In the future, 2020 will likely be known as the year of the coronavirus pandemic. But there was another unsettling event that took place that only energy traders will likely remember: Oil prices fell, briefly, below zero. The oil market got so bad so quickly that several industry giants laid out plans for a greener future, including BP (NYSE:BP). Here are some things to consider before you decide to buy into BP's big makeover.
1. A bold promise
International energy giant BP announced in Aug. 2020 that it would be going "from [an] international oil company to [an] integrated energy company." As it transitions along this path, management intends to increase its investment in clean energy 10 times over. That shift will be front-loaded, as well, with at least an eightfold increase in such spending by 2025. It's also looking for a 20-fold increase from 2019 levels in its renewable power generation.
Along the way, the company intends to refocus on its most profitable oil and natural gas investments. That sounds like a good idea -- however, it will result in energy production falling by 40% by 2030. That's a massive decline in what is currently the company's core business. And the company promised to limit its exploration efforts to those countries in which it already has a presence, further curtailing its opportunities in the future. All in all, BP is drastically shifting toward clean energy as it shrinks its carbon-based fuels business.
2. Moving very fast
The company doesn't appear to be wasting much time. For example, the number of geologists, engineers, and scientists BP employees in the energy business has fallen from over 700 a few years ago to under 100, according to Reuters, who spoke to company insiders. And BP has been aggressively investing in renewable power projects at the same time, including offshore wind. Meanwhile, it has been ramping up the sale of carbon-based assets, with a goal of $25 billion worth of divestitures by 2025.
Although some might argue that speed is of the essence when dealing with the environment today, BP may be moving too aggressively for its own good. For example, it recently paid top dollar for offshore wind development rights at a United Kingdom auction. That's not hyperbole -- BP paid 65% more than the second-place bidder and 85% more than peer Total (NYSE:TOT) was willing to dish out, according to Bloomberg's analysis of the bidding. Meanwhile, BP has been exiting energy assets in the middle of an industry downturn, so it probably isn't getting top dollar when it sells. Usually you want to buy low and sell high -- but in BP's haste, it seems like it might be selling low and buying high.
3. Working off a (relatively) weak base
The asset sales, however, will likely be a very important source of cash, given that BP's balance sheet is among the weakest in its peer group. For example, the company's debt to equity ratio of 1 is roughly four times higher than that of U.S.-based Chevron, which probably has the strongest finances in the industry. Looking at leverage another way, long-term debt makes up nearly 45% of BP's capital structure. That figure at European peer Total, which has a roughly 0.75 debt to equity ratio, is about 35%. To be fair, BP's balance sheet isn't in terrible shape per se, but the company is looking to make drastic and costly changes from a position of relative weakness. That's not reassuring, and helps explain why it may need to sell assets quickly, since layering on even more debt would likely displease investors greatly.
4. Have we been here before?
Adding yet more reason for investors to be concerned, as the new millennium got under way BP tried to rebrand itself as "Beyond Petroleum". As is still the case, the company's goal back then was to increase its presence in clean energy. But by 2011 it had basically shut the whole Beyond Petroleum idea down, selling the last of its major investments in the clean energy space. That was a decade or so ago, and times were different -- but if BP couldn't pull off that clean energy overhaul, it's kind of hard to have confidence in its ability to do better this time around.
A bold bet on the future
When you add it all up, BP is making a massive business shift, moving extremely quickly, and working off a relatively weak financial foundation -- and has tried, and failed, to do something similar before. Now throw in the 50% dividend cut in 2020, and investors should probably be treading with caution here. All in all, most long-term investors will likely want to err on the side of caution and wait until BP is much further along in its transition before jumping aboard here.