Shareholders Digest BP's Transition Strategy Transitions

The Issue

Questions have surrounded the efficacy of BP's energy transition strategy since it was first unveiled three years ago, but a yawning equity performance gap has finally forced a recalibration. To be sure, the share price performances of the European majors have more broadly lagged those of their US peers coming out of the Covid-19-led downturn, creating headaches in the board rooms of Shell and TotalEnergies as well. But with the wider macro environment for oil and gas and climate progress running particularly afoul of BP's underlying assumptions, the UK major has had to amend its strategy toward something of a blend of its peers in a bid to reassure investors and maximize returns.

BP Takes Stock

BP made significant changes to its transition strategy last week that will see the UK major keep more oil and gas in the mix for longer and refocus its low-carbon investments to emphasize areas it believes it can achieve relatively higher returns. The reset brings BP’s approach to oil and gas closer to that of its European peers — albeit with still peer-leading output cuts — and elements of its low-carbon focus that draw from the playbooks of European and US majors alike. CEO Bernard Looney pitched the pivot as boosting earnings and returns.

The changes start to address some long-standing concerns about BP’s more aggressive transition strategy that have dogged its shares since August 2020. Equity analysts and industry players alike scratched their heads at the time at the calculus BP laid out: How would BP have enough cash to fund its plans if its core oil and gas businesses shrunk so significantly and swiftly? Could renewable electricity — an area where BP lagged peers — really be so rapidly deployed without compromising already smaller returns? And could BP really hope to simultaneously fund growing shareholder returns through this process?

It is unsurprising, then, to see Jefferies analysts characterize last week's shift “as an attempt to correct the course set in 2020 following disappointing returns in renewable energy as well as an improved outlook for oil [and] gas." Indeed, the market's wider response to BP's changes has been unquestionably positive, with its shares up 16.7% in London and 17.7% in New York over the past week.

Despite the bounce, BP still has work to do to close the equity performance gap with its peers. There is growing enthusiasm around the company’s ambitious returns policy, which includes both dividend increases and pledges to direct 40% of surplus free cash to share repurchases. But questions remain as to whether it will be enough to court investors and is sustainable.

“We do not expect the market to pay up for 2030 earnings growth given BP's patchy track record and multiple strategy pivots in recent years," RBC analyst Biraj Borkhataria said in a note. "However, the bottom line is with the growing dividend and lofty buyback, investors are being paid to wait.” RBC estimates that BP's potential 14% shareholder return this year would be the highest in its peer group.

The Other Side

And of course not all investors are interested exclusively in near-term returns.

If BP’s 2020 strategic overhaul was meant to lure in climate-minded investors, the company’s cadre of “active owners” will now have to decide how to make sense of last week's recalibration — which includes the relaxation of BP's Scope 3 (end-use) emissions targets — and whether continued investment aligns with their portfolio targets.

“In the context of a very strong financial outcome, those investors with net-zero goals, including many of our clients, will be concerned at such a material change to BP’s 2030 absolute emissions reduction target,” said Bruce Duguid, head of stewardship, EOS at Federated Hermes. “It also raises a significant governance question, given the high proportion of investors that supported the original target only nine months ago at BP’s 2022 AGM ‘say on climate’ vote,” he added, referencing the nearly 89% of BP shareholders that voted in favor of the company's "Net Zero: From Ambition to Action" strategy report last May.

Duguid leads engagement with BP for the massive Climate Action 100+ coalition, whose members have $68 trillion under management and that has threatened to divest from companies they see taking inadequate measures to reduce emissions in a manner “consistent with the Paris Agreement’s goal.” That said, Duguid noted that BP maintained its goals to cut its Scope 1 and 2 (operational) emissions and to allocate 50% of its spending to low-carbon businesses by 2030.

Investors may have the opportunity to have a direct say on the matter via a vote at the UK major’s annual meeting this spring. Activist group Follow This, which buys small stakes in companies in order to bring forward shareholder initiatives, has filed a resolution at BP asking investors whether they want the company “to align its existing 2030 reduction aims …. with the goal of the Paris Climate Agreement,” including for Scope 3 emissions of all products sold. Notably, similar resolutions at BP and other oil and gas firms saw declining support last year.

Questions Remain

BP’s strong performance does not necessarily mean that the reset has erased all doubts about its ability to profitably navigate the transition. Even with a now-oilier portfolio, BP has not put to rest questions around how it can consistently fund growing shareholder payouts as well as its more transition-minded investment program given its increasing reliance on cashflows from businesses whose returns profile is still uncertain. After all, BP's oil and gas portfolio is still set to shrink by more than 20% between 2019 and 2030 — although higher asset sale proceeds will help.

“We are concerned that a significant portion of the Ebitda growth story presented yesterday hinges on overly optimistic volume growth and margin expectations for the low-carbon businesses,” analysts at investment bank Jefferies said in a note to clients following BP's announcement.

Even Borkhataria, who is bullish on BP shares, noted that the company’s earnings guidance looks “highly ambitious” relative to Street estimates. “BP's Ebitda guidance for 2025 is some 20% ahead of consensus (+15% ahead of RBCe), and for 2030, the gap grows even wider (+40% versus consensus).” More broadly, while BP might be right-sizing its transition aspirations, the discount between the European and US majors shows that investors have not decided whether they want exposure to oil and gas and renewable energy in the same company.

Analysts point out that as much as 50% of BP’s additional earnings expectations — anywhere from $5 billion to $7.5 billion by 2030 — are due to increases in the company’s assumed oil and gas prices rather than underlying business prospects. The idea that prices could remain high even as demand starts to decline has gained momentum, but some point out that BP’s own energy outlook calls for oil and gas demand in 2035 to be 5% -6% lower than it expected just a year ago, as the Russia-Ukraine conflict drives an accelerated transition in Europe.