By Rohit Nair, Corporate Ratings

As BP refocuses on its core oil and gas business while trimming debt in what it referred to as a “fundamental reset” of its strategy, deteriorating market conditions could complicate its deleveraging efforts, strain cashflow, and embolden activist shareholders calling for bolder action.

We expect BP’s strategy to be marginally positive for the company’s credit profile in the short term, given the company’s explicit commitment to reduce net debt and significantly improve cashflow. Failure to keep leverage under control will reduce the headroom for BP’s issuer rating. Over the longer term, however, continuing investments in traditional oil and gas activities could support profitability at the expense of the business risk profile, particularly as the global energy transition accelerates.

BP is scaling back its ambitions in renewable energy, reducing overall capital expenditure, slashing investments in green energy while increasing capex on oil and gas exploration and production.

This strategic shift follows a volatile five-year period in which management invested in renewable energy assets with relatively low returns while grappling with the legacy of the Deepwater Horizon disaster without taking full advantage of higher oil prices to meaningfully pay down debt. This has left the company with some of the highest leverage amongst its peers, leaving it particularly vulnerable to further oil price declines and shareholder scrutiny.

Deleveraging promises based on possibly optimistic oil price assumptions

BP now finds itself with a commitment to lower leverage and improve cashflow by 20% annually just as oil prices look set to drift lower in the short to medium term. BP’s commitments rest upon assumptions of Brent prices at USD 70/bbl, USD 4/mmBtu gas price and refining margins at USD 17/bbl.

However, with Brent prices already close to the minimum price required for BP’s plans to succeed and refining margins running below assumptions, the company faces a Herculean effort to meet shareholders’ expectations while right-sizing its balance sheet for any future oil price shocks and/or reducing relative production costs to bring them in line with peers.

The company may also be forced to accelerate its plan to sell assets (signalled at around USD 20bn over the next three years) which would significantly help deleveraging efforts. This could include the sale of its lubricants unit Castrol and taking a more measured approach to share buybacks.

BP not alone in reassessing future investment in green energy

BP’s strategic shift is not out of line with the general trend in the industry – see our recent Oil & Gas Outlook.

Among Europe’s IOCs, Shell has recently scaled back its offshore wind investments and reduced its emissions targets as it prioritises shareholder returns and return on capital. Equinor pre-empted BP’s shift away from renewables by a matter of days, halving its investments in renewable energy, notwithstanding its recent acquisition of a 10% stake in Danish wind-farm developer Ørsted, while aiming to increase its oil and gas production by 10% over the next two years.

TotalEnergies remains an outlier in the industry and still plans to invest significantly in low-carbon energy though even the company is increasing investment in oil and gas to 40% of the total in 2025, up from 34% last year, while holding renewable capex at 25%.

Despite these shifts, all major European oil companies – BP, Eni, Equinor, Shell and TotalEnergies – are maintaining their net-zero 2050 ambitions, providing some comfort to environmental advocates concerned over the recent slowdown in decarbonisation efforts.

However, the stakes are high for BP. Activist minority shareholder Elliott Management, which has reportedly amassed a 5% stake, has a history of investing in companies that end up being broken up (Honeywell, Smiths Group). If falling oil prices disrupt BP’s reset, calls for a break-up or an outright sale of the company could grow louder.

A takeover by a rival IOC seems unlikely in the short term given BP’s current size, but management’s asset sale plans over the medium term, resulting in a smaller, leaner BP, may give potential buyers food for thought.

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