Monday, 17 August 2015

To BP or not to BP?

BP currently yield just under 7% and a market cap of c£70bn, it’s a global, vertically integrated company who generated $32.8bn in operating cash flow in 2014. Share prices across the industry have fallen significantly recently providing a potential chance to buy slices of companies at multi-year lows – what’s not to love?! The world needs oil and they’re providing it!

There are two issues at the moment – the first is the oil price, crashing through the floor as Saudi / OPEC do battle with the US shale producers, the glut builds, supply and demand do their dance and we, the consumers at the pump see little change in the price being paid… but this puts pressure on those dividends. As a contrarian you might take it as a bargain and the best time to get in. The oil industry is used to shocks and upheaval and this is no different, buy on the cheap, wait for the rebound and off you go, capital gains and a strong, high dividend.

Hopefully a period of low prices will help stimulate general economic activity and prices will drift upwards, all your shares follow and all is well. Except it’s not because the second issue and elephant in the room is the fact that oil will become economically unviable.

There are two ways this could play out; Mad Max style, or like the gradual replacement of steam locomotives, with change coming quietly and without revolution, no one will really feel any difference because you’re still getting a train, it’s just running on different juice.

So, should I invest in an oil company? I’ve no doubt that the larger companies will survive, and may be a profitable bet in the short term and they are used to dealing with the fluctuations of a volatile market. The question is whether I could fire and forget for 20+ years.

In considering this and keeping an eye out in the press I wonder if it is with deep irony, crystal clear foresight or a sense of moral imperative that the likes of the Rockerfeller investment arm and Norway’s sovereign wealth fund are divesting from fossil fuels? Is there a still a business for the likes of BP and Shell in 15yrs? The pace of change and the ability for individuals to create products that change the world combined with the fact that climate change risks seem to be more mainstream means there may be a snowball gathering pace, coming to wipe out our dependence on fossil fuels.

We may already be witnessing the first revolutions – it is not inconceivable that in 10yrs you will have a solar array on the roof and a battery pack in the garage allowing you to draw only a small amount of electricity from the grid. This would mean the current lot of power stations don’t need to be replaced with such urgency. Electric cars may become the norm, congestion falls, oil consumption drops and car ownership in general becomes the equivalent of owning a horse, a pleasant pass-time for those who can afford it, but not actually practical or cost effective as a means of transport for the majority. Perhaps 3D printers become standard kit in everyone’s home and the waste associated with current production and distribution methods falls away, further limiting demand for oil products.

The above is science fact, not fiction, these and many more will disrupt different industries, the question is how much. Oil companies are also threatened from more conventional areas such as state backed companies of nations who may not have governments or judiciaries that are beyond reproach.

How is big oil responding? A number of European oil majors including BP backed plans to introduce a “substantial” deal for energy efficiency recently, and websites include references to renewable energy generation. However, these are not anywhere close to replacing, or even hitting parity with oil revenues, so you could say it’s just lip-service to keep the active investors happy and keep the CSR / PR team in business. The Shell deal with BG gives them “cleaner” reserves, but that’s prolonging the status quo, not leading the industry into the solar powered uplands. Maybe they are secretly developing the renewable sources of energy, seeking to corner the market and nimbly outflanking the still fledgling renewables sector ensuring their ongoing cash and profits for generations… I hope so, they have the clout to at least go some or most of the way to doing so.

I fear it may be death by a thousand cuts, of Porter’s classic five forces model, they could be said to be facing all five. Which brings me back to the main question – take 7% income now, but risk the industry declining into dwindling profits, or look to invest in companies that will have a viable model in 15yrs time (potentially when I’ll be hitting FI if things go well!) I suppose the answer is both. I can’t see BP ceasing to be, but will it go nowhere over the next ten years and will the dividend be cut reflecting a lesser company? The thinking continues!

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