Viewed over a three-year time frame, both BP (LSE: BP) and Shell (LSE: SHEL) have registered some of the best performances in the FTSE 100. Their share prices are up 239% and 304%, respectively. Despite this, they still trade at lowly price-to-earnings multiples compared to their US peers.
A key question I therefore keep asking myself is, what will it take for these two oil majors to close the gap? Or, is this as good as it gets?
2023 – a mixed year
A slowdown in oil prices, together with a glut of natural gas, meant that in 2023 neither company repeated the success of 2021 and 2022. However, Shell did manage to eke out a share price gain of 9%, while BP’s fell 4%.
This difference in performance can be explained by the fact that BP has a larger renewables business, and it was forced to take a significant impairment charge on its offshore wind portfolio.
Still, early in 2023 BP did pivot, scaling back its pledges to cut oil and gas production by 2030. I think this speaks volumes about where it believes the market is heading over the coming years.
Great rotation
In 2022, investors began rotating out of overvalued, long-duration financial assets, such as mega-cap tech stocks, and into hard assets. Although this has reversed in 2023, I view this as a temporary blip. In other words, I don’t see 2022 as a one-off.
One key reason why I believe this will be the case, is that I expect inflation to begin re-accelerating in the coming years.
The alarming growth in public debt, particularly in the US, is one primary reason. It’s estimated that its debt will double over the next 12 years to an eye-watering $67trn.
But that’s not my only reason. I think increasing geopolitical tensions will force Western governments to begin allocating a greater proportion of their GDP to defence spending.
On top of that, the cost-of-living crisis has led to a wave of strikes across the world. As unions begin flexing their muscles, a repeat of the wage-price spiral of the 1970s is a distinct possibility.
In such an environment, I want to be owning tangible assets. This is because during inflationary periods, they hold their value much better than paper money.
If capital does come pouring into the space, then where is it likely to primarily go? Among cheap, established, FTSE 100 companies like BP and Shell.
Capital conservatism
I could be wrong about inflationary trends. But, today, there is one undisputed fact. Capital expenditure across the industry remains historically low.
The mantra today is dividends and share buybacks. There is no appetite for exploration and risk taking.
One reason I ascribe to this is ESG mandates. There’s simply no reason for companies to invest large amounts of capital into multi-year long projects without an expectation of a decent return. After all, they don’t want to be left with stranded assets, as the transition toward renewables accelerates.
The elephant in the room, though, is just how long will it take for this transition to occur. My opinion is that it will take longer than many commentators would have us believe.
