping channel that has been in place since 2009 (Chart I-8). Typically, when a market or ratio experiences such a major breakdown, the recovery does not occur quickly and is unlikely to be V-shaped. In short, the structural breakdown in the global stocks-to-bond ratio suggests that global share prices will likely stay under downward pressure for some time. Bottom Line: Odds are that risk assets remain in a liquidation phase and investors should avoid catching a falling knife. The odds are also high that EM share prices in US dollar terms have another 18% downside. We reckon at those levels – where the MSCI EM equity index is around 800 – it would be safe to start accumulating EM equities, even if the global growth outlook remains mired in uncertainty. For now, we recommend playing EM on the short side. What To Do With Oil Plays Despite periodic spikes in crude prices over the past few years, we have held our conviction that oil is in a structural bear market. We doubted the sustainability of the OPEC 2.0 arrangement, arguing that Russia would not cooperate with Saudi Arabia in the long term. Russia did cooperate much longer than we had expected, temporarily supporting oil prices. Ultimately, Russian President Vladimir Putin abandoned the cartel late last week, and the Saudis have hit back with massive price discounts amid large output increases. Consequently, oil prices have crashed and are presently oversold (Chart I-9). Given the uncertainty related to both the global growth trajectory and the Covid-19 epidemic, the only way for investors to gauge a market bottom is to continuously examine valuations, technicals and market internals. However, there will be no rapprochement between the Saudis and the Russians for some time. Given the drop in demand amid sharp increases in supply, crude oil prices may well slide further. Since July 11, 2019, we have been recommending a long gold/short oil and copper trade (Chart I-10). This position has generated a large 40% gain. Today, we are taking profits on this trade. Instead, we are replacing it with a new position: long gold/short copper. Chart I-9A Long-Term Profile Of Oil Prices Chart I-10Book Profits On Long Gold / Short Oil And Copper Trade   Among oil plays, we have been overweight Mexico and Russia within EM, both in fixed income and equity universes. That said, for absolute return investors, we have not been recommending unhedged long positions in either Mexico or Russia because of our expectation of a drop in oil prices and the ensuing broad-based EM selloff. Regarding Russia, for investors who were looking to gain exposure to local currency bonds, we have been recommending that they hedge this position by shorting oil since November 14, 2019. This recommendation has paid off well, and we are closing this position with a 26% gain. We will be looking to buy Russian local bonds unhedged in the weeks ahead. Chart I-11Relative Performance Of Russian And Mexican Domestic Bonds Is Facing Near-Term Headwinds In Mexico, we have also been reluctant to recommend naked exposure to local currency or US dollar bonds because of our bearish view on oil and the risk of large outflows from EM that would hurt the peso. Indeed, the oil crash and outflows from EM have led to a plunge in the Mexican currency. Instead, in Mexico we have been recommending betting on yield curve steepening. The proposition has been that short rates are anchored by a disinflationary backdrop and tight fiscal policy in Mexico while the long end of the curve could sell off in a scenario of capital outflows from EM. As with Russia, we are monitoring Mexican markets and are looking to recommend buying domestic bonds without hedging the currency risk in the weeks or months ahead. Bottom Line: We are taking profits on our long gold/short oil and copper trade. Oil prices may stabilize, but risks are still skewed to the downside. In the near term, the relative performance of Mexican and Russian stocks and local currency bonds versus their respective EM benchmarks could be undermined by capital outflows from EM in general and these countries in particular (Chart I-11). Nevertheless, both nations’ macro fundamentals remain benign, and their fixed-income and equity markets will outperform their EM peers in the medium term. Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com   Footnotes   1     Calculated as ratio of equal-weighted average of total return indices of cad, aud, nzd, brl, idr, mxn, rub, clp & zar relative to average of jpy & chf total returns (including carry); rebased to 100 at January 2000. Equities Recommendations Currencies, Credit And Fixed-Income Recommendations

Highlights Oil prices fell 30% when markets opened Monday morning, following a split between OPEC 2.0’s putative leaders – the Kingdom of Saudi Arabia (KSA) and Russia – over production cuts to balance global oil markets (Chart 1). If KSA and Russia are able to repair the break in what OPEC Secretary General Mohammad Barkindo once called their “Catholic Marriage” the sudden collapse in prices could serve a useful purpose in reminding producers, consumers and investors of the need for full-time management of production and inventories, and restore prices to the $60/bbl neighborhood in 2H20.1 If not, markets could be in for a drawn-out market-share war lasting the better part of this year, with damaging consequences for all involved, with Brent prices remaining closer to $30/bbl (Chart 2). Feature Much as we rely on modeling to guide our expectations, this is purely political at the moment. How Long Will The Oil Price Rout Last? That’s the question that repeatedly is being asked by clients following the breakdown in Vienna last week, and news over the weekend that KSA would engage a market-share war opened by Russian Energy Minister Alexander Novak prior to departing Vienna. Novak gave every impression of renewing a market-share war after Russia rejected the plan put forth by OPEC to remove an additional 1.5mm b/d of production from the market, to combat the demand destruction expected in the wake of COVID-19. The only answer we have to the question: No one knows with certainty. Chart 1Oil Sell-Off Accelerates, As Market-Share War Looms Chart 2A Market-Share War Will Keep Oil Prices Depressed Neither of the principal actors responsible for the 30% rout in oil prices on Monday morning when markets opened for trading – KSA and Russia – are providing guidance at present. Prices since recovered slightly and were down ~ 20% Monday afternoon. Much as we rely on modeling to guide our expectations, this is purely political at the moment. There are two large personalities involved – Saudi Crown Prince Mohammad bin Salman bin Abdulaziz Al Saud and Russian President Vladimir Putin – who have staked out opposing positions on the level of production cuts needed to balance markets in the short term, as the COVID-19 outbreak spreads beyond China leaving highly uncertain demand losses in its wake.2 If a meeting of OPEC 2.0’s leadership can be arranged before the end of March, a hope expressed by Iran's Oil Minister Bijan Namdar Zanganeh in a Bloomberg interview over the weekend,3 the stage could be set for a rapprochement between KSA and Russia allowing them to repair the rupture in the OPEC 2.0 leadership. Should that occur, the rally in prices could be dramatic – maybe not as dramatic as today's price collapse when markets awoke to the opening rounds of a full-on market-share war between OPEC and Russia. But, over the course of the next few weeks, prices for 2H20 Brent and WTI would begin recovering and moving back toward $60/bbl as markets price in lower inventories on the back of a return to production discipline by OPEC 2.0. If we do not see such a meeting next week, markets will be forced to price in a prolonged price-war that could extend into the end of this year, which will not be easy to arrest. If, as seems to be the case, the Russians' goal is to directly attack shale-oil production in the US with a market-share/price war, the effort most likely will fail. True, there will be an increase in bankruptcies among the shale producers and their services companies. This will set up another round of industry consolidation – i.e., more M&A in the US shales – with the large integrated multinational oil companies that now dominate these provinces adding to their holdings. It is worthwhile remembering that US bankruptcy law recycles assets; it does not retire them permanently. In addition, the acquirers of bankrupt firms’ assets get them at a sharp discount, which greatly helps their cost basis. So, shale assets will change hands, stronger balance sheets will take control of these assets, and a leaner, more efficient group of E+Ps will emerge from the wreckage. What’s Being Priced? It is in neither KSA’s nor Russia’s interest to engage in a prolonged market-share war that keeps Brent prices closer to $30/bbl than to $70/bbl. We estimate oil markets now have to price in the return of ~ 2.8mm b/d of OPEC 2.0 production at the end of this month – i.e., a 10% increase of GCC output, led by KSA’s production getting up to 11mm b/d by year-end; ~ 600k b/d of cuts we were assuming would be approved in last week’s Vienna meetings; and ~ 260k b/d from Russia (Chart 3). This could be understated, as KSA claims 12.5mm b/d of capacity (including its spare capacity). Unchecked supply growth would force inventories to build this year (Chart 4).  In fact, absent a return to production-management by OPEC 2.0, oil markets will extrapolate the higher production and low demand into an expectation for steadily rising inventories, that will – once it becomes apparent the supply of storage globally will be exhausted – force prices toward $20/bbl. Weaker-than-expected demand growth would accelerate this process. Chart 3Higher Production Will Overwhelm Demand In Market-Share War Chart 4Market-Share War Could Exhaust Storage Forcing Production Out of The Market It is in neither KSA’s nor Russia’s interest to engage in a prolonged market-share war that keeps Brent prices closer to $30/bbl than to $70/bbl. The apparent unwillingness of Putin and the Russian oligarchs running the country’s oil companies to make relatively small additional production cuts – vis-à-vis what KSA already has delivered – to support prices has not been well explained by Russian producers. The revenue benefits from small production cuts almost surely exceed the additional revenue that would accrue from a 200-300k b/d increase in  output and keeping prices in the $30-$40/bbl range, a level that is below Russian producers' cost of production onshore and offshore, according to the Moscow Times.  KSA's costs are ~ $17/bbl on the other hand.4 Russia’s economy was wobbly going into the Vienna meetings, which makes sorting this out even more complicated. One thing that can be said for certain is that over the past six months Vladimir Putin has entered into another consolidation phase in attempting to quell public unrest, improve the government’s image, and tighten up control over the country, while preparing for another extension of his time as Russia’s supreme leader. A Battle For Primacy? At one level, it would appear the Russians were pushing back against an apparent demand by OPEC (the old cartel led by KSA) to fall in line. Russia’s rejection of the OPEC proposal could be read as an assertion of their position to show they were, at the very least, KSA’s equal in the coalition. A stronger read of the rejection, given the Russian Energy Minister’s comments following the breakdown in Vienna at the end of last week – "... neither we nor any OPEC or non-OPEC country is required to make (oil) output cuts” – would be Russia was attempting to assert itself as the leader of OPEC 2.0. Giving Russia what amounted to a take-it-or-leave-it ultimatum on production cuts was a high-stakes gamble on KSA’s part. On KSA’s side, it is likely the Saudis grew irritated with the Russian failure to get on board to address a global oil-demand emergency that was spreading beyond China, when they were discussing extending and deepening production cuts in the lead-up to last week’s meetings. Giving Russia what amounted to a take-it-or-leave-it ultimatum on production cuts was a high-stakes gamble on KSA’s part, to say the least. However, as OPEC’s historic kingpin, KSA may have believed its role was to lead the coalition.  Russia’s in a better position now relative to KSA in the short term vis-à-vis foreign reserves ($446 billion), budget surplus (~ $8 billion), and its lower fiscal breakeven price for oil ($50/bbl) vs KSA’s ($84/bbl), as we discussed in our Friday alert (Chart 5). However, with Russian per-capita GDP at ~ half that of KSA’s, it is highly likely – if this market-share war is prolonged – its citizens are going to be hit with the consequences of the oil-price collapse in short order: FX markets are selling ruble heavily today, and, in short order this will feed through into higher consumer prices and inflation. Indeed, we estimate a 1 percentage-point (pp) depreciation in the ruble vs. the USD y/y leads to a 0.14pp increase in Russian inflation (Chart 6). Chart 5Foreign Exchange Reserves Chart 6Russian Ruble Sell-Off Presages Inflation The Saudi riyal is pegged to the USD, and does not move as much as the ruble. However, KSA’s citizens also will be buffeted once again by a collapse in oil prices, as they were during the 2014-16 market-share war when government revenues came under severe stress. Things To Watch The OPEC 2.0 joint market-monitoring committee could meet again next week in Vienna, but that is not a given. If they do meet, the agenda likely will be dominated by trying to find a face-saving way for both sides to resume production management. Arguably, the presumptive target of the Russian strategy – US shale producers – will be severely damaged by this week’s price collapse, and both could argue the short-term tactic of threatening a price war was a success. The Saudis could also go for a quick solution, if their primary objectives are to sort things out with Russia, stabilize the global economy, and keep President Trump in office, rather than to push down prices in an adventurous attempt to escalate Iran’s internal crisis. We believe Russia badly miscalculated, and was too early in making a play for dominance in OPEC 2.0, if that was its intent. If, on the other hand, these large personalities cannot agree, the price collapse begun today will continue until global oil storage – crude and products – is filled, forcing prices through cash costs of all but the most efficient producers in the world. This level is below $20/bbl. These lower prices could redound to the benefit of China, as fiscal and monetary stimulus provided by policymakers there in the wake of COVID-19 to get the economy back on track for 6% p.a. growth gets super-charged by low oil prices. Bottom Line: We believe Russia badly miscalculated, and was too early in making a play for dominance in OPEC 2.0, if that was its intent. Russian GDP has twice the sensitivity to Brent prices that KSA does, which means such a tactic takes a toll on it as well as the shale producers (Chart 7). Capital markets had the US shale producers on the ropes, so it is difficult to argue there was a need to accelerate the process and shock the world. We again note a full-blown market-share war will set up another round of industry consolidation in the US shales, but, over the medium to longer term, the shale assets of bankrupt companies will only be re-cycled to more efficient operators, as we saw following the last market-share war. This will contribute to a stronger shale sector in the US in the medium term. Chart 7Russian GDP More Sensitive to Brent Prices The only other consolation for Russia is a higher likelihood of regime change in the US (more political polarization in the US benefits Russia), and yet the Trump administration has been the most pro-Russian administration in years so this is not at all a clear objective. We will be watching very closely for a meeting of OPEC 2.0’s joint committee next week. If we get it and a face-saving resolution is agreed by KSA and Russia we would expect stronger demand growth in 2H20 to absorb whatever unintended inventory accumulation a still-born price war causes. If not, we will expect a price war into the end of the year, after which the economies of oil producers globally will have been sufficiently battered to naturally force production lower and investment in future production to contract sharply. At that point, oil and oil equities will be an attractive investments for the medium and long term.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com   Footnotes 1     Please see Russia and Saudi Arabia Hold 'Catholic Marriage' with Poem and Badges, Form Enormous Oil Cartel published by Newsweek July 3, 2019. 2     We will be updating our demand estimates in Thursday’s publication, after we get fresh historical data from the principal providers (EIA, IEA, OPEC). 3     Please see Iran's Oil Minister Wants OPEC+ Output Cut, Hopes for Russia Meeting Soon published by Bloomberg, March 8 2020. 4     Please see Russian Oil Production Among Most Expensive in World published November 12, 2019 by The Moscow Times.  

Highlights Crude oil prices fell ~ 10% Friday after Russia refused to support additional production cuts agreed by OPEC in Vienna (Chart 1). As we go to press, Brent is trading close to $45/bbl and WTI is trading ~ $41/bbl. OPEC producers could implement the go-to strategy they’ve employed in the wake of past demand shocks and cut production on their own, in order to balance the market. That said, there are indications the Saudis will not shoulder the market-balancing role alone. Russian producers have consistently demanded relief from production restraints since 2017, when OPEC 2.0 took over balancing the market. With shale-oil producers on the back foot owing to parsimonious capital markets, Russia could finally be able to deliver the coup de grâce it has been waiting for. This supply shock hits the market as COVID-19 threatens demand globally. Whatever Russia’s intent – be it removing the near-certainty of a production cut, which it always agreed to in the past, or crippling US shale production – two-way risk has returned to these Vienna meetings. Feature Oil markets once again are faced with a possible price collapse – not unlike the swan dive seen when OPEC’s market-share war took Brent from more than $110/bbl in mid-2014 to $26/bbl by early 2016. The proximate aim of that market-share war – led by the Kingdom of Saudi Arabia (KSA) – was to significantly reduce the revenue Iran would receive when it returned to export markets, following its agreement with the US to end its nuclear program in 2015. Tanking oil prices was the most expedient way of accomplishing this. Secondarily, shale-oil producers also may have been targeted, although such a goal was never clearly articulated by KSA’s leadership. Chart 1Russia's Supply Shock Craters Brent, WTI Prices OPEC’s market-share war did thin the US oil-shale herd, but it did not destroy the industry. If anything, it forced shale-oil producers to focus on their best drilling prospects with their best rigs and crews. This produced a leaner more productive technology-driven cohort of drillers, which posted record production levels on a regular basis. Indeed, by the end of 2019, US production topped 12.9mm b/d – 8.2mm b/d of which was accounted for by shale-oil output – making the US the largest oil and gas producer in the world. The market-share war also brought KSA and Russia together in November 2016 as the putative leaders of OPEC 2.0. The sole mission of this unlikely coalition was to clear the global inventory overhang left in the wake of the market-share war by managing OPEC and non-OPEC production. Russia’s Coup de Grâce Managing global production and inventories with KSA – while US shale-oil producers continued to raise their output to new records regularly – never sat well with Russia’s oil producers.   Managing global production and inventories with KSA – while US shale-oil producers continued to raise their output to new records regularly – never sat well with Russia’s oil producers. Ahead of OPEC 2.0 meetings in Vienna, Russian oligarchs could be counted on to demand higher output levels, and President Vladimir Putin could be counted on to deliver something close to agreed production cuts in time to assuage markets. This semi-annual ritual came to resemble a tightly choreographed set-piece, which may have inured market participants to the oligarchs’ resolve to ultimately increase production levels. Russia certainly was well-prepared when it delivered Friday’s supply shock. Time will tell, but Friday’s breakdown in Vienna could be the coup de grâce Russia’s oligarchs have been waiting to deliver to US shale producers since the formation of OPEC 2.0. Or it could be a well-timed reminder that nothing in oil markets is certain – particularly Russian compliance with production-restraint agreements. The once-certain 11th-hour agreement to adhere to whatever production-cutting agreements OPEC 2.0 came up with is now gone. And with it, the high-probability bet that, regardless of the tensions leading up to the Vienna meetings, a production-management agreement would be delivered, and shale-oil producers would live to fight another day. Chart 2Russia, KSA Foreign Exchange Reserves Whatever the case, Russia certainly was well-prepared when it delivered Friday’s supply shock. It has steadily built its foreign-exchange reserves since the price collapse begun in 2014, which now stand at $446 billion, up 45% from their nadir of 2015 (Chart 2). KSA’s foreign-exchange reserves, on the other hand, fell sharply in the wake of the 2014 – 2016 market-share war and have languished at lower levels since. Chart 3Russia, KSA Per-Capita Income Still, the Kingdom is not without stout resources. It’s gross national income per capita is ~ 2x that of Russia’s (Chart 3), and its days-forward import cover expressed in terms of days of foreign reserves is similarly stout (Chart 4). Chart 4Russia, KSA Import Cover The economies of both KSA and Russia are exquisitely linked to Brent oil prices (Chart 5). So tempting another market-share or price war is a strategy that could not be sustained by either country for an extended period of time. Chart 5Russia, KSA GDP vs Brent Prices Chart 6Russia, KSA GDP Highly Sensitive To Brent Prices The End Of OPEC 2.0? Post-GFC, we estimate Russia’s real GDP elasticity to changes in oil prices is close to twice that of Saudi Arabia. This suggests Russia’s strategy could have dismal consequences for its economy. Oil markets will gnaw on Friday’s breakdown in Vienna, sorting out the signals that were missed in Russian messaging, and figuring out what happens next. Neither Russia nor KSA have the resources to wage an indefinite war of attrition with US shale producers. Both are highly dependent on oil revenues to sustain their economies (Chart 6). Of the two, Russia’s economy is more sensitive to Brent oil prices than KSA’s, as it markets more of its output in trading markets. Post-GFC, we estimate Russia’s real GDP elasticity to changes in oil prices is close to twice that of Saudi Arabia. This suggests Russia’s strategy could have dismal consequences for its economy. Russia’s $50/bbl fiscal breakeven price vs. KSA’s $84/bbl price might give Russia more staying power in the short run, but with per-capita income at roughly half that of Saudi citizens, it will not want to revisit the dire days of 2014-16 when its economy last suffered through an oil-price collapse.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com  

Highlights OPEC 2.0 ministers continue to negotiate oil production cuts to replace those expiring this month. We expect cuts of 1mm b/d – perhaps more – extending to end-June, undertaken to offset COVID-19-induced demand destruction. Making the not-unreasonable assumptions of no change in US sanctions-related output losses – 1mm b/d in Venezuela and 2mm b/d in Iran – and that 1mm b/d of Libyan output stays offline, the 1mm b/d cut coming out of this week’s meeting in Vienna will push average 1H20 OPEC 2.0 outages – planned and unplanned – to ~ 5mm b/d. The US economy is growing ~ 2.7% p.a., suggesting the Fed’s surprise 50bp rate cut this week is aimed at reducing global economic policy uncertainty (GEPU), lowering its accompanying USD safe-haven demand, and guarding against a collapse in US money velocity (Chart of the Week). This will weaken the USD, thereby supporting EM incomes and oil demand. We continue to expect policymakers in China to overshoot on fiscal and monetary stimulus, as they scramble to deliver 6% pa growth this year. Feature In the wake of ongoing negotiations – right into today’s meeting in Vienna – we expect OPEC 2.0 to deliver a production cut of at least 1mm b/d for 2Q20. Maybe more. Gulf Cooperation Council (GCC) states have been lobbying for a large cut – 1mm b/d at least. The Kingdom of Saudi Arabia’s (KSA) consistently lobbied for such cuts, and was instrumental in achieving the 1.7mm b/d output reduction for this quarter when the coalition met at the end of last year in Vienna. KSA’s partner in OPEC 2.0, Russia, has been slow to support production cuts going into this week’s meeting, which is the stance it typically takes during these negotiations. Nonetheless, it did agree in December to cuts, and we expect they will do so again this week. After this go-round, we’re likely to see an agreement to meet in June to determine whether cuts should be extended and/or expanded.1 Chart of the WeekFed Rate Cut Meant To Reduce Uncertainty The 1mm b/d in planned outages for 2Q20 coming out of this week’s meetings would add to the ~ 4mm b/d of unplanned outages in Venezuela, Iran and Libya this year. If the producer coalition fails to agree to a significant output cut this week, we would expect a sell-off in crude oil that takes Brent prices below $50/bbl, and WTI into the mid-$40s (Chart 2). An agreement to remove at least 1mm b/d of output likely will push Brent into the mid-$50s and WTI into the low-$50s during in 2Q20. Assuming the COVID-19 outbreak subsides by then, we expect Brent to rally in 2H20, with prices trading above $60/bbl and WTI trading $4/bbl below that on average. We will be updating our supply-demand balances and forecasts when we get fresh historical data from the key agencies (EIA, OPEC and IEA). The 1mm b/d in planned outages for 2Q20 coming out of this week’s meetings would add to the ~ 4mm b/d of unplanned outages in Venezuela, Iran and Libya. If these persist to end-June, planned and unplanned OPEC 2.0 production outages would average more than 5mm b/d in 1H20 (Chart 3). Chart 2A Failure To Cut Production Would Push Benchmark Crudes Lower Chart 3Core OPEC 2.0 Will Agree Cuts On the demand side, the big global hit to growth from China in 1Q20 should be out of the system by the end of 1H20, assuming the COVID-19 outbreak does not shut down global commerce the way it did in China. We think the odds of such a shutdown are low, given such policies only can be implemented by a central government in which all power is consolidated in a ruling party. Besides, given the massive hit to China’s manufacturing – auto production was down 80% y/y in February, e.g. – such policies are unlikely to be recommended in all but the most dire of circumstances. We continue to expect Chinese policymakers to overshoot on their fiscal and monetary stimulus, as they scramble to get 2020 GDP growth back above a 6% p.a. rate. Our view aligns with BCA’s China Investment Strategy, which last week observed, “It is becoming evident that the Chinese leadership is willing to abandon its financial de-risking agenda in exchange for a rapid economic recovery.”2 Our colleagues go on to note, “Monetary conditions are already more accommodative than during the last easing cycle in 2015/2016. The recently announced policy initiatives on infrastructure, housing, and automobile sectors also resemble policy supports that led to a V-shaped economic recovery in 2016.” Fed Cuts Rates To Reduce Uncertainty The economic pressure arising from a strong USD is particularly acute for EM economies. Even before the COVID-19 outbreak in China at the end of last year, global economic policy uncertainty (GEPU) and the broad trade-weighted USD (USD TWIB) were hitting new highs. This was driven by trade wars, the emergence of left- and right-wing populists globally, uncertainty over the effectiveness of monetary policy, and a host of other issues that drove investors, firms and households to seek safe-haven assets like the dollar (Chart 4). In fact, these variables became highly correlated over the past 3-, 4- and 5-year intervals.3 The novel coronavirus outbreak in China, which literally shut down China’s economy in January and February, added to this uncertainty. It continues to lurk in the background now that the coronavirus has spread globally. This also contributes to safe-haven USD demand. While a rate cut cannot address the COVID-19 directly, it can loosen financial conditions – thus removing some uncertainty at the margin – and reduce USD strength. The economic pressure arising from a strong USD is particularly acute for EM economies, which are the dominant source of commodity demand growth globally (Chart 5). At the margin, this demand for dollars arising from increased global policy uncertainty suppresses oil demand growth in EM economies, by raising its cost in local-currency terms ex-US and ex-GCC producing states with currencies pegged to the dollar. It also incentivizes production at the margin, as local-currency costs are depressed, which reduces local costs, while revenues are realized in USD – the perfect arb. Chart 4Global Uncertainty Was High Before COVID-19 Hit Markets Chart 5EM Growth Suppressed By Strong USD Exploring The Dominant Currency Paradigm The USD’s dominance of global trade is receiving considerable attention in academia and at the Fed. The USD’s dominance of global trade is receiving considerable attention in academia and at the Fed. One theory we find useful is the “Dominant Currency Paradigm,” which holds the dollar is the dominant currency in the world and is used disproportionally vis-à-vis its GDP weight in the global economy (Chart 6). Its dominance is reflected in (1) invoicing of international trade, (2) bank funding, (3) corporate borrowing, (4) central-bank reserve holdings, and (5) the relatively low expected returns accruing to USD-denominated risk-free assets that violate uncovered interest-rate parity no-arbitrage conditions – i.e., the dollar’s so-called “exorbitant privilege.”4 Chart 6USD Is The Dominant EM Invoicing Currency Demand for USD rises when global economic policy uncertainty rises, which is why dollar liquidity is crucial: When demand for safe asset spikes, there is a need for aggressive liquidity (supply) of dollar to avoid a market collapse (Chart 7).5 By cutting US rates now, the Fed is effectively increasing USD supply and/or removing some of the demand for USD relative to other currencies. This will be especially important if global economic policy uncertainty remains strong. This somewhat buffers EM corporates and governments with high levels of USD-denominated debt against a rush to safe-haven USD holdings. We believe this will ease financial conditions in EM economies, which should, all else equal, provide more of a shock absorber for uncertainty generally. Chart 7Dollar Liquidity Mutes US Dollar Appreciation   Our modeling suggests higher global economic policy uncertainty (GEPU) can shock the USD TWIB, US 10-year Treasurys and EM trade volumes directly. In addition, USD-denominated debt is relatively pronounced in some EM economies (Chart 8). USD appreciation increases domestic banks’ liabilities vs. assets. This is negative for bank’s balance sheets and leads to a tightening in financial conditions, which limits growth. EM corporate bond issuers are exquisitely sensitive to USD movements as they affect their capacity to service foreign-currency debt. Chart 8A Strong US Dollar Hurts Vulnerable EM Economies It is important to remember the US economy continues to perform relatively strongly against other major economies, with 1Q20 US GDP growth estimated by the Atlanta Fed’s Nowcast at 2.7% p.a. The fact that the Fed surprised markets with a 50bp rate cut suggests to us it is concerned with EM growth slowing sharply if the coronavirus becomes a global threat. The Fed also is likely to be concerned that lower US consumer confidence will lead to a decrease in the velocity of money. This concern also is addressed by increasing money supply pre-emptively. Our modeling suggests higher global economic policy uncertainty (GEPU) can shock the USD TWIB, US 10-year Treasurys and EM trade volumes directly, and that these shocks can persist (Chart 9).6 The Fed's policy action today will, if our modeling is correct, reduce demand for USD as a safe haven, all else equal, reduce long-term US rates and boost EM trade volumes. Bottom Line: We expect OPEC 2.0 to deliver at least 1mm b/d of production cuts in 2Q20, which will be reviewed at the end of June to determine whether they should be extended or deepened. Global economic policy uncertainty remains high, supporting demand for the USD. We believe the Fed’s surprise rate cut this week was directed at alleviating some of the global uncertainty keeping the USD well bid, in an attempt to buffer EM economies affected by USD demand. It also is a safeguard against a collapse in the velocity of money in the US that could occur if uncertainty were to suddenly rise. Chart 9GEPU Shocks Are Transmitted To USD And US Treasurys   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Hugo Bélanger Associate Editor Commodity & Energy Strategy HugoB@bcaresearch.com   Commodities Round-Up Energy: Overweight The EIA’s weekly inventory report gives no evidence of a COVID-19-induced backup in crude and product inventories in the US. Total stocks of crude and products fell almost 12mm barrels last week on the back of strong product draws, led by gasoline and distillates, both of which were down close to 5mm barrels on the week. Commercial crude oil inventories were mostly unchanged at ~ 445mm barrels. Crude oil exports rose almost 500k b/d last week to 4.15mm b/d, accounting for most of the 9.73mm b/d of crude and product exports from the US. (Chart 10). Base Metals: Neutral Expectations China will deploy aggressive stimulus targeting infrastructure and manufacturing activities in response to the COVID-19 outbreak, along with Brazil reporting a 15% month-on-month decline in exports of iron ore helped iron ore and steel futures post significant gains earlier this week, with the Singapore Exchange's 62% Fe Iron Ore futures closing 5.6% higher on Monday. However, these gains were short-lived – and will remain capped in the short-term – as weak Chinese demand persists and steel rebar inventories remain at record highs. Precious Metals: Neutral Amid a broader market sell-off gold prices dipped 4.5% on Friday – the worst performance since 2013 – but have since recovered, on the back of the Fed’s surprise rate cut this week. The US central bank delivered an emergency 50bps rate cut on Tuesday, gold erased all the losses with spot prices rising 3.2% at the close, to reach $1645.27/oz. Silver followed a similar pattern rebounding 2.9% on Tuesday, closing at $17.22/oz. We are long both metals and believe more upside is yet to come if central banks around the world coordinate on additional monetary easing (Chart 11). Ags/Softs:  Underweight Expectations of a stronger stimulus in response to COVID-19 pushed soybeans higher for a third consecutive day on Tuesday, with prices hitting a 6-week high intraday. Bean prices then retreat and close 0.3% higher than the previous session. Gains were capped by favorable weather conditions in Brazil, leading analysts to expect a record harvest this season. Wheat also rebounded on the Fed’s rate-cut news after a sluggish week that saw prices falling almost 5%. Uncertainty still reigns though, as the Australian Bureau of Agriculture crop report predicts wheat output to recover 41% to 21.4 Mn Mt in 2020, due to rainfall ending a period of severe drought. The most active wheat futures were up 0.8% at Tuesday’s close. Chart 10US Crude Oil Exports Are Rising Chart 11Lower Real Rates Will Support Gold       Footnotes 1     We do not rule out the possibility KSA or the GCC core producers shoulder the lion’s share of the cuts they seek, in order to balance the market. 2     Please see China: Back To Its Old Economic Playbook? published by BCA Research’s China Investment Strategy February 26, 2020. It is available as cis.bcaresearch.com. 3    This heightened uncertainty – i.e., the increase in “unknown unknowns” markets are attempting to process – is a recurrent theme in our research. See, e.g., 2020 Key Views: Policy Uncertainty Continues To Drive Commodity Markets published December 19, 2019. It is available at ces.bcaresearch.com. 4    Please see Gopinath, Gita and Jeremy Stein. “Banking, Trade, and the Making of a Dominant Currency,” Working Paper currently under revision for the Quarterly Journal of Economics. 5    Gopinath (2016) finds that the dollar’s share as an invoicing currency for imported goods is approximately 4.7 times the share of U.S. goods in imports. Please see Gopinath, Gita. “The International Price System.” Jackson Hole Symposium Proceedings, published in January 2016. See also Obstfeld, Maurice (2019), “Global Dimensions of U.S. Monetary Policy,” presented at the Federal Reserve Board Conference on Monetary Policy Strategy, Tools, and Communication Practices (A Fed Listens Event) in Washington June 4, 2019. 6    Our results reflect the vector autoregression (VAR) model we use to study the interaction of GEPU shocks and the USD TWIB and US 10-year treasurys.   Investment Views and Themes Strategic Recommendations Tactical Trades TRADE RECOMMENDATION PERFORMANCE IN 2019 Q4 Commodity Prices and Plays Reference Table Trades Closed in 2020 Summary of Closed Trades

Highlights The COVID-19-induced demand shock in China – and a stronger USD – will reduce growth in global crude oil consumption to just over 1mm b/d this year, vs. earlier expectations of ~ 1.4mm b/d. Significant fiscal and monetary stimulus from China will be required to put economic growth back on track over the critical 2020-21 interval. An accommodative monetary-policy backdrop globally also will support demand. On the supply side, OPEC 2.0 likely will cut output by an additional 600k b/d in 2Q20, which will remove 2.3mm b/d off member states’ official quotas. For 2H20, we expect the coalition to revert to its 1.7mm b/d in cuts to keep markets balanced. US shale-oil output growth will continue to slow under market-imposed capital discipline. We are revising our baseline price forecasts in 2020 lower to $62/bbl and $58/bbl for Brent and WTI, respectively (Chart of the Week). This is down $5/bbl vs our previous forecast. Price risk is to the upside, however. 2021 Brent and WTI forecasts remain at $70/bbl and $66/bbl, respectively, as we do not expect long-lived demand destruction from the COVID-19 outbreak. A growing consensus around policy stimulus and production cuts makes us leery. Feature Chart of the WeekCOVID-19 Knocks Oil Forecasts Lower COVID-19 continues to hammer Chinese oil demand, forcing refiners there to drastically reduce output. This crude oil is ending up in inventories, but, so far at least, overall storage capacity in China is not being maxed out by the unintended accumulations of crude and product inventories. Data are difficult to come by, but there are a few observations that provide some insight into the state of the refining market in China as the COVID-19 episode unfolds. Platt’s reported independent refiners in Shandong Province, which has ~ 3.4mm b/d of refining capacity, cut runs to a four-year low of ~ 40% of capacity this month, down from a January rate of 63.5%. Shandong refiners represent 50%-60% of China’s independent refining capacity.1 We estimate EM demand – led by downward revisions in China – will fall by ~900k b/d in 1Q20 – when most of the damage to the economy likely will occur – and by an average 300k b/d for the year vs. our previous estimates. Ursa Space Systems’ radar satellite monitoring of inventories close to coastal refineries indicated Chinese oil storage at the beginning of the month was at 60% of capacity.2 This figure likely is higher, given refinery runs remain low, but it does not yet suggest storage capacity in China will be exhausted in the near future. In our modeling of the COVID-19 impact on oil demand, we estimate EM demand – led by downward revisions in China – will fall by ~900k b/d in 1Q20 – when most of the damage to the economy likely will occur – and by an average 300k b/d for the year vs. our previous estimates. This leads us to believe EM oil demand will increase by 1mm b/d this year, down from our earlier expectation of 1.26mm b/d pre-COVID-19. For DM economies, demand growth also will disappoint, revised down by 100k b/d on the back of a warmer-than-expected winter and stop-and-go growth in manufacturing induced by COVID-19. Policy Stimulus Will Revive Chinese Demand The COVID-19 outbreak will result in a significant hit to China’s GDP, which will require substantial stimulus to put growth back on a 6% p.a. track this year. This growth rate is required for the Chinese Communist Party (CCP) to deliver on its pledge to double GDP and per-capita income over 2010-20, a pledge that was memorialized in writing following the Party’s 2012 Congress. In addition, next year marks the 100th anniversary of the founding of the CCP, and, we believe, it is an all-but-foregone conclusion the Party’s leadership will not want a faltering economy on display as it celebrates this important milestone. Given these considerations, the possibility policymakers will over-stimulate the economy to get it back on track is a non-trivial upside risk.3 We do not think it is unreasonable to expect policymakers to lean into reviving growth this year and next with policy stimulus. Our baseline 2020 forecast envisions prices will falter somewhat versus our previous expectation – with Brent averaging $62/bbl this year, and WTI trading $4/bbl below that, vs. $67/bbl and $63/bbl previously. We are mindful of the impact Chinese policy stimulus can have on the global oil markets. The effects on GDP growth following demand shocks of past stimulus can be seen in the response of China’s GDP following the 2003 SARS outbreak; the 2008-09 GFC; the 2011-12 eurozone debt crisis; and even in China’s 2015-16 slowdown (Chart 2). For this reason, we do not think it is unreasonable to expect policymakers to lean into reviving growth this year and next with policy stimulus. And it is for this reason that we believe price risk tilts to the upside this year. Our updated Ensemble price forecast includes two additional demand-side simulations to assess its sensitivity to changes in EM oil demand: Chart 2Chinese Stimulus Will Support Oil Demand Higher EM demand scenario (20% weight): We model the impact of the coronavirus as short-lived, with only a temporary impact on China’s economy. Consumer demand and industrial production in China converge to pre-COVID-19 levels rapidly in 2H20. Chinese policymakers overstimulate in 2Q20, over fears the virus could have severe long-term consequences on the economy. This scenario assumes EM demand increases by 100k b/d vs. our base case in 2020 and 2021. Lower EM demand scenario (10% weight): We model the impact of the coronavirus as a severe and long-lasting event. This triggers a negative feedback loop for EM oil demand; collapsing demand forces production lower, which reduces employment and pushes demand further down. This reverberates to other EM economies and affects global supply chains. This scenario assumes EM demand decreases by 240k b/d in 2020 and returns to our base case in 2021, supported by China stimulus. Oil-Demand Reduction (Not Destruction) The outbreak also is contributing to greater global economic uncertainty, which continues to support the USD broad trade-weighted index (TWIB). The COVID-19 outbreak in China caused us to reduce our expectation for global oil demand growth by ~ 360k b/d, taking 2020 year-on-year growth to ~ 1.04mm b/d, versus our earlier expectation of 1.4mm b/d. The outbreak also is contributing to greater global economic uncertainty, which continues to support the USD broad trade-weighted index (TWIB). Dollar strength produces a headwind for EM GDP growth, which suppresses oil-demand growth. The combination of the COVID-19-induced demand reduction and the stronger USD TWIB likely will compel OPEC 2.0 to maintain its production discipline until the global policy uncertainty abates and the USD TWIB retreats. Such a reversal in trend would become a tailwind for commodity demand (Chart 3). Chart 3Global Economic Uncertainty Keeps A Bid Under USD TWIB Global supply growth will continue to be constrained by demands from investors to return capital to shareholders. We expect the hit to global demand to be offset by increased production cuts from OPEC 2.0, which will be agreed next month. OPEC 2.0 production also will be impacted by continued output losses in Iran and Venezuela, which have seen y/y production fall by ~ 1.8mm b/d in 2019. Global supply growth will continue to be constrained by demands from investors to return capital to shareholders – via stock buybacks – and for steady and increasing dividends to make their equity competitive with alternative sectors (e.g., tech). These capital-market pressures – in addition to growing pressure from Environmental, Social and Governance (ESG) investors – will continue to have a profound effect on capital availability for oil and gas E+P companies for decades to come. This is a theme we will return to often in future research. We summarize these supply-demand dynamics in Chart 4. For OPEC 2.0, the 1.7mm b/d reduction in output the coalition agreed for 1Q20 remains in place, as do losses from Iran and Venezuela. For 2Q20, we assume the coalition adds another 600k b/d of production cuts. After that, we assume OPEC 2.0 reverts to its earlier production cuts of 1.7mm b/d for 2H20. In 2021, we assume OPEC 2.0 takes production cuts back down to 1.2mm b/d in January 2021, then gradually increases its production over 1H21 to balance the market and to avoid spiking prices. We also expect the Kingdom of Saudi Arabia (KSA) to remove 300k b/d of overcompliance next year, as markets tighten. In 2H21, we see OPEC 2.0 production levels remaining flat at ~ 44.8mm b/d (Table 1). Table 1BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) Chart 4Supply-Demand Balances Chart 5Global Oil Inventories Will Resume Drawing For 2021, we are leaving our Brent forecast unchanged at $70/bbl, and WTI at $66/bbl. For the US, we reduced our Lower 48 production assumptions, and now have 740k b/d growth in 2020 and 300k b/d in 2021. Shales account for almost all of this increase. We also include a scenario in which US production comes in lower in our ensemble forecast. These fundamentals combine to put global oil inventories back on a downward trajectory in 2H20 (Chart 5). That said, there is an important caveat going into 2H20: If the US Economic Policy Uncertainty Index starts rising in 2H20 on the back of US election risks, markets will continue to price in a stronger USD in 2020 vs. what we now expect. For 2021, we are leaving our Brent forecast unchanged at $70/bbl, and WTI at $66/bbl. Odds favor a return to the pre-COVID-19 price trajectory for oil next year, with continued upside risk from Chinese fiscal and monetary stimulus, and a globally accommodative monetary-policy backdrop. Higher Spare Capacity Reduces Risk Premium The market remains partly balanced by OPEC 2.0’s production cuts. This means that the group’s spare capacity is increasing, reducing the risk premium the market typically includes in crude oil prices to reflect sudden output losses. The risk premium in oil prices evaporated following the drop in demand and the increase in spare capacity due to the large OPEC 2.0 cuts. When China’s economy resumes its normal activity, demand will pick up and the market will balance, increasing the impact of possible supply disruptions. However, the market remains partly balanced by OPEC 2.0’s production cuts. This means that the group’s spare capacity is increasing, reducing the risk premium the market typically includes in crude oil prices to reflect sudden output losses. In addition, if production capacity of ~ 300k-500k b/d in the Neutral Zone shared by KSA and Kuwait is restored, the risk premium could drop even lower, given this production is expected to be retained as spare capacity. If this is the case we could have lower prices in 2020 vs. our current forecast (down to ~ $60/bbl). We will be exploring the changes in OPEC 2.0 spare capacity and the consequences for overall production in future research. Bottom Line: Assisted by Chinese policy stimulus, oil demand will recover this year from the COVID-19-induced demand shock. On the supply side, the combination of deeper OPEC 2.0 production cuts – which we expect will be settled at the upcoming March meeting – and capital-market-imposed reduction in US oil production will push oil markets to a supply deficit. The ongoing demand shock forces us to reduce our 2020 Brent price forecast to $62/bbl from $67/bbl previously. For 2021, we maintain our $70/bbl target. Risks to our view are mounting. Three crucial pieces to our 2020 and 2021 expectations remain uncertain: The duration and magnitude of the impact of the coronavirus shock, The level of production cuts by OPEC 2.0 and the degree of compliance by all members, and The trajectory of the US dollar – if global economic policy uncertainty remains elevated the USD could remain well bid, which would continue to pressure EM GDP growth – and commodity demand – at the margin. Our base case remains that prices will rise from here, but our conviction level is slightly lower. One reason for this is the apparent consensus emerging around the likelihood of Chinese stimulus and OPEC 2.0 production cuts. If either of these assumptions prove wrong, oil prices likely would move lower.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Hugo Bélanger Associate Editor Commodity & Energy Strategy HugoB@bcaresearch.com     Commodities Round-Up Energy: Overweight As of Tuesday’s close, Brent prices were up 8% from their Feb 10 low of $53.27/bbl, supported by receding COVID-19 fears and rising expectations OPEC 2.0 will deepen its production cuts at its March meeting. Earlier this week, oil prices received an additional lift from the newly-imposed US sanctions on Rosneft Trading SA – a subsidiary of Russia’s state-own company – for its activities with Venezuela’s PDVSA. Rosneft Trading intensified its involvement in Venezuela’s oil sector and now handles the majority of the country’s crude exports, providing vital support to the Maduro government. The US restrictions include a 90-day wind-down period for companies to end their activities with Rosneft Trading. Base Metals: Neutral Chinese steel consumption – which accounts for ~50% of global demand – has been hit hard by the coronavirus outbreak. Steel and iron ore prices in China plunged 11% and 3% YTD (Chart 6). Steel mills’ inventories increased to record levels, reaching full capacity. Mills are now forced to export their surplus at reduced prices – flooding seaborne steel markets – or to cut output. Accordingly, more than 33% of steel mills are considering cutting steel production, according to a recent Platts survey. Margins at producing mills are declining and could harm high-grade iron ore prices. This is a short-term risk to our view. Precious Metals: Neutral Gold prices surged past $1,600/oz on Tuesday – overlooking positive manufacturing data in the US. Silver shadowed gold’s movement, closing at $18.13/oz. Precious metals are bought as insurance against risks of a wider-than-expected spread of the coronavirus and should remain well bid until uncertainty dissipates. Gold is somewhat overbought based on sentiment, momentum and technical indicators (Chart 7). If, as we expect, the daily increase in confirmed cases ex-Hubei slows meaningfully over the coming months, gold and silver prices will lose some steam. Ags/Softs:  Underweight CBOT March wheat futures surged 4.4% on Tuesday after Australia’s government sharply lowered its estimate of the country’s wheat harvest as severe drought affected crops. The Australian agricultural agency said the crop totaled 15.17 mm MT, the lowest since 2008, paving the way for stronger US exports. Corn also moved higher, with the prompt contract gaining 1.26% on the back of a new round of Chinese tariff exemptions on US goods. A USDA report showed US soybean export inspections bound for China were still half of last year's volumes. Soybeans futures closed 1.25 cents lower at $8.915/bu as markets await large Chinese purchases of US soybeans. Chart 6Increasing Inventories Pressure Steel and Iron ore Prices Chart 7Gold Technical Indicators Signal Overbought Market     footnotes 1     Please see China's Shandong independent refiners cut run rates to 4-year low of 40% in Feb, published by S&P Global Platts February 13, 2020. 2     Please see Oil demand falls on coronavirus: how much will inventories rise? posted by Ursa Space Systems February 7, 2020. 3     Please see Iron Ore, Steel Poised For Rally, published January 13, 2020, for a discussion of the significance of 2020 vis-à-vis the Communist Party’s pledge to double GDP and per-capita income vs. 2010 levels, memorialized by the CCP at its 2012 Peoples Congress.  We also discuss the 100th anniversary of the Party’s founding next year, which also will be a significant milestone for the CCP – and another reason the Party will not want the Chinese economy faltering as it is celebrated.   Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades TRADE RECOMMENDATION PERFORMANCE IN 2019 Q4 Commodity Prices and Plays Reference Table Trades Closed in 2020 Summary of Closed Trades