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Should I buy BP shares to profit from the rising oil price?

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The price of barrel of Brent crude oil rose to $68 on Friday, a level not seen since before the coronavirus pandemic. Shares in oil and gas giant BP (LSE: BP) are responding and BP’s share price has risen by 25% over the last month.

Despite this gain, BP is still down by more than 20% compared to a year ago. I think this popular dividend stock could still be cheap, so I’ve been considering whether to buy the shares for my portfolio.

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OPEC caution could help BP

The oil price got a big boost last week when Opec leaders Saudi Arabia and Russia agreed not to increase production to reverse last year’s cuts.

Travel bans last year caused oil demand to collapse, but a recovery appears to be underway. By showing caution now, I suspect Opec is trying to ensure oil stays above $60 per barrel. That’s a level which generates comfortable profits for most big producers.

Higher oil prices should certainly be good news for BP. The London-based group has promised to cut its oil and gas output by 40% by 2030. Instead of investing in production growth, BP will be diverting cash from oil sales into renewable projects and debt reduction.

My analysis suggests extra cash from selling oil at higher prices could speed up the group’s transition.

BP share price: why I’m tempted

I don’t expect the oil market to return to the kind of frenzied boom we saw in the noughties, when oil hit a record high of $148. But I do think this unloved market has plenty of gas left in the tank.

One thing I’ve learned over the years is that the oil price always overshoots. Last year we saw prices fall too low — the oil price briefly went negative. As the world recovers from the coronavirus pandemic, I expect to see a period of strong performance.

City analysts appear to share this view. Consensus forecasts suggest BP’s profits will bounce back to $6.3bn in 2021, before rising 47% to $8.6bn in 2022. Based on BP’s share price at the time of writing, these projections price BP at 14 times 2021 earnings, falling to a P/E of 9.5 in 2022.

What could go wrong?

However, there are a couple of problems that might stop me buying BP shares. One is that the company’s plan is to pay a fixed dividend for the foreseeable future. Any extra cash is expected to be used for share buybacks rather than dividend growth.

In general, I prefer to invest in dividend stocks where the payout is linked to earnings. Otherwise, the impact of inflation means the real value of the payout falls over time.

I’m also worried about the future profitability of the business. As I mentioned earlier, big production cuts are planned over the next year. I don’t yet know how successfully BP will be able to replace this lost income with profits from renewables.

I can see a real risk that BP’s share price will stay lower for longer in this uncertain environment. Despite the tempting 4.8% dividend yield, I think there are better options elsewhere. I won’t be buying BP shares at the moment.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.