BP’s (LSE: BP) share price has dropped 18% from its 12-month high on 10 February 2023.
Much of the fall was in line with the decline in the oil price over the last quarter. And some of it followed the announcement of Q3 profits undershooting analysts’ expectations.
My view is that in the short term, the oil market could trend higher again this year. This could also be sustained long term, as the transition to greener energy may well take longer than many analysts expect.
BP’s strong positioning in both the fossil fuel and renewable energy markets has been underestimated by analysts, in my view. This should allow it to drive earnings and profits higher over time.
Its ability to do this is evidenced by its high return on capital employed (ROCE). Currently, at 24%, BP’s ROCE is more than double the oil and gas industry average of 11%.
This powerful driver of future returns has also been underestimated by the market, I think.
One risk in the stock is that oil prices continue to decline. Another is that anti-oil sentiment leads the company to change the balance of its energy transition approach.
Balanced energy transition strategy
The final statement from December’s UN Climate Change Conference underlined to me that the energy transition will take longer than many expect.
It mentioned “transitioning away” from fossil fuels but did not include anything to do with phasing them out entirely.
A target net zero point remains 2050, but this must be done “in keeping with the science”, it said.
The International Energy Agency added recently that government pledges fall well short of achieving greenhouse gas net zero by 2050.
In October, OPEC forecast that oil demand will rise to 116m barrels per day (bpd) by 2045. Currently, it is around 100m bpd.
Increased global demand against reduced supply to meet energy transition guidelines is positive for the oil price.
Short-term price spikes may also come from a widening out of the Israel-Hamas War, much as we all hope this won’t happen. The World Bank said recently that the Brent benchmark price could soar to over $150 per barrel in this event. Currently, it is around $77.
BP’s strategy is to aim to become a net zero company by 2050 or sooner. Since 2019, it has reduced emissions from its operations by 41% and by 15% from its oil and gas production. By 2030, it intends to have reduced oil and gas production emissions by 25%.
Undervalued against its peers
The effectiveness of this strategy does not appear to have been reflected in its share price. Over the last three years on average, its earnings per share has increased by 84% a year. But its share price has only increased by 34% a year on average during that time.
This has also left the stock looking very undervalued compared to its peers.
BP currently trades at a price-to-earnings (P/E) ratio of just 3.9. Petrobras trades at 3.5, Shell at 7.3, ExxonMobil at 9.7, Chevron at 11, and Saudi Arabian Oil at 16.8. This gives a peer group average of 9.7.
BP is due to announce its Q4 2023 results on 6 February. Based on its current undervaluation, earnings potential, and balanced business strategy, I am looking to add to my holding before then.
