The pandemic hit oil companies hard in 2020, and BP (LSE:BP) was no exception. Lockdowns and travel restrictions were introduced worldwide last year to help slow the spread of infection. But as a result, cars remained parked at home, planes on the ground, and some factories shuttered or working below capacity. This all led to oil demand plummeting to its lowest point in decades, taking the BP share price with it.
However, over the last few months, the stock has been climbing – increasing from 205p in November to around 300p today. Is this an early sign of the firm’s recovery? And should I be adding BP to my portfolio?
Why is the BP share price rising?
Like other oil companies, BP has little pricing power over its products. This proved to be problematic in the early days of the pandemic. However, the firm can mitigate its losses in several ways. In 2020, it cut its dividend, sold some sites and facilities, and focused on paying down debt to reduce interest expenses.
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The latter of these, I believe, is a primary contributor to BP’s rising share price. By the end of Q1 2020, net debt stood at around $51.4bn and was dangerously close to the business’s total market capitalisation. But based on the latest updates, these long-term obligations have been cut by nearly 25%. As it stands, net debt is now around $38.9bn, with the management team expecting it to fall below its target of $35bn by the end of Q1 2021.
This is excellent news for two reasons. The first and most important, in my opinion, is it strengthens the balance sheet and increases BP’s financial health. The second is a reduced debt level increases the availability of excess cash flow to pay dividends and perform share buybacks. In fact, BP has already said that once the $35bn debt target is met, a minimum of 60% of surplus cash flow will be used to buy back shares.
Uncertainty ahead
BP is constantly under scrutiny for its impact on the environment and global warming. So I find it encouraging to see it has initiated a zero-emissions long-term strategy. Under this new direction, the firm has begun its transition to sustainable and clean energy generation.
But BP is one of the largest oil companies in the world. A complete transition like this will be a multi-year process, during which many complications could arise.
For example, producing and selling oil will be key to fund its shift into renewables. However, as electric vehicles become cheaper and more widely available, oil demand will likely suffer, as will its price, restricting BP’s access to internal capital, as well as affecting its share price.
Another risk that I’ve previously highlighted is renewable technology itself. Green energy generation methods may not be as profitable as oil is today. And consequently, the surplus cash flow used to reward shareholders may be significantly impacted.
The bottom line
There are still many unknowns regarding the company’s transition into renewable energy. But now that oil prices have returned to around $60/barrel, and the net debt level is close to being back under control, I believe that the BP share price can recover in 2021. Or at least it could be close to doing so. Therefore, I would consider adding it to my income portfolio.
