The Wall Street Journal - USA (2020-11-16)

B10| Monday, November 16, 2020 THE WALL STREET JOURNAL.

HEARD

ON

THE

STREET

FINANCIAL ANALYSIS & COMMENTARY

Virus Adds to Oil-Sector Fear

Covid-19 makes foreign policy the industry’s first Biden worry

Cash-likeassetsofJapanese
regionalbanks

Source: Bank of Japan

Note: ¥105.1 = $1

¥60

0

10

20

30

40

50

trillion

1990 2000 ’10 ’20

Cash negotiable

certificates of

deposit checks and bills

Due from the central

bank and other

commercial banks

OilproducedonDepartmentoftheInterior-managed

leasesasashareoftotalU.S.production

Source: Department of the Interior, Energy Information Administration

*Fiscal year ended Sept. 30, 2019

35

0

5

10

15

20

25

30

%

FY2010 ’11 ’12 ’13 ’14 ’15 ’16 ’17 ’18 ’19*

America’s energy industry had
been bracing for a potential shift
away from the fossil-fuel-friendly
Trump administration since last
year. Then the Covid-19 pandemic
hit and President-elect Joe Biden’s
potential actions affecting domes-
tic oil-and-gas production seem to
have lost their teeth in the near
term. At the same time, his for-
eign-policy moves look more sig-
nificant.
The extent to which Mr. Biden
can push his clean-energy agenda
will only become clear in January
once the two pivotal Senate seats
in Georgia are filled, but there are
executive orders he can pursue
without Congress on his side. Mr.
Biden has said he wouldn’t ban
fracking outright, but he has called
for ending its use on federally con-
trolled lands.
A ban on new federal permits
does have some potential for dam-
age, though not any time soon.
New drilling isn’t a priority for en-
ergy companies with prices and
demand still depressed.
“It’s a very different discussion

today than a year ago, when the

U.S. was growing oil production

one to two million barrels per day

a year,” notes Scott Hanold, ana-

lyst at RBC Capital Markets. Even

if West Texas Intermediate oil

prices were sustained at $60 a

barrel—they are around $40 to-

day—annual oil production would

be likely to grow somewhere

around 300,000 barrels a day, “a

far cry from the one to two million

barrels per day you saw in 2018

and 2019,” he noted.

Instead, a more pressing near-

term threat could stem from for-

eign policy. Mr. Biden favors re-

turning to the 2015 Iran nuclear

deal—a move that could bring the

major oil producer sanctions relief.

According to a research note from

RBC, the White House has author-

ity to issue enforcement waivers

on sanctions without Congress if it

certifies that Iran is meeting its

nuclear-deal obligations.

A move to sanctions relief could

bring as much as a million barrels

a day of supply, or about 1% of

global production, back to the

market in the second half of 2021,

RBC notes. A research note from

Morgan Stanley figures that num-

ber could be as much as two mil-

lion barrels a day, though likely

not all at once. There are many

moving parts in the global oil mar-

ket, but such a big addition to sup-

ply would harm private energy

companies across the board.

Domestic policy could have

more of an impact in the long

term. Federally controlled areas

account for roughly one-quarter of

all U.S. oil production. In places

such as New Mexico, land owner-

ship looks much like a checker-

board, with federal lands sitting

adjacent to state and private acre-

age, notes Scot Anderson, partner

at Hogan Lovells. That will make it

a headache for producers with a

heavy presence in those states to

figure out permits, especially be-

cause most drilling today occurs

horizontally. Moreover, royalty

rates, the percentage of oil reve-

nue that an energy company must

share with the underlying land-

owner, are cheaper for federal

lands than for state- and private-

owned acreage.

Companies with higher expo-

sure to federal lands, such asEOG

ResourcesandOccidental Petro-

leum, have experienced steeper

drops in their share prices relative

to peers since before the election

when a Biden victory began to

look likely. In some cases, the com-

panies have used the downturn to

hedge their exposure through con-

solidation:Devon Energy’s an-

nounced merger withWPX En-

ergy, for example, reduces its

exposure to federal lands. And if

the U.S.-focused producers face in-

crementally higher costs because

of new regulations, companies

with heavy international expo-

sure—for example, supermajors

such asExxon MobilandChev-

ron—could find themselves in a

marginally better position.

Mr. Biden’s clean-energy-fo-

cused agenda does have potential

to shift the fortunes of energy

companies—especially if he has

Congress on his side. However, the

effects might only show once the

cloud of the pandemic lifts.

—Jinjoo Lee

The World Should Watch Japan’s Efforts to Save Struggling Banks

strophically low even a few years

ago.

A marginal shift in interest

rates on accounts held with the

central bank might not sound like

much, but Moody’s Investors Ser-

vice rightly notes that given re-

gional banks had an average re-

turn on assets of just 0.14% in the

last fiscal year, an extra 0.1 per-

centage point return on large cash

balances is nothing to sniff at.

It isn’t the only measure Japan

is taking. Later this month, a new

law exempting regional banks from

normal antitrust considerations

comes into force. A merger be-

tween Kyushu-based Eighteenth

Bank and Shinwa Bank was held

up for years by regulators before

finally beginning operations last

month.

selves in regional lenders around

the world.

European policy makers should

be paying particularly close atten-

tion, given their similar desire to

consolidate the banking sector.

Banking policy can’t be ex-

pected to solve a problem that is

fundamentally macroeconomic:

Japan’s sluggish nominal growth

has required the low interest rates

that have hollowed out lenders’

bottom lines. But it can ameliorate

the situation significantly.

Breaking down barriers to

mergers and offering additional fi-

nancial incentives to pursue them

won’t fix what ails the sector, but

it may well encourage more activ-

ity, something other countries

might want to make a note of.

—Mike Bird

If paying so much attention to

small lenders worth little in finan-

cial markets seems unusual, it’s

worth remembering that without a

healthy financial system, it’s far

more difficult to implement mone-

tary policy: Banks in distress may

not respond to interest-rate sig-

nals in predictable ways.

Smaller lenders elsewhere don’t

all face the same constraints.

Some in the U.S., for example,

have serious exposure to the trou-

bled energy sector.

But any institution that relies

on interest income is going to be

squeezed continually if rates re-

main low for an extended period,

as bond market prices clearly ex-

pect them to.

With less fee income, similar is-

sues are likely to present them-

Japan is trying to encourage

mergers among its ailing regional

banks by introducing a sweetener

for those that cut costs. Other ad-

vanced economies should pay at-

tention: Rock-bottom interest rates

mean Japan’s present is likely to

be their future.

The Bank of Japan is offering

commercial lenders an extra 0.1

percentage point in interest on

their deposits with the central

bank if they reduce their overhead

ratio by certain benchmarks, or

merge or integrate their busi-

nesses.

After 30 years of falling and

even negative interest rates, many

of Japan’s regional lenders have

share prices of 0.2 to 0.3 times

their book value—levels that

would have been considered cata-

Shares of small companies
are posting outsize gains,
driven by investors’ bets that
a rebounding economy and ex-
pected Biden administration
policies will boost profits at
smaller U.S. companies.
The Russell 2000 index of
small-company stocks rose
6.1% last week, hitting its first
record close since 2018 and
extending a recent race ahead
of other major indexes. It fin-
ished the first two weeks of
November up 13%, its best 10-
session start to a month on re-
cord, according to Dow Jones
Market Data. The broader S&P
500 gained roughly 9.6% in
that period.
That marks a reversal from
earlier in the year, when shut-
downs hammered shares of
small-cap companies, which
tend to have fewer business
lines and a greater reliance on
the domestic economy than
larger, diversified peers. The
Russell 2000 lagged behind
the market rebound and has
now gained roughly 4.5% in
2020, according to FactSet
data, compared with 32% for
the Nasdaq Composite and 11%
for the S&P 500.
Shares of giants including
Apple Inc. and Amazon.com
Inc. drove much of that
bounce from March’s lows,
lifted by bets those companies
would benefit from consumers
staying home in greater num-
bers. While Amazon, with its
$1.6 trillion market value, is
the biggest stock in the S&P
500’s consumer-discretionary
sector, Penn National Gaming
Inc., a roughly $10 billion op-
erator of racetracks and casi-
nos in 19 states, was the Rus-
sell 2000’s largest consumer-
discretionary company as of
Oct. 31.
Hopes for a Covid-19 vac-
cine, however, have upended
that trade in recent sessions,
sparking a recovery in sectors

gest gainer since Election Day

is Five Prime Therapeutics

Inc., which has climbed more

than 300% after releasing re-

sults last week of a Phase 2

study of its potential gastric-

cancer therapy.

One looming factor that

could slow the rally: mounting

Covid-19 cases. While the

prospect of a vaccine has

brightened the long-term out-

look, the pandemic’s U.S. re-

surgence could prompt new

lockdowns and other measures

that could disproportionately

hurt profits at small-cap com-

panies.

“You had a narrow market

with a struggling economy,”

Mr. Gannon said. “That idea of

the economy broadening out

and the earnings story is the

real key.”

MARKETS

such as energy, travel and en-

tertainment. In the two ses-

sions after Pfizer Inc. and

partner BioNTech SE an-

nounced significant progress

on a vaccine for Covid-19, the

Russell 2000 beat the tech-

heavy Nasdaq Composite by

8.52 percentage points—the

greatest margin since at least

1986, according to Dow Jones

Market Data.

Small-cap stocks were al-

ready outperforming their

larger peers, fueled by bets

that a Biden administration

would push for more govern-

ment spending to boost the

recovery. With the voting past,

some investors said they are

watching for signs of mount-

ing growth to support the

gains in small stocks, which

can climb ahead of their larger

peers when investors are opti-

mistic but also tend to post

big declines when the mood

darkens.

“No matter the outcome of

the election, it’s the sustain-

ability of the recovery that’s

more important to the small-

cap space,” said Francis Gan-

non, the co-chief investment

officer at asset manager Royce

Investment Partners, which fo-

cuses on small-cap companies.

One big winner is auto-

parts maker Cooper-Standard

Holdings Inc., which has

jumped 70% since surprising

analysts with an upbeat earn-

ings report Nov. 6. Earlier in

the year, the pandemic shut-

downs offered investors a rea-

son to avoid the stock, said

Benchmark analyst Michael

Ward. “Now they have an ex-

cuse to buy it.”

Other big gainers since the

election include thermostat-

maker Resideo Technologies

Inc., up 68%; freelancing plat-

form Upwork Inc., up 62%;

biotech Denali Therapeutics,

up 60%; and Caesars Enter-

tainment Inc., up 24%.

Some have surged for eso-

teric reasons. The index’s big-

BYPAULVIGNA

Economic Hopes Fuel Big Gains at Small Stocks

Nov. 2 Nov. 11

• 20

0

20

40

60

80 %

Resideo Technologies

Upwork

Denali Therapeutics

Caesars Entertainment

Penn National Gaming

Russell 2000

S&P 500

Nasdaq Composite

Small caps have been outperforming their large-cap peers recently.

Share-priceandindexperformancesinceElectionDay

Source: FactSet

Penn National Gaming was the Russell 2000’s largest consumer-discretionary company as of Oct. 31.

ETHAN MILLER/GETTY IMAGES