BP’s Pivot to Renewables Has Big Potential—and Sizable Risks
Investors wanting to inject some fuel into their portfolio could do a whole lot worse than to consider energy giant BP.
BP (ticker: BP) has the potential for big gains over the next 12 months as the company engages in a significant stock buyback program, continues transitioning toward renewable energy, and markets its oil and gas at relatively high prices, analysts say.
“We see BP as a compelling multiyear investment case,” says a recent report from Barclays. “We expect it to become increasingly evident over the coming 12 months that BP can deliver a material and sustained improvement in free cash flow.”
Barclays’ upside scenario sees the stock rising as much as 80% over the recent ADR price in New York of $28 within 12 months. That assumes the price of Brent crude oil, the international benchmark, averages $70 a barrel over the long term. Plus, investors should receive a projected 4.6% dividend from BP. In the year to date, the ADRs have gained 35% compared to a 12% increase for the S&P 500. Neither figure includes dividends.
The key to BP’s bullish story is a stock buyback that would use 60% of the company’s surplus cash flow. The move comes after the company reduced the amount of its net debt outstanding (using its own definition) to $33.3 billion, below its target of $35 billion. That leaves the way for buybacks of $4 billion a year, assuming average Brent crude prices of $60 a barrel, the Barclays report says.
However, the buyback could conceivably be larger, with an oil price assumption that now looks conservative. Oil prices could shoot to $77 from $71 recently, says Adam Johnson, founder of the Bullseye Brief newsletter and a former oil trader. Johnson also notes that the summer driving season, combined with the lifting of Covid-19 restrictions, is likely to enhance already high demand. “The price is very well supported,” he says. “Demand is on its way.”
At current prices, the stock looks inexpensive. BP trades at nine times projected earnings compared to an average of 22 times over the past five years, according to Morningstar.
BP is a leader among the oil majors in shifting its business away from fossil fuels and toward renewables. “BP plans to pivot toward low-carbon energy over the long run…through a tenfold increase in low-carbon investments to around $5 billion per year,” states a recent CFRA report.
There are some caveats in this bullish story. While pivoting to greener energy might attract sustainability-focused investors, it could also come at the price of lower returns. BP’s pivot would cut oil and gas production by 40% and reduce refining volumes by 30%, CFRA says. Such a move could destroy some value, as returns on renewables are about a third of those from fossil fuels, says Jia Man Neoh, a Kuala Lumpur–based equity analyst with CFRA.
Meanwhile, BP is still on the hook for $7 billion more in costs related to the 2010 Deepwater Horizon disaster in the Gulf of Mexico, according to estimates from CFRA’s Neoh. Compared to the $92 billion market cap, that is “quite small,” he says.
However, a major risk hanging over BP investors is that oil prices suffer a steep drop, which is what happened last year in the early months of the pandemic. A big enough decline could bring the stock buyback program to a halt. Plus, the shift to renewables could prove to be disappointing, says Johnson.
While it makes sense for oil companies to pivot, companies often stumble in transforming themselves so fundamentally. “It made all the sense in the world for Kodak to embrace the digital camera, but they didn’t,” says Johnson.