It hasn’t been pretty in the oil patch. For the past year, every major player in the energy sector has been shedding assets and slashing investment. In a world awash with cheap oil and gas, maintaining dividends and keeping debt loads in check has become a much bigger priority.
Interestingly, given how reluctant oilmen are to commit capital to new production, British energy major BP plc (ADR) (BP) made headlines last week by inking a deal with the China National Petroleum Corporation.
So, what might this mean for BP stock?
The two companies will cooperate in exploration, development and production of shale gas resources in the Sichuan Basin of southern China. The deal also allowed for further collaboration, including retail operations, carbon emissions trading and liquefied natural gas trading.
But at its core, the deal means that BP will be helping China develop its domestic shale gas resources.
It’s pretty easy to see China’s motives here. China currently uses coal for a disproportionate share of its domestic energy needs, and the air in Chinese cities has become all but unbreathable.
China also takes a lot of heat from the West and from environmental activists over its carbon emissions and overall environmental record. So, anything China can do to clean up its image and improve the quality of its people’s lives is obviously a major win.
There are also geopolitical factors at play. China saw the shale revolution transform America from perpetual energy importer to production powerhouse over the last decade, and they want to see something similar on their own soil. China has the world’s largest shale gas reserves by a wide margin. In fact, by U.S. Energy Information Administration estimates, China’s shale gas reserves are nearly double America’s.
Imagine the geopolitical appeal to China. Gas piped in from domestic Chinese sources is gas not piped in from rival nations like Russia or from the volatile regimes of Central Asia and the Middle East.
Can China Help BP Stock?
For BP, this is also a win because, frankly, opportunities are harder to come by elsewhere. And in China, the projects have a patron that is less concerned with current profitability and more concerned with long-term strategic objectives.
Looking at BP stock, there is a decent bit to like. Energy is one of the few pockets of the stock market that is actually in bargain territory these days, and BP is one of the cheapest among the global energy majors. BP stock trades for about 12 times expected earnings this year and yields a fat 8.2% in dividends.
Now, given the state of the energy market, I don’t see BP being able to raise its dividend any time soon, and analysts have openly questioned whether BP’s dividend is sustainable at current rates. According to BP’s management, BP can fund all needed capital expenditures and meet its current dividend commitments with current cash flow so long as the price of crude oil stays above $60 per barrel.
Well … the price of crude oil is, of course, nowhere near that level. So unless the price of oil rises by another 50% in a hurry, BP will need to either accelerate asset sales, reduce capital spending more or allow its leverage to grow a little in order to fund the dividend.
Management has said that it is willing and able to do all of the above, and I agree — at least for a year or two. After that, it gets more questionable. So this really becomes a question of your outlook for crude oil.
If you believe that the price of crude oil will be significantly above $60 per barrel in another year or two, then BP stock is worth a look. If not … you should probably keep looking.
Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas. As of this writing, he was long BP.
