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The global oil and gas industry generated free cash flow last year of more than $1.4trn BP (LSE:BP) stock is on the radar of many investors.
I’m bullish on fossil fuels in the medium term, and I wouldn’t shy away from adding oil and gas giants to my portfolio.
However, I found several red flags in BP’s cash flow statement.
Windfall of war (and underinvestment)
BP’s operating cash flow – revenue minus operating expenses – will increase from $12.2bn in 2020 to $40.9bn in 2022.
| Operating cash flow ($ million) | |
| 2020 | 12,162 |
| 2021 | 23,612 |
| 2022 | 40,932 |
US President Joe Biden said in October last year: “Today’s record oil company profits are…the lows of the brutal conflict that has devastated Ukraine..”
But President Biden left out an important factor: oil and gas prices are also rising due to less investment in sectors that are sapping production.
With politicians around the world beating the drum for fossil fuel phase-out, capital-intensive, decades-long exploration and extraction projects seem riskier than normal.
However, I believe oil will continue to be the lifeblood of the global economy for decades to come. Materially intensive ‘green’ technologies do not exist or are in an embryonic stage throughout the developing world.
Therefore, I want to own shares in oil and gas companies that have the foresight to remain diligent in investing in the future of fossil fuels.
I just don’t believe BP fits the bill.
Cannibal cash flow
BP’s operating cash flow increased by 237% from 2020 to 2022. Meanwhile, the company’s expenditure to finance new projects increased by only 75%.
While $27.3trn in financing activity between 2020 and 2022 seems like a lot, consider that the company spent $17.3trn on assets over the same period, with a net figure of just $10trn.
| Net cash used in financing activities ($ million) | |
| 2020 | (7858) |
| 2021 | (5694) |
| 2022 | (13,713) |
Now, compare it to how much the company pays dividends and buys back shares, the elements included in ‘net cash used in financing activities’.
| Net cash provided by (used in) financing activities ($ million) | |
| 2020 | 3,956 |
| 2021 | (18,079) |
| 2022 | (28,021) |
Of course, everyone loves dividends and buybacks. But when overdone, these feel-good activities cannibalize the company.
There are also elements of glass and mirrors here. This is because, despite the problems regarding the buyback of BP’s giant shares, the company has also increased the number of outstanding options, through the equity-approved employee stock option plan, by 1,900% between 2020 and 2022.
| Number of options outstanding (millions) | Weighted average exercise price ($) | |
| 2020 | 28.2 | 3.79 |
| 2021 | 590.9 | 4.26 |
| 2022 | 564.1 | 4 |
This causes dilution which will, to some degree, cancel out the share buyback.
After coaching BP financials, I decided not to buy shares in the company, despite the bullishness of the sector.
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