BP (LSE:BP) shares are not currently part of my portfolio. In fact, the resource sector is underrepresented among the stocks I own.
In short, the BP share price has demonstrated extreme volatility in recent years. This is primarily due to major demand and supply shocks, namely the pandemic and Russia’s invasion of Ukraine.
But this has distracted the conversation away from long-term trends and narratives, precisely understanding the role of scarcity in this increasingly resource competitive world.
Understanding scarcity
Scarcity is an important concept in economics. It refers limited availability of resources in relation to unlimited wants and needs of individuals and society. It plays a fundamental role in shaping economic decisions and behaviours. Naturally, energy, namely oil and gas, is one of the most important resources in economic terms.
As the world’s population grows and economies expand — notably those in East Asia — the demand for hydrocarbons continues to rise. However, as we know the supply of oil is finite. Known sources of oil are drying out and new easily accessible discoveries are hard to come by.
All of this points to a higher long-term average crude oil price.
Replacing hydrocarbons with green energy
BP had placed itself at the forefront of the green energy transition, but there appeared to be something of a reversal last year. Activists accused the smallest oil majors of putting the climate at risk as it reaffirmed its investments in oil.
The firm is now expected to spend about double the amount on oil and gas projects in 2023 than on renewable investments. And this likely reflects the understanding that hydrocarbons will continue to be a major part of our future of the foreseeable despite ongoing attempts at energy diversification.
According to the International Energy Agency, hydrocarbon usage in cars is expected to keep increasing until 2028/2029. Supply and demand data further reinforces this trend. We can observe factors such as growing populations, notably in fast-developing countries with higher fossil fuel intensity, and geopolitical competition in the context of resource security.
Is BP worth it?
Of course, we can’t build an investment thesis without looking at a company’s valuation. While other majors like Shell, Exxon and Chevron boast higher margins, this is of little consequence as BP’s shares trade at a significantly lower valuation.
BP looks very attractive at just 4.3 times earnings on a trailing 12-month basis. With oil prices generally lower this year than last, we can also observe a forward price-to-earnings of 5.2.
It also stands out as a formidable cash generator, producing an impressive $26.12bn in net income and $27.75bn in free cash flow over the past year, despite having the lowest gross profit margin among the supermajors at 30.73%. In addition, its ability to generate funds is highlighted by the company’s $2.3bn excess cash in Q1.
With a positive long-run demand forecast, and a highly attractive valuation, this is a stock I’m looking to purchase. For me, it’s the cheapest stock in a ‘must-have’ sector.
