BP PLC

BP's second-quarter earnings of $5.7 billion increased from $2.4 billion the year before, exceeding market expectations, as higher prices and wide refining margins offset lower volumes. New CEO Meg O'Neill laid out her five key priorities in pursuit of a step change in performance.

Why it matters: Like peers, BP is benefiting from disruptions in the Middle East to deliver strong earnings and cash flow. However, it remains in catch-up mode as its performance has trailed peers amid a series of management turnovers and strategic missteps. O'Neill made her and BP's priorities clear, along with a strong statement about the need to do more. The five key priorities are: strengthening the balance sheet, simplifying the portfolio, investing with greater discipline, driving operational excellence, and hardwiring high performance and accountability. Progress in the first two is most noticeable. Net debt fell during the quarter, and the $14 billion-$USD 18 billion target is set to be achieved early, by year-end. Management indicated further reductions beyond that. Portfolio simplification is ongoing with numerous announced asset sales and the newly launched sales process for the North Sea and Archaea Energy.

The bottom line: Our no-moat rating and GBX 530/$41.60 fair value estimates are unchanged, leaving shares fully valued.

Big picture: Although not a full strategic update, O’Neill made clear where BP's focus lies. We see the admission of a performance shortfall, particularly operationally, as refreshing. The decisions to exit the North Sea demonstrate a lack of sentimentality and focus on returns. Plans to sell Archaea, formerly a keystone of the energy transition strategy, in the wake of the Lightsource BP exit decision, mark a full repudiation of the energy transition strategy that left BP a laggard. The priorities are the right ones, but execution will ultimately decide BP's success. We will be looking at future quarters for further signs of progress on each one.

Our fair value estimate incorporates the latest futures pricing, but assumes a moderation over the next few years to our midcycle price of $65/bbl.

After updating our model with the latest commodity prices, which reflect increases due to the war in Iran, our fair value estimate is $46.70 per share. We also incorporate the latest guidance from BP’s capital markets day and the company's strategic pivot. Our fair value estimate corresponds to an enterprise value/EBITDA multiple of 3.1 times our 2027 EBITDA forecast of $46.4 billion.

We have stripped Rosneft's earnings and value from our model, given the uncertainty surrounding its ultimate disposition value.

Our fair value estimate is derived using Morningstar’s standard three-stage discounted cash flow methodology. Under this methodology, we derive a terminal value using our assumptions for long-term earnings growth and return on new invested capital. This valuation methodology also more explicitly incorporates our moat rating, which reflects how long we expect a given firm to deliver excess returns on invested capital from a discounted cash flow analysis.

In our DCF model, we assume Brent prices of $90 per barrel in 2026 and $88 in 2027. Our long-term oil-price assumption is $65. We assume a weighted average cost of capital of 7.1%.

Our production forecast assumes 2.4 mmboe/d in 2030, at the midpoint of management guidance. Actual volumes will vary depending on divestitures. We do not explicitly model divestments, since volumes and value received remain unknown. We forecast downstream earnings to be strong early in our forecast period due to favorable market conditions and to remain so as organic investments increase earnings capacity through 2030.

In our view, BP does not have an economic moat, as our forecast for excess returns has fallen too low while its cost position is not strong enough to offset the future uncertainty around commodity prices.

Under its latest strategic plan, BP should make headway in reducing costs and improving profitability in the next few years. However, we forecast returns to barely exceed the cost of capital in the later years of our forecast, assuming $65/bbl.

Furthermore, the uncertainty around excess returns 10 years from now has increased due to changes in the business' composition and potential commodity price levels over that period. Although BP has trimmed its ambitions, we don't have confidence that its investments in renewable and low-carbon businesses will create competitive advantages or that commodity prices will remain high enough to generate excess returns over the next 10 years. As such, BP fails to meet key criteria for a narrow economic moat rating. As time passes and BP demonstrates strong competence and execution in these newer areas, if our view of commodity prices changes, divestitures meaningfully reshape the portfolio, or it materially improves the returns of its core oil and gas business, we could revise our moat rating.

Incremental investment in BP's hydrocarbon portfolio will likely be value-accretive. As part of its updated strategy, the firm is increasing investment relative to previous plans; exploration and upstream capital spending is set to rise to roughly $10.5 billion annually through 2027, above prior guidance. The investment will deliver up to 20 major projects through 2030, improving BP's upstream margins. Total volume impact will be limited, though, with expected production of 2.3-2.5 million barrels of oil equivalent per day in 2030. The lower end of the range is about even with 2024 levels but higher than previous expectations. Based on Rystad data, we estimate BP's project queue (sanctioned and unsanctioned) has an average breakeven price of $40/bbl, well below our assumed midcycle price of $65/bbl.

Although this would imply that BP can safely deliver incremental excess returns, the last decade or so has left us wary. Including 2008, oil prices have crashed three times. While they quickly rebounded to $100/bbl by 2010, they crashed again in 2014 due to the oversupply from the emergence of light tight oil in the US. This also represented a permanent downward shift in the cost curve and led to the revision of our midcycle price to $65/bbl. As a result, BP's cumulative economic profit over 2011-19 was negative. In 2020, the coronavirus pandemic caused another oil price crash. In 2026, the outbreak of the Iran war created another significant price spike—Brent swung from roughly $118/bbl in March to $70/bbl by July before rebounding above $100/bbl—boosting returns. As of now, cumulative economic profit over the next five years is positive, even assuming oil prices moderate to $65/bbl and BP's cost structure improvement holds.

Regardless, the excess returns we forecast for BP at our midcycle price are too narrow to instill the confidence that it can endure the cycle across various price environments; thus, our no-moat rating.

Our no-moat rating also reflects uncertainty around the company's strategic shift toward renewable and low-carbon businesses even as it has materially trimmed those ambitions, a move we believe will result in higher returns. However, it remains committed to many areas such as carbon capture, hydrogen, and EV charging, where returns are uncertain. Its plan beyond 2027 is unclear, and BP's original target tied to its transition growth engines now looks out of reach as originally framed. Greater clarity on its plans after 2027 would potentially make us revise our moat rating.

In total, BP expects its updated plans to deliver returns on capital employed of more than 16% in 2027. At this level, returns would safely exceed BP's cost of capital, but we remain concerned. The returns assume $74/bbl of oil versus our midcycle estimate of $65/bbl, as well as higher US natural gas prices and refining margins than 2024 levels.

Returns will also benefit from BP's new strategy for renewable power generation. Previously, investments in wind and solar were key elements of its strategy. However, both have struggled to deliver returns, especially offshore wind, where BP recorded impairments. BP plans to reduce investment, narrow its opportunity set, and raise the quality of its portfolio. It will also tap partners to reduce capital intensity and improve returns. It has already placed its offshore wind assets in a joint venture with JERA (JERA Nex BP) and is separately reducing its exposure to solar through a planned stake sale in Lightsource BP. Both efforts should improve BP's reported returns.

BP faces several environmental, social, and governance-related risks. Still, these have no bearing on our final moat rating, as most are too long-term for moat consideration or are not a probable or material enough risk to cause material value destruction. BP's primary ESG risk stems from carbon emissions tied to its operations and product use, as well as effluents and waste generated in operations, including oil spills.

Oil spills are an ever-present risk for oil companies operating offshore and can devastate a firm's value, as BP's Macondo incident shows. While oil companies regularly cause spills, most are immaterial in size, and associated fines and cleanup costs are manageable.

BP’s pivot back to oil and gas should result in stronger long-term performance and higher returns than its previous energy transition strategy.

BP’s strategy of moving renewable investments into stand-alone JVs reduces capital intensity and improves returns while maintaining exposure to renewable power growth.

Although BP lacks strong production growth, its new projects have higher margins and lower development costs, improving returns and lowering breakeven levels. BP will maintain hydrocarbon production at current levels for longer than expected, ensuring continued levels.

BP’s pivot back to oil and gas will not sufficiently satisfy investors displeased with its performance, and its underperformance will continue.

BP’s relative lack of oil production growth puts it at a disadvantage to peers. Oil demand will continue to grow for another decade, while current industry underinvestment will result in higher-than-expected prices.

Reducing low-carbon spending and risking long-term emissions targets will likely turn off ESG-oriented investors, eliminating a potentially large shareholder base in Europe.