The world is shifting toward clean energy, which will lead to years of growth for options like solar and wind. BP (NYSE:BP) has, basically, said it sees the writing on the wall and is ready to make a green energy shift along with the rest of the world. Is the company's big plan enough to make the stock a buy?
Trouble in the oil patch
The big picture story in the energy sector is that the world is moving toward low-carbon alternatives, like solar and wind power, among other options. So far that's meant a massive drop in demand for coal and fears that oil will be next. For the global energy sector, which has long benefited from steadily rising demand for oil and natural gas, this would be a change in dynamics that has, basically, never been seen before. This shift is very real, but the question is when it will have a material effect... and no one has the answer to that question.
Complicating the picture today are the economic effects of COVID-19, which have led to a massive drop in demand. Unused oil is sitting in storage, creating an overhang on energy prices. It's a terrible situation that actually pushed a key U.S. oil price below zero in early 2020. However, the energy sector is highly cyclical, and supply and demand have long managed to realign over time. In today's market, the supply side is pulling back hard, with many exploration and production companies ending up in bankruptcy court.
BP, however, has predicted that the world may have seen oil demand peak in 2019. That's a bold statement and one that it is acting on in a big way, cutting its dividend by 50% and laying out an aggressive plan to expand in the clean energy sector. The key takeaways are that BP intends to reduce its oil and gas production by 40% over the next decade, while amping up its investment in low-carbon businesses 10 times over. Does this news make BP a buy? Probably not, and here's why.
1. We've been here before
BP was once known as British Petroleum. After a major disaster in the Gulf of Mexico roughly a decade ago, it had to drastically reposition its business. Part of that involved selling off assets to raise cash so it could deal with the financial fallout, but it also changed its name to BP in an effort to rebrand and distance itself from the disaster. However, this wasn't the first effort to reimagine the company's name. At the turn of the millennium, BP coined the term "Beyond Petroleum" and started to invest in renewable power.
The problem is that BP never really lived up to the hype of Beyond Petroleum. In fact, it shut down a major solar power operation in 2011 and shifted away from things like carbon capture. You could argue it was too early, or you could argue it was a major strategic misstep for the company to think it would be able to move into a new area it knew little about. The new plan today appears to be better grounded, but the Beyond Petroleum era doesn't inspire confidence.
2. Change takes time
The next issue to consider is the timing of the world's shift toward clean energy -- not so much when it will start, since it clearly already has, but how long it will take. The shift from coal to oil as the world's major energy source took roughly 100 years. If that's the case with renewable power and oil, then the changeover is really only just getting under way. In fact, based on the global efforts in place today, oil and natural gas (and even coal) will remain vital players in the world's energy market for decades to come. There may, in fact, be no need for BP to make a dramatic shift. Moreover, returns in the oil and gas sector tend to be higher than in the renewable power space, which could mean BP lags more oil-focused peers if it sticks to this new plan. That's not something that investors will be likely to cheer.
3. Leverage limits
One of the things that sets BP apart from its peers is its balance sheet, but not in a good way. BP is one of the most leveraged oil majors on Earth, sporting a financial debt-to-equity ratio of roughly 0.8 times. For comparison, Chevron has one of the strongest balance sheets, with a financial debt-to-equity ratio of about 0.2 times. Leverage limits BP's flexibility relative to peers. But consider that fact in conjunction with its clean energy goals, which will not come cheaply. It has already inked a $1.1 billion deal to buy a 50% stake in two planned U.S. offshore wind farms. Yes, BP plans to sell oil assets to help fund its clean energy ambitions, but such sales tend to be lumpy and right now isn't a great time to sell assets. It isn't unreasonable to fear that BP could get itself into a financial crunch if it spends too much too quickly.
Lots of uncertainty
Stepping back and looking at BP's history, the trends in the energy market, and BP's financial position today, there are very real reasons to worry that the risks here outweigh the potential rewards. Until there's more concrete progress toward the goals BP has set out, it will be hard to fully evaluate the success it is having. Conservative long-term investors should probably take a wait-and-see attitude for now.