It’s easy to be an oil bear these days. Recession fears causing demand destruction, together with the issue of long-term viability, continue to weigh on the BP share price (LSE: BP). Year to date, the stock is fairly flat. Despite these headwinds, I remain confident that we are still very much in the early innings of a commodities bull market.
2022 no outlier
As oil prices have come down from their recent spike, many analysts view the next five years or so being characterised by a kind of low plateau.
In a note to clients back in June, analysts at JP Morgan stated: “It is becoming increasingly clear that high oil prices over the past two years did exactly what they are supposed to do – incentivise supply”.
I personally do not ascribe to this view. I see the medium term being characterised by continued price volatility together with tight supply.
One key factor pulling prices down has been the US government’s decision to dump its strategic petroleum reserves on the market to boost supply following the Covid re-openings. Now sitting at levels not seen since the 1980s, those taps will be turning off soon.
A further key factor is US oil and gas operating rig count. On a monthly change basis, they just saw their biggest decline in three years, back when oil prices turned negative. All-in-all, the stage is being set for oil prices to remain strong over the coming months and years.
Inflation isn’t dead
Another reason why I believe that this commodities bull market is far from over relates to the likely re-emergence of inflation.
History shows that inflation tends to build on itself. During the 1940s and 1970s, surges in inflation were punctuated by disinflationary periods. This is exactly what we are seeing today.
As inflation falls, many think the worst is over. But rising interest rates is making access to capital difficult and forcing companies to cut exploration budgets.
On top of this, oil companies are spending less on capital expenditure and more on returning cash flows to shareholders in the form of dividends and buybacks. In my opinion, the stage is being set for another damaging oil price surge in the near future.
BP shares are a buy
What is interesting is that despite underlying replacement cost profit declining by 70% compared to a year ago, the BP share price has held up well. This suggests to me that all the negative news is already factored into the price.
One set of average quarterly results doesn’t make or break a company the size of BP. It remains committed to allocating 60% of surplus cash flow to buybacks. It also hiked its dividend by 10%; a clear sign of confidence in its future resilience.
Investors really need to think long-term when it comes to oil and gas. The industry is not going to die out anytime soon. One case in point is the onshoring trend. As more companies bring their manufacturing capabilties back to the US, oil and gas will be needed to build the infrastructure.
In the years ahead, I think investors will look back and realise what a steal BP shares were today. That is why I continue to buy more whenever finances will allow.
