UK Edition
The outlook for BP has changed significantly since Questor advised readers to sell shares in the oil and gas company in June last year.
Then the price of crude oil stood at just $40 a barrel and the world’s economic output was forecast to post a 4.9pc decline for the year, according to the International Monetary Fund. Moreover, the company had reported a £3.1bn loss for the first quarter of 2020 and a 13pc quarterly rise in net debt as the pandemic wreaked havoc on its operations.
Since then, the company’s share price has fallen by 7.4pc. By contrast, the FTSE 100 has risen by around 12pc. However, the prospects for BP now appear to be improving.
Notably, the oil price has surged higher to reach $70 a barrel. This enabled the firm to report a £2.2bn profit in the second quarter of 2021, while net debt is now 37pc lower than it was at the time of our sell recommendation. Indeed, the firm’s asset disposal programme seems to be creating a leaner and financially stronger business.
Meanwhile, the global economy is poised to experience a period of reflation as successful vaccine rollouts gradually lead to an end of lockdown measures. This is expected to produce world economic growth of 6pc this year and 4.4pc in 2022, according to the IMF.
Increased economic activity normally has a positive effect on demand for oil. Indeed, the International Energy Agency expects global demand for oil to rise by 5.5pc this year and by a further 3.1pc in 2022.
Furthermore, it forecasts that oil demand will be more than 8pc higher in 2026 relative to this year’s level due to rising demand from Asian economies. As a result, the medium-term prospects for BP’s profitability look buoyant – even as the world aims to transition from fossil fuels to cleaner forms of energy.
The oil price can also be expected to react positively to higher global inflation, since commodity prices have historically risen in line with prices more generally. Many economists forecast inflation to rise as a result of increasing post-pandemic economic activity and loose monetary policies pursued by central banks.
This should help to sustain growth in BP’s profitability and dividends; it expects to increase its payments to shareholders by 4pc a year between now and 2025.
Of course, BP continues to face a major challenge in gradually shifting its focus from fossil fuels to low-carbon energy sources, such as wind and solar. This process is likely to take many years and to require vast amounts of investment.
However, its progress looks encouraging in this regard. For example, it has almost doubled the size of its renewables pipeline since the start of 2021 through investment in wind and solar assets. With profits from oil likely to remain relatively robust and a marked improvement in the firm’s balance sheet over recent months, it should be in a good position to invest further in a low-carbon future.
Clearly, the pace at which the world moves to cleaner forms of energy remains a “known unknown”. It is likely to have a major impact on the prospects for the oil and gas industry and could mean that the oil price remains volatile in the coming years. Similarly, the pandemic remains a threat to BP’s financial prospects. New variants and lockdown measures would dampen demand for oil and send its price lower.
However, the company’s low valuation suggests that these risks have been factored in by investors during its recent underperformance of the FTSE 100. The stock trades on a forecast price-to-earnings ratio of around 7.5, which in our view offers a margin of safety.
An improving economic outlook, rising inflation and higher forecast demand for oil should put BP in a stronger position to successfully manage its transition towards lower-carbon energy.
In the meantime, it offers a relatively high yield and a dividend that it expects to grow at an above-inflation rate, as well as capital growth potential by virtue of its low valuation.
Questor says: buy
Ticker: BP
Share price at close: 298p
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