Commodity & Strategy Report October 28, Shape

2021 Your ConvictionTM 01

Energy Strategy COP26 Meets During Policy-Induced Crisis

Commodity & Energy

Strategy

Strategy Report October 28, 2021

In this Issue
COP26 Meets During Policy-Induced Crisis
02 Feature

02 China's Impressive
Renewables Push

03 UK, EU
• The 26th Conference of the Parties
(COP26) will open this weekend in CHART OF THE WEEK
Market-Distortions
Glasgow, Scotland, amid a global crisis Policy-Induced Energy Crisis
05 Unfocused Policy Will Raise CO2 Emissions
Hinders induced in no small measure by poli- 20000
MM
ANNUAL CO2 EMISSIONS FROM:
Energy Transition cies and regulations that led to ener- MT
NORTH AMERICA
06 Investment gy-market failures. SOUTH & CENTRAL AMERICA
EUROPE
Implications CIS
• Price-distorting regulations and MIDDLE EAST
07 Commodities AFRICA
ad hoc fixes – e.g., retail price 15000
CHINA
Round-Up
caps, "windfall profits" taxes – will INDIA
08 Investment Views & ASIA PACIFIC
compound the current crisis.
Recommendations
• Mad rushes to cover energy and
10000
space-heating demand in spot coal
and gas markets when renewable-en-
ergy output falters will be repeated,
given utility-scale battery storage will
continue to be insufficient to replace 5000
Editorial Board hydrocarbons in the transition to a
low-carbon economy.
Robert P. Ryan
Chief Commodity &
• On the back of higher coal, gas and oil
Energy Strategist 2021
demand, CO2 emissions will return 0
Roukaya Ibrahim 2000 2004 2008 2012 2016 2020
Editor/Strategist
to trend growth or higher this year
(Chart of the Week). SOURCE: BP STATISTICAL REVIEW OF WORLD ENERGY (2021).
Ashwin Shyam
Research Associate
• Base metals capex will have to • We remain strategically long the COMT
Paula Struk
increase at the mining and refining ETF and the S&P GSCI index, as these
Research Associate
levels to meet renewables and EV fundamental imbalances are addressed.
Matt Gertken
Vice President
demand. This includes the need to We also are initiating a resting buy order
diversify metals' production and refin- on the XME ETF if this basic materials
Robert Robis
Senior Vice President ing concentration risks more broadly.1 ETF trades down to $40/share.
1
Please see our report entitled La Niña And The Energy
Transition, published on September 30, 2021, for discus-
sion.

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Commodity & Strategy Report October 28, 2021 02
Energy Strategy COP26 Meets During Policy-Induced Crisis

Feature caps actually did result in bankruptcies of

smaller electricity providers. In the EU, price
Going into the COP26 meetings starting this caps and "windfall profits" taxes are being
weekend, delegates no doubt will be preoc- imposed on retail energy providers in differ-
cupied with the global energy crisis engulfing ent states in the wake of the energy crisis.2
markets as the Northern Hemisphere winter
approaches. In no small measure, the crisis
is a product of poor policy design and regu- China's Impressive
latory measures meant to accelerate the tran-
Renewables Push
sition to low-carbon economies globally.
China has been making significant progress
This is most apparent in China, the UK
in introducing renewable energy to their
and the EU. China and the UK use retail
energy supply mix, particularly wind and
price-caps to control the cost of energy to
solar (Chart 2), accounting for 81.5% of
households. In China, the price caps recently
Asia-Pacific's wind generation last year, and
brought state-owned electricity providers
55.5% of the region's solar generation.
to the brink of bankruptcy, because suppli-
ers were not able to pass through higher
2
Please see Spain to Cap Windfall Energy Profits as Rally
wholesale prices for coal and natural gas Hits Inflation published by bloomberglaw.com on Septem-
to retail consumers. In the UK, retail price ber 14, 2021.

CHART 2
Wind, Solar Output Grows
700
TWh
WIND GENERATION:
600

500 FOR BOTH PANELS:

NORTH AMERICA
400 SOUTH & CENTRAL AMERICA
EUROPE
CIS
300
MIDDLE EAST
AFRICA
200 ASIA PACIFIC

100

0
500
TWh
SOLAR GENERATION:

400

300 NORTH AMERICA

SOUTH AND CENTRAL AMERICA
EUROPE
CIS
200
MIDDLE EAST
AFRICA
ASIA
100

2021
0
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
SOURCE: BP STATISTICAL REVIEW OF WORLD ENERGY (2021).

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Commodity & Strategy Report October 28, 2021 03
Energy Strategy COP26 Meets During Policy-Induced Crisis

China generates just 11% of its energy from owned Global Times news service reported
renewables. This has been insufficient to more than 150 coal mines have been
meet demand over the past year, owing to approved to re-open.5 The regional govern-
a combination of reduced coal supplies; ments can prioritize their energy intensity
colder-than-normal temperatures last targets over energy consumption. Coal-fired
winter, and hotter-than-normal temps power prices, which are largely state-con-
during the summer brought on by a La Niña trolled, will be allowed to fluctuate by up to
event. While energy demand was expanding 20% from baseline levels. However, raising
over the course of the year due to strong household tariffs is seen as a difficult task
economic growth in 1H21 and weather-re- politically, given that China's per-capita
lated demand over the course of the year income remains low.6
(for heating and cooling), provincial officials
were vigorously enforcing the state-man-
dated "dual-control policy," which in some UK, EU Market-Distortions
instances led to overly aggressive shut-
The UK electricity production and supply
downs of coal mines that left local markets
market consists of three segments –
short of the fuel needed to supply ~ 63% of
producing, distributing, and selling electric-
the country's electricity.3
ity. Entities can operate in any or all of these
Chinese authorities have said that they areas. As in many things, the UK punches
would “go all out” to boost coal production way above its weight in renewables,
in a bid to tackle widespread power cuts. accounting for 15% of wind generation and
Some 20 provinces in China have experi- 7.5% of solar produced in Europe, as seen
enced electricity rationing and blackouts in Chart 2. Wind can supply ~ 25% of UK
over the past month due to power-pro- power, depending on weather conditions.
duction shortfalls driven by a lack of coal. For all renewables, the UK accounts for 14%
The power rationing was imposed due to of Europe's total generation capacity.
a shortage of coal supply, which led to the
Twice a year, the national energy regulator,
surge in coal prices. The high coal prices, in
The Office of Gas and Electricity Markets
turn, forced coal-power companies to cut
(Ofgem) sets a cap on the price at which
back their production to avoid losses that
electricity sellers or retailers can supply
threatened to bankrupt them.4
power to the final consumer. While the
To be able to ensure coal and electric- maximum price retailers can sell electric-
ity supplies this winter, state authorities ity to consumers is capped, the price they
released new rules to enforce a policy can buy it from the electricity producer is
scheme that includes increasing coal not. This price depends on market factors,
production capacity and revising the elec- including fuel costs.
tricity pricing mechanism. China's state-

3 5
Please see carbonbrief.org's China Briefing for 23 and 30 Please see Chinese officials move to increase coal output
September and 14 October 2021 for additional discussion, amid shortage published by globaltimes.cn 13 October
and fn 1 above. 2021.
4 6
Please see ‘All out’ to beat power shortages; 2050 ‘net-zero’ Data from the World Bank showed China's GDP per capita
for airlines; ‘Critical decade” for global warming, published reached $10,500 in 2020, below the global average of
by China Brief on 7 October, 2021. $10,926. Some experts expect any reform to be gradual.

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Commodity & Strategy Report October 28, 2021 04
Energy Strategy COP26 Meets During Policy-Induced Crisis

When wind power dropped sharply this past

CHART 3
summer, electric suppliers were forced to
Global Competition Pushes Natgas Higher
scramble for natgas as a generation fuel, 35
USD/
and, at the margin, coal. In the UK, natural MMBtu
gas powers more than 35% of the electric- NATURAL GAS PRICES:
30 HENRY HUB
ity mix, and accounts for 15% of Europe's TTF
natgas-fired generation. Coal generation in JKM

the UK accounts for 1% of Europe's coal 25

fueled electricity generation.

China's push to secure additional coal and 20

natgas places it in direct competition for

limited supplies with European buyers. High
15
demand, stiff competition, reduced supply,
and low inventories all contribute to higher
gas prices globally (Chart 3). 10

Easing pandemic related restrictions glob-

ally has released pent-up energy demand, 5

which is expected to move higher over

2021
the next few months, as the Northern 0
Hemisphere possibly sees another cold- 2017 2018 2019 2020 2021

er-than-normal winter, and economic NOTE: DOTTED LINES DENOTE FORWARD CURVE PRICES.
SOURCE: BLOOMBERG FINANCE L.P., CME GROUP, ICE.
growth boosts manufacturing demand.

Capping selling prices during periods of

more established ones – may not be keen
very high fuel costs squeezes retailers’ profit
to borrow from the government to take on
margins. In the last six weeks, seven UK
additional consumers.
retailers have gone under, affecting ~ 1.5
million consumers. Such a system favors the The EU also finds itself facing stiff compe-
incumbents: retailers that can produce their tition from Asia for natgas imports. Accord-
own electricity and hedge their exposure to ing to Qatar’s energy minister, suppliers
price volatility have access to lower costs of prefer Asian buyers since they purchase
capital and higher economies of scale. natgas on fixed long-term contracts to
ensure energy security, unlike European
When retailers are no longer able to oper-
buyers which purchase much of their fuel
ate due to bankruptcy, their customers are
on the spot market.8
distributed to the remaining suppliers. The
British government would prefer to offer
financial support to persuade larger compa- 7
Please see Kwarteng insists UK will avoid power shortages
as gas crisis worsens, published by the Financial Times on
nies to take on stranded consumers than September 20, 2021.
save retailers who are being forced to go 8
Please see Qatar calls for embrace of gas producers for en-
out of business.7 However, as wholesale gas ergy transition, published by the Financial Times on October
24, 2021.
prices rise, industry operators – even the

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Commodity & Strategy Report October 28, 2021 05
Energy Strategy COP26 Meets During Policy-Induced Crisis

The EU's natgas imports are projected to

CHART 4
remain uncertain as Russian exports have
UK Gas Inventories Lowest In Europe
fallen below pre-pandemic levels and supply B
700
Bcf
via the NordStream2 pipeline is delayed. GAS IN STORAGE
With one of the lowest working inventories
600
within the EU (Chart 4), the UK, which
imports ~ 65% of its natural gas, is unable
to protect itself from supply volatility. These 500

high prices coincided with low wind speeds

earlier this year, curtailing wind power, 400
which as of 2020, is the UK’s second high-
est electricity source.
300

Unfocused Policy 200

Hinders Energy Transition

NETHERLANDS
It is impossible to gainsay the merit of the

GERMANY
100

POLAND
FRANCE
decarbonization of the global economy.

SPAIN
ITALY

UK
Disrupting weather patterns, spewing
0
particulates and chemicals into the atmo- NOTE: DATA AS OF OCTOBER 25, 2021.
2021

sphere, dumping plastics into the oceans SOURCE: GAS INFRASTRUCTURE EUROPE AGSI.

and waterways, and ravaging forests world-

wide do not contribute to any species be required over the coming decades to
fitness for survival. develop and deploy renewables, most
recently in La Niña And The Energy Tran-
However, policymakers appear to be
sition last month. Base metals – like oil
completely ignoring existing constraints
and gas markets – are extremely tight, and
any serious decarbonization effort would
are operating in years-long physical deficit
require. Encouraging the winddown
conditions, as can be seen in the bellwether
of fossil fuels decades before sufficient
copper and Brent markets (Charts 5 and 6).
renewable-energy and carbon-capture
technologies are developed and deployed Any policy contemplating a global build-
to replace the lost energy indirectly forces out of renewable-energy generation and its
a harsh calculation: Do sovereign govern- supporting grids, along with EVs and their
ments want to restrict income growth and supporting infrastructure, should start
quality-of-life improvements to the energy with the recognition laws, regulations and
available from renewables (including EVs) rules need to encourage responsible, safe
at any point in time? Who actually makes and sound incentives for developing the
that choice and enforces the rules and regu- supply side of base metals markets.
lations that go with it?
An argument also could be made for
We have written about the enormous fossil-fuels, which arguably should
increase in base metals supply that will receive technology subsidies and favor-

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Commodity & Strategy Report October 28, 2021 06
Energy Strategy COP26 Meets During Policy-Induced Crisis

CHART 5 CHART 6
Base Metals Markets Are Tight … As Is Oil...
Th. Mn. MMb/d MMb/d
MT MT 12 CURRENT ENSEMBLE ESTIMATES*
BALANCE (LS)
25 102
800 PRODUCTION (RS)
CONSUMPTION (RS) 8
400 20 98
4
0 94
15
0
-400 90
10
-4 FOR BOTH PANELS:
-800 BCA CRUDE OIL BALANCE (LS) 86
5
BCA WORLD SUPPLY (RS)
-1200 BCA WORLD DEMAND (RS) 82

Th. FOR BOTH PANELS: Th. MMb/d MMb/d

MT REFINED COPPER MT 12 SEP/21 ENSEMBLE ESTIMATES*
1600 1600 102

1400 INVENTORY 1400 8 98

1200 1200
94
4
1000 1000
90
800 800 0
86
600 600
2021 2021
-4 82

2000 2004 2008 2012 2016 2020 2014 2015 2016 2017 2018 2019 2020 2021 2022
NOTE: SHADED AREA DENTOTES ESTIMATION AND FORECAST. * REFLECTS THE PROBABILITY WEIGHTING SCHEME OF OUR FORECAST.
SOURCE: AUSTRALIAN GOVERNMENT DEPARTMENT OF NOTE: SHADED AREA DENOTES FORECASTS.
INDUSTRY, SCIENCE, ENERGY AND RESOURCES, BLOOMBERG SOURCE: US EIA, OPEC, BCA RESEARCH.
FINANCE L.P.

able tax treatment – not unlike those commodity-index exposure – the S&P GSCI
granted to renewables and EVs – to invest index and the COMT ETF – and long the
in carbon-capture tech development. PICK ETF. At tonight's close we are open-
Rules and regulations favoring long-term ing a resting order to buy the XME ETF if if
contracts so that producers are able to trades to or below $40/share.
address stranded-asset concerns and secure
funding for these projects also should be
developed. Robert P. Ryan
Chief Commodity & Energy Strategist
[email protected]
Investment Implications
Ashwin Shyam
Absent a more thought-out and focused Research Associate
effort to write laws, develop rules and Commodity & Energy Strategy
regulations on at least the level of trading [email protected]
blocs, the evolution to a low-carbon energy
future will be halting and volatile. This in Paula Struk
an of itself is detrimental to funding such Research Associate
an enormous undertaking. Until some- Commodity & Energy Strategy
thing like it comes along, we remain long [email protected]

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Commodity & Strategy Report October 28, 2021 07
Energy Strategy COP26 Meets During Policy-Induced Crisis

Commodities Round-Up
Energy: Crude oil markets unexpectedly moved lower mid-week on the back of yet another drop
Bullish in Cushing, OK, inventory levels reported by the US EIA. Cushing crude-oil stocks stood
at 27.3mm barrels vs. 31.2mm barrels for the week ended 22 October 2021. Two years ago,
Cushing inventories were at 46mm barrels. Markets had been rallying on falling Cushing
storage levels over the past couple of weeks. The EIA's estimate of refined-product demand
– known as "Product Supplied" – remains below comparable 2019 levels at this time of year,
although not by much (19.8mm b/d vs. 21.6mm b/d). We expect global oil and liquids demand
to rebound above 100mm b/d in the current quarter. Stronger demand in 2022 and 2023
prompted us to raise our Brent forecasts to $80/bbl and $81/bbl, respectively (Chart 7).

Base Copper continues to trade lower as markets price in a higher likelihood of softer demand for the
Metals: bellwether metal as the global power-supply crunch weighs on manufacturing activity, particu-
Bullish larly in China. Copper inventories are still at precariously low levels, with the red metal in global
inventories hitting lows not seen since 2008 (Chart 8). This will keep copper's forward curve
backwardated over time, as inventories are drawn to fill the gap between supply and demand
globally. Low inventory levels are expected to persist as power rationing in China, which was
responsible for more than 41% of global refined copper output in 2020, persists.

Precious Federal Reserve Chairman Jerome Powell's remarks stating supply disruptions are expected
Metals: to keep US inflation elevated next year are supportive to base metals. Higher inflation will
Bullish increase demand for the yellow metal, as investors look for a hedge against USD debasement.
However, the Fed's asset-purchase taper, which we expect to be announced in November, and
the interest rate hikes we expect as a result of it beginning in end-2022, will push bond yields
higher and raise the opportunity cost of holding non-yielding gold. That said, we believe the
Fed will remain behind the inflation curve and will work to keep real rates weak, which will
tend to support gold prices.

CHART 7 CHART 8
USD/ USD/ MM Ann%
bbl BRENT PRICES: bbl MT Chg
ACTUAL GLOBAL COPPER INVENTORIES*:
120 BCA ESTIMATES 120 1.75 LEVEL (LS) 75
FORWARD CURVE GROWTH RATE (RS)
110 110
100 100 1.50 50
90 90
80 80 1.25 25
70 70
60 60 1.00 0
50 50
40 40 .75
-25
30 2021 30

2010 2012 2014 2016 2018 2020 2022 2024 2010 2012 2014 2016 2018 2020
NOTE: SHADED AREA DENOTES BCA RESEARCH FORECASTS. *SUM OF LME, COMEX, SHFE AND BONDED WAREHOUSE STOCKS.

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Commodity & Strategy Report October 28, 2021 08
Energy Strategy COP26 Meets During Policy-Induced Crisis

Investment Views And Themes

ENERGY BASE METALS PRECIOUS METALS AGS & SOFTS

BULLISH BULLISH BULLISH NEUTRAL

THEME #1: Saudi-Russia Production Pact Likely Endures

Market Will Test Commitment To Pact

THEME #2: Favor Base Metals

Energy Transition Is Bullish BM

THEME #3: Balance Of Risks Favors Gold

Inflation Risks Are Rising

THEME #4: Elevated FX Risk

Commodities Will React To FX Shifts

THEME #5: Global Inflation Will Lift

Fiscal And Monetary Stimulus Will Lift Inflation

NOTE: ALL WEIGHTINGS BY SECTOR REFLECT RELATIVE POSITIONS VS. THE BLOOMBERG COMMODITY INDEX. PLEASE SEE BLOOMBERG COMMODITY INDEX 2020 TARGET WEIGHTS ANNOUNCED,
PUBLISHED BY BLOOMBERG.COM OCTOBER 30, 2019. WE WILL UPDATE THE INDEX’S WEIGHTING SCHEME AS CHANGES ARE ANNOUNCED.

Recommendations

SHOPPING LIST NEW, PENDING AND CLOSED TRADES

• At tonight's close we are opening a resting order to buy the XME

ETF if trades to or below $40/share

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Commodity & Strategy Report October 28, 2021 09
Energy Strategy COP26 Meets During Policy-Induced Crisis

Strategic Recommendations
INCEPTION INITIATION
RETURN STOP COMMENTS
LEVEL DATE
ENERGY
Long S&P GSCI Dynamic
$31.40 Mar 12/21 21.1% +15%
Roll Index ETF (COMT)*
Long S&P GSCI Index 2405.7 Dec 7/17 22.3% +15% Total Returns
PRECIOUS METALS

Long Spot Gold $1860/oz Sep 23/20 -3.6% -10% CME Group

BASE METALS
Long MSCI Global Metals
& Mining Producers ETF $42.07 SEP 23/21 3.9% -10%
(PICK)
AGS & SOFTS

OTHER

Long FIW ETF $91.91 Sep 2/21 -2.4% -10%

Long DFA Dimensional

Emerging Core Equity $28.11 Sep 16/21 -0.2% -10%
Market ETF (DFAE)
Long US Tips 265.5 Oct 1/20 4.7% +3.0% Total Returns

*COMT WAS ORIGINALLY RECOMMENDED

NOTE: THE RECOMMENDATIONS ARE INITIATED BASED ON THE CLOSING PRICE ON THE THURSDAY WE PUBLISH. THE STOP-LOSSES AND UPSIDE TARGETS ARE BASED ON CLOSING PRICES. THE
MARK-TO-MARKET CALCULATIONS ARE BASED ON TUESDAY CLOSES.

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Commodity & Strategy Report October 28, 2021 10
Energy Strategy COP26 Meets During Policy-Induced Crisis

Archive Of Previous Reports

Please click on the links below to view reports:

1. Short-Term Oil-Price Risk Moves To The Downside - October 21, 2021

2. Inflation Surges, Slows, Then Grinds Higher - October 14, 2021
3. Conflicting Signals Challenge Gold - October 7, 2021
4. La Niña And The Energy Transition - September 30, 2021
5. Natgas Markets Continue To Tighten - September 23, 2021
6. Upside Price Risk Rises For Crude - September 16, 2021
7. NatGas: Winter Is Coming - September 9, 2021
8. Investing In Water Supply - September 2, 2021
9. US-China: War Preparation Pushes Commodity Demand - August 26, 2021
10. Permian Output Approaches Pre-Covid Peak - August 19, 2021
11. Global Grain, Bean Markets Balanced; USD Expected To Drive '21/22 Prices - August 12, 2021
12. Uncertainty Checks Gold's Recovery - August 5, 2021
13. OPEC 2.0's Forward Guidance In New Baselines - July 22, 2021
14. Demand Dictates Oil Price Expectations - July 15, 2021
15. Assessing Risks To Our Commodity Views - July 8, 2021
16. "Dot Shock" Continues To Roil Gold; Oil … Not So Much - July 1, 2021
17. Oil, Metals Vol Creates Buying Opportunities - June 24, 2021
18. Balance Of Risks Tilts To Higher Oil Prices - June 17, 2021
19. Gold, Silver, Indexes Favored As Inflation Looms - June 10, 2021
20. A Perfect Energy Storm On The Way - June 3, 2021
21. Less Metal, More Jawboning - May 27, 2021
22. OPEC 2.0's Production Strategy In Focus - May 20, 2021
23. Surging Metals Prices And The Case For Carbon-Capture - May 13, 2021
24. Importance Of US Gas, Oil Exports Increases Daily - May 6, 2021
25. Renewables ESG Risks Grow With Demand - April 29, 2021

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 Commodity & Strategy Report October 28, 2021 11
Energy Strategy COP26 Meets During Policy-Induced Crisis

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