By Brian Swint

BP has been falling behind its peers for years. If it doesn't narrow the gap, its days as an independent company could be numbered.

The world's fifth-largest oil major, which traces its origins to discoveries of oil in Iran in the early 20th century, has been on its back foot since the Deepwater Horizon oil spill in 2010 that cost the company $65 billion. BP's decline has accelerated in recent years following a big and ultimately bad bet that demand for oil and gas wouldn't stay strong, as the company leaned in hard on the transition to green energy. Rival energy companies that stayed focused on fossil fuels have fared better.

That bad bet could now push BP into the arms of its crosstown London rival Shell, or another suitor such as Exxon or Chevron in the U.S., if BP CEO Murray Auchincloss can't find a way to bolster its flagging share price. In a worst-case scenario, BP could be dismantled and its profitable operations sold off.

"In the medium term, BP might be merging with Shell," said Paul Gooden, a portfolio manager at Ninety One in London. "BP has been suffering from 'noble cause corruption.' They've been focused on something other than creating shareholder value."

Gooden is referring to BP's low-carbon investments in wind, solar, and other renewable energy that haven't been as profitable as oil and gas. The company says it is committed to becoming an integrated energy company.

The problem for BP is that there is no easy way out. If it stays on its current course, its performance compared with peers probably will only get worse -- its total returns came to 39% for the past 10 years, compared with Shell's 49%. It is even further behind Exxon's 80% total returns and Chevron's 98%, taking dividends into account. But BP is also likely to be punished if it tries too aggressively to clean up its balance sheet. For example, slashing its stock buyback program to pay down its debt, or selling off assets, could lead to an even sharper drop in the stock price.

BP reports fourth-quarter earnings on Feb. 11, and it hosts a capital markets day on Feb. 26. A spokesman for BP declined to comment on the company's plans ahead of those events.

Gooden expects a "course correction" rather than an "overreaching review." Auchincloss was chief financial officer under Bernard Looney, the previous CEO who set the company on its current trajectory.

Even though Auchincloss has taken steps to simplify and slim down the company -- he announced cuts of 4,700 employees, or about 5% of the workforce, and 3,000 contractors in January -- he still represents continuity.

"Strategically, BP lost their way," said Biraj Borkhataria, global head of energy transition at RBC Capital Markets in London. "BP needs to show evidence that its new engines are providing earnings growth. 2025 is an important year."

BP remains a profitable company with a dividend yield of more than 6%. The issue is the company's hefty debt, which means that the dividend and share buybacks may need to be cut quickly if oil and gas prices should fall -- something that President Donald Trump has promised to make happen.

"BP has the highest debt profile versus its peer group," said Bill Selesky, a strategist at Argus Research. "Investors expect oil and gas to be highly volatile, and they want a less risky investment."

To illustrate: BP's debt-to-equity ratio was 23.3% in the third quarter. TotalEnergies was at about 13%. At the end of last year, Exxon's was 13%, Chevron's was 13.9%. Shell lies in between -- its ratio was 17.7% in 2024.

Like other big oil companies, BP made record profits in 2022 as crude prices spiked in the wake of Russia's invasion of Ukraine. Unlike its peers, the company didn't use the funds to significantly reduce its debt load. Instead, it went shopping, snapping up firms like Archaea Energy, the largest renewable natural-gas producer in the U.S., and EDF Energy Services, a retail power company.

Auchincloss suggested in October that BP's buyback plans may need to be revisited, indicating that investors are right to be worried that the distributions can't last.

"High dividend yields are more of a red flag than a green light," said Allen Good, a strategist at Morningstar. "Shell has the blueprint. They sold off some low carbon assets, reduced investment overall while increasing investment in oil and gas, and they're cutting costs."

Good says a merger between BP and Shell isn't out of the question, but it wouldn't be easy. For one, BP hasn't said it wants to sell, and Shell hasn't said it's interested in acquiring it. A spokesperson for Shell declined to comment.

Plus, Shell is still working to get its shares up after changing tack under CEO Wael Sawan, who took the reins at the start of 2023. Shell trades at 8.5 times forward earnings, the same as BP -- which makes it hard to argue that BP's shares are relatively undervalued in those terms. By comparison, Exxon trades at 13.7 times, and Chevron is at 13.8.

"Shell and BP trade on similar multiples, and so we don't see the obvious accretion from a potential merger," RBC's Borkhataria noted.

BP could also consider splitting itself up. Its U.S. onshore oil-and-gas business, called bpx, is a prize asset. But if BP gets rid of its most promising oil and gas fields, it reduces its potential to grow.

It isn't obvious how much time BP has before it reaches a crisis, but investors are getting frustrated. That could make them vulnerable to activist campaigns. One group, Bluebell Capital Partners, pushed for a strategy shift for years but just closed shop in December -- ultimately, it was too small to wield much influence.

Others may see BP as ripe for a big shake-up. The pressure on Auchincloss is only going to increase.

Write to Brian Swint at brian.swint@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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February 04, 2025 10:28 ET (15:28 GMT)

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