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Is BP Fixing Its Balance Sheet at the Expense of Its Business Model?

By Reuben Gregg Brewer – Jul 25, 2020 at 8:33AM

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Facing massive industry headwinds, BP is selling a big piece of its business. What's this really doing to the company?

BP (BP 3.35%), formerly known as British Petroleum, is shaking things up in the middle of a deep industry downturn. On the surface, the changes it's making are good news -- but when you dig in a little bit deeper, there are risks that could play out over the longer term. Here are some things to think about when you consider BP's recent $5 billion asset sale.

Slimming down

Investors are taught that diversification is good for their portfolios because it spreads risk around. That same idea plays out at the corporate level: Companies look to have operations in more than one industry or across different industry segments. For companies like BP, that means owning assets from the drilling (upstream) area of the energy sector all the way to the chemicals and refining niche (downstream). To be fair, COVID-19-related demand disruptions have left every part of the energy sector in a downturn, but historically when oil prices are low downstream businesses benefit from reduced input costs. That, in turn, helps offset the top- and bottom-line pain of weak energy prices. 

A man standing in front of an oil rig with tablet in his hand

Image source: Getty Images

This is the model that most of the world's largest energy companies use, which is why they are often referred to as integrated energy giants. Note that these companies, including BP, are not just diversified across the energy sector -- they're also diversified geographically. So BP spreading its bets around is a key piece of the company's story. In fact, the energy giant is one of many that are starting to invest in renewable power, including solar, wind, and biofuels. BP and the others want to make sure they have their fingers in as many energy pies as possible. 

However, today's industry downturn is unusually deep, with the price of oil actually falling below zero at one point in early 2020. There were technical reasons for that, but for a brief point in time oil producers were paying customers to take oil off of their hands. Oil prices have recovered, but remain at historically low levels. Even industry giants are struggling to cope, with BP among them. It's taking drastic steps, including the recently announced $5 billion sale of petrochemical assets.

Good or bad?

BP has a heavy debt load and is looking for ways to trim the burden. It laid out plans to sell $15 billion worth of assets, and the current disposition allows it to reach that goal a year ahead of its original plan. With the entire energy industry facing headwinds, it's hard to argue about the value of solidifying BP's balance sheet so it can survive this storm. In this way, it's a good call. 

Moreover, when it announced the sale, BP highlighted that, "Strategically, the overlap with the rest of bp is limited and it would take considerable capital for us to grow these businesses." Again, on the surface, it sounds like a great call to raise cash by selling non-strategic aromatics and acetyls-producing assets. Moreover, jettisoning these businesses will mean freeing up cash for growing the company's core operations. 

BP Financial Debt to Equity (Quarterly) Chart

BP Financial Debt to Equity (Quarterly) data by YCharts

However, from a bigger-picture perspective, BP is pulling out of businesses that diversify its portfolio. Effectively these businesses were customers for the company's upstream products. Though perhaps not directly using the oil and natural gas BP drilled, historically, having these businesses allowed the company to benefit (from buying relatively cheap oil to process) when falling oil prices were putting downward pressure on its upstream operations.  With regard to future investment, BP is now limiting its set of growth options. Yes, there might be material expenses involved, but if the returns are high enough (perhaps not now, but some time in the future) that would be a much less important issue.

And more to the point today, by slimming down its downstream operations, BP is effectively making a bigger bet on its upstream business. Oil prices are notoriously volatile, so this move will likely increase the ups and downs investors have to deal with in the company's earnings in the near term. As noted above, in more normal times, downstream operations are a vital offset to energy-price volatility.

All in all, there are positives and negatives associated with this decision. It is not a clean win.

What to do from here

If you are looking at BP, you should probably be considering other energy names, as well. For those looking to play the energy downturn with the least risk possible, Chevron, which has industry-leading balance sheet strength, is probably a better option than BP. That said, Chevron is focused heavily on the oil and natural gas production space. If you want a company that's also venturing into the renewable power arena, then take a closer look at Total. This global energy giant maintains a broadly diversified portfolio and is swiftly becoming a major electricity player in Europe. You might decide that BP is a better option for you, but make sure you go in understanding the broader implications of the shifts it is making to its portfolio.

Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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