As the BP share price rides the crest of a wave, can the party continue?

As free cash flow continues to grow, Andrew Mackie explores what it could mean for the BP share price.

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In just 18 months, the BP (LSE: BP) share price has more than doubled. And it’s up 31% over 12 months. Soaring oil and gas prices have turned the group into an extraordinary cash generating machine.

However, it hasn’t been all plain sailing. The share price has had a few wobbles recently. The forced sale of Rosneft, together with the imposition of fresh lockdowns in China, both led to significant sell-offs.

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On both occasions, I took the opportunity to add to my position. Here, I want to explain why I did and why I remain so bullish on BP’s prospects.

Rising cash mountain

In its Q1 financial statement, BP reported a 53% increase in underlying replacement cost profit on the previous quarter. Operating cash flow surged to $8.2bn. Free cash flow jumped 37% to stand at $4.1bn.

With so much excess cash at its disposal, it has instigated a number of friendly shareholder initiatives. Prime among them, have been share buybacks. In Q1, it completed $1.6bn worth of them and announced a further $2.5bn to be completed in Q2.

Up to 2025, it has committed to allocate 60% of free cash flow to buybacks. During that timeframe, it estimates that if oil averages $60, it will complete $4bn annually. I expect oil prices to remain well above this level for many years to come.

An uninvestable industry

For many investors, oil and gas is to be avoided like the plague. Pressure from governments, institutional investors and individuals concerning climate change is the predominant reason. Another factor is the fear that these companies will be left with stranded assets as the world transitions to more renewable sources of energy.

That makes sense, especially with BP’s decision to write down to zero its 19.75% stake in Rosneft that resulted in a pre-tax charge of $24bn and a reported loss for the period of $20.4bn.

But with oil over $100 and trading at exceptional levels, I feel its strategy and shareholder returns won’t be impacted.

And what of the potential for a windfall tax? Whether one happens or not it wouldn’t change BP’s investment case for me.

A compelling investment proposition

Since the global financial crash, we’ve seen less investment in the natural resources sector than others (like technology, for example). But has the pendulum swung too far?

Arguably, the reputation of the oil and gas industry has suffered as more investors consider Environmental, Social and Governance (ESG) standards. The level of capital investment in the sector as a whole is at historically low levels, relative to the price of oil. Until this resolves itself, oil prices will likely remain elevated.

On top of continued volatility in energy markets, other factors could keep BP’s share price riding high.

For one, I expect investors to go back to valuing companies using traditional valuation metrics, and I believe this would benefit BP. We are already seeing evidence of that as US tech stocks have largely had a torrid start to the year.

As BP begins to execute on its transition strategy, we might well see its share price rise or fall depending on initial reactions. And when an opportunity presents itself in the form of a dip, I will keep buying more BP shares.

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Andrew Mackie has positions in BP. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Should you invest the value of your investment may rise or fall and your Capital is at Risk. Before investing your individual circumstances should be considered, so you should consider taking independent financial advice.

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