A sudden spike in crude oil prices has provided a much needed tonic for BP (LSE: BP.) shares. An escalation of tensions between Iran and Israel is certainly not good news. But when considering investing in oil stocks, it’s important to look beyond short-term noise and consider the longer-term investment case.
Nationalism
Since the end of the cold war in the early 1990s, the world has seen one of the most sustained periods of peace in human history. Globalisation and cooperation between nation states has been the biggest driver, in my opinion.
In the early 2000s, China entered the World Trade Organisation (WTO). This ushered in a new era of manufacturing outsourcing and the onset of global trade. But today, mutual cooperation between countries is being replaced with a wave of nationalism.
Trump’s tariffs are part of much bigger problems. Bond markets revolting against unsustainable government deficits, growing social unrest, and the return of sustained inflation for the first time in 50 years are leading to increased market volatility.
Oil prices
When I zoom out and consider these factors, what I conclude is that oil prices are at the beginning of a long-term upward trend.
BP remains one of my favourite picks because its valuation multiples are low compared to all its peers, and I think, unjustifiably low.
Of course, its problems are well documented. A disastrous pivot to renewables at a time when oil prices began spiking four years ago is chief among them. But a huge boost to investment in its upstream business back in February, means that foray is well and truly over.
The world remains very much in the energy addition phase. Demand is coming from multiple sources. These include a growing Asian middle class, manufacturing renaissance in the US, a drive for increased base metal supply to power the green revolution, and data centre expansion.
Net debt
When picking an individual oil stock, it’s extremely important for an investor to understand the specific risks associated with it over and above sector-wide risks. For BP, one of the biggest is net debt.
When oil prices went negative in 2020, the company’s net debt ballooned to $51bn. That huge debt mountain may have come down by 50%, but since 2022 it has been trending higher. Share buybacks and the issuance of hybrid bonds have been two of the biggest contributors to the increase.
The oil major has set out a target of reducing net debt to a range of $14bn-$18bn by 2027. But reaching this target very much depends on whether it can offload its lubricants business, Castrol. It’s also contingent on it finding a partner to share the risk for its solar and battery storage business, Lightsource BP.
But, for me, there is still a lot to like about the stock. A 6% dividend yield is sector leading. With management guiding to a 4% annual increase, I’m being handsomely rewarded for remaining patience.
As BP ramps up investment in oil and gas to $10bn a year, I fully expect this to translate into growing free cash flow over time. And with a belief that oil prices are heading higher in the coming years, I will be continuing to drip feed cash into my investment in BP at every opportunity.
