Despite oil giant BP’s (LSE: BP) attractive-looking dividend yield and the contrarian allure of the low oil price, I’m avoiding the firm’s shares. Instead, I’m focusing on three factors that I believe undermine a long-term investment in the firm.
Operational risk
The business of finding and extracting oil and gas from beneath the earth’s surface is fraught with danger. BP tries hard to control risks and pays a great deal of attention to health and safety, but taking on the forces of nature leads to sometimes-unpredictable outcomes. We need only look at BP’s 2010 Gulf-of-Mexico disaster to see how badly things can go wrong. That oil blowout caused loss of human and animal life, environmental pollution on a massive scale, and thumped BP with extra costs of billions.
Risks like that do not sit well in a portfolio of long-term share investments. But, no matter how careful the firm is with its operations, a similar disaster could happen again, anytime and anywhere. That’s one reason that BP’s share price will never trade at a high P/E rating. The share price is accounting for the risks.
Commodity pricing
Oil and gas producers need commodity prices to be high enough to cover their costs if they are to return a profit. The trouble is that they have little influence over what commodity prices might be. The best that firms such as BP can do to optimise their returns is to allocate asset investment in accordance with supply and demand cycles such that money is put to work when the pricing environment is favourable and trimmed back when it is not.
Right now, the price of oil is low compared to the highs it reached over recent years, which makes life difficult for BP. No-one knows whether the oil price will return to former glories. If anybody knew how to predict the future price of oil, they would have told us about the recent plunge!
Whether oil goes up again or stays down, commodity pricing is another reason that BP’s shares rarely trade on a high multiple to profit. So, I’m not counting on a valuation re-rating upwards with BP and I’m not relying on the sustainability of the dividend either. However, because BP’s forward price-to-earnings rating is high at around 13, there is the risk that the firm’s share price could re-rate downwards if a rebound doesn’t happen with the oil price, as investors seem to expect.
Disruptive technology
The word’s hydrocarbon economy looks ripe for disruption by up-and-coming technologies. That vision may seem fanciful, but who knows how fast petrol and diesel vehicles will be usurped by solar powered electric vehicles, or how soon buildings will be self-regulating when it comes to temperature with zero heating requirements.
Disruptive technology could combine with persistent oversupply of oil to keep the oil price down for generations. If that happens, an investment in BP now could perform poorly in the years to come.
With so many other great businesses listed on the stock market, I can’t see the point in risking my capital on a cyclical behemoth such as BP.
