CASE STUDY: BP

In 2019, BP was the worlds fourth largest oil and natural gas producer (after ExxonMobil, Chevron and Royal Dutch Shell), with over 73,000 employees. The company is an integrated oil company, in the sense that it has both upstream (exploration and production) and downstream (refining and marketing) operations. In this respect it is similar to other integrated oil companies like ExxonMobil and Total. This case is about the companys upstream activities.

The company is registered in Britain, but 40 per cent of its assets are in the United States, and it is that countrys largest gas producer. It does 80 per cent of its business outside the UK, and is inherently engaged in international business, needing to succeed in many diverse political, economic and technological environments. In one recent year, its sources of oil and gas (measured in barrels of oil equivalent per day) were:

• Europe 201,000
• United States, 778,000
• Russia, 985,000
• Rest of world 1,478,000 (including Iraq)

While acknowledging that oil demand will eventually decline because of electric vehicles, Bob Dudley [CEO since 2010] insists the switch will take decades because of the difficulty of replacing oil in trucks, ships, aircraft and chemicals.

There will be a need for oil well into the second half of the century. There will be 2bn more people in the world by 2035 Every kind of energy is going to be needed (from an article by Andrew Ward, Financial Times, 21 December 2017).

Advances in surveying and drilling technology mean that oil reserves previously out of reach can be recovered such as those in deep oceans or beneath the Arctic ice cap. The company aims to secure access to sufficient oil reserves to at least replenish what it extracts, and to meet growing demand. It is also investing heavily in reserves of shale oil in 2018 it paid $410.5 billion to acquire another companys US shale oil business. It has also invested heavily in gas (which now accounts for almost 60 per cent of its production) and, to a lesser extent, in green technologies.

BP faces issues of corporate responsibility throughout the business, especially in exploration and production. Oil production inevitably brings environmental damage and an explosion in 2010 on a production rig working for BP in the Gulf of Mexico showed the hazards of deep water production. Environmental groups challenge oil exploration in sensitive areas, and a task for BPs corporate governance is to ensure that the company addresses these concerns alongside financial ones.

It has a large presence in the United States, where it both extracts and sells oil. Safety failures have damaged its relationships there, and it has had to pay significant compensation to individuals and businesses affected by these events, as well as fines to the US Government.

Those arising from the 2010 disaster have cost it 65 billion, and it expects them to cost at least 1bn a year for the next 15 years.

Below, Measures of financial performance in financial years ending 31 December:

Profit (loss) before interest and tax($m) 2018 - 19,378 2017 - 9,474

Profit (loss) after taxation ($m) 2018 - 9,383 2017 - 3,389

Dividend per ordinary share (cents) 2018 - 40.5 2017 - 40.00

The companys financial performance affects many stakeholders, as most pension funds hold shares in the company, using the dividend income they receive to pay their pensioners. Financial returns have been affected in recent years by the 2010 disaster and (until recently) by low all prices. By 2018, oil prices had risen and it had also been able to reduce production costs throughout the business. The directors decided to pay a dividend to shareholders of 40 cents a share for 2015. The figures above show the main financial indicators of performance in two recent years.

Managing to add value

Securing oil and gas reserves

A central preoccupation for management has traditionally been to secure new oil supplies, though it is now giving equal attention to acquiring sources of gas. The company has invested heavily to acquire licences to search for oil and gas itself and by acquiring, or creating joint ventures with, companies that already own such licences. For example it owns a 10 per cent stake in the Zohr gasfield off the coast of Egypt, which began producing in late 2017. In the same year, it bought resources in Abu Dhabi, Senegal and Mauritius part of a continuing effort to rebuild the business after more than $60 billion of assets were sold to settle its Gulf of Mexico legal obligations.

In 2011, the Indian Government approved a $7.2 billion oil and gas investment, which gave BP a 30 per cent stake in a large but technically difficult natural gas field off Indias east coast. This positioned the company as the first oil major to gain a foothold in a country where demand for oil is growing rapidly. Its collaborator in the deal is Reliance Industries, a major Indian company with a good reputation for project delivery and strong political connections. A year later, there were signs of difficulty, with administrative delays to investment plans, and evidence that output from the field (which has been operating for several years) was declining more rapidly than expected.

The company has to face the political risks that these ventures entail, especially in politically unstable countries where power conflicts amongst ruling elites can, directly or indirectly, threaten commercial ventures.

Joint ventures and governments

The companys most significant joint ventures have been with Russian companies. It owns 19.75 per cent in Rosneft, a state-owned Russian oil group, that has become an important source of earnings. The holding stems from a 2012 deal in which Rosneft acquired BPs share in TNK-BP, an earlier venture. As part of the deal, BP received a 20 per cent stake in Rosneft, giving it preferential access to resources, and a close alignment of their interests with those of the Russian Government.

Critics of this venture present BP as a passive investor with little influence, which Bob Dudley (who is also on the Board of Rosneft) rejects. He says the pair are working very smoothly on joint exploration and development projects, giving BP access to some of the worlds most plentiful and competitive resources. US and EU sanctions against Russia have complicated the relationship, but not derailed it. Mr Dudley knows all about the pitfalls of doing business in Russia but insists the country is worth the risks. It is one of the lowest-cost resource nations of the world. Its a natural place for us to be (from an article by Andrew Ward, Financial Times, 21 December 2017, p.11).

Culture and structure

During John Brownes tenure as chief executive (from 1992 to 2007), the company became decentralised, in the sense that managers responsible for a business unit faced tough financial targets but had considerable autonomy in how they met them. Senior managers believed this helped to reduce administrative costs and enabled unit managers to use their local knowledge and contacts to best advantage.

When Tony Hayward replaced Browne in 2007, he began to change the style, requiring managers to develop common working processes across the business, to reduce complexity and cut costs. This continues, and unit production costs have fallen 40 per cent since 2013, bringing the companys break-even point (the oil price needed to cover dividends and capital investments) to below $50 a barrel. Savings came from selling older assets and working more efficiently. Design has been simplified, equipment in all new developments standardised, and digital technologies make operations faster and more reliable.

Safety

The companys reputation had suffered in March 2005 when an explosion at the Texas City refinery, its biggest in the USA, killed 15 people and injured about 500. An internal BP report found that, although the plant was very profitable, local senior managers had ignored advice to invest in improving safety. There was further damage in 2006 when a pipeline spilled 270,000 gallons of crude oil into Alaskas Prudhoe Bay. The Alaska Department of Environmental Conservation blamed corrosion, which BP denied on the grounds that expenditure on corrosion maintenance was higher than it had ever been.

On 20 April 2010, the Deepwater Horizon a production rig exploded in the Gulf of Mexico while taking oil from the Macondo well which BP owned. The safety arrangements intended to cap the well in such circumstances failed to work, and oil flowed into the sea for many months, polluting it and the nearby coastline. The explosion killed 11 workers and the ensuing pollution caused economic damage to fishing and tourism, and widespread public criticism of the company in the United States. The company neither owned nor operated the production rig but agreed to pay compensation to businesses and communities affected by the accident.

To meet these costs and the fines for breaching US safety and environmental laws, BP suspended dividends payments to shareholders (which resumed in 2011) and sold several oil fields and refineries. By 2018, the disaster had cost BP $65 billion, though costs are now falling $7.5 billion in 2016, $5 billion in 2017 and likely $3 billion in 2018.

The company also made many internal changes including the resignation of the chief executive, Tony Hayward. He was replaced by Bob Dudley, a US citizen who had previously been chief executive of the Russian venture TNK-BP. His immediate task in handling the massive disturbance of the spill was to ensure the leak was plugged. The companys engineers did so in August 2010 a remarkable feat of engineering, as the well was over 5000 feet below sea level. Then he had to (amongst other things):

• meet claims for damages without letting the costs run out of control
• stabilise BPs financial position by selling assets
• establish the cause of the incident in conjunction with US Government agencies
• reform relevant internal practices
• restore the companys reputation in the USA
• develop a new strategy for the business.

Inquiries identified technical and managerial failures which had caused the accident including inadequate maintenance and inaccurate interpretation of data from the well. BP acknowledged its own failings, but also argued that other companies were partially responsible, including Transocean, which owned and operated the rig, and Haliburton, a contractor working on it: Haliburton had supplied the faulty cement intended to seal the leak. BP sought substantial damages from both companies alleging that Transocean workers failed to spot evidence of oil and gas escaping, and did not respond effectively when the escape became evident.

Aspects of BPs context

Oil demand and supply

In early 2013, a barrel of Brent crude oil (the standard used to measure prices) cost almost $120: by 2016, this had fallen to about $40. All oil companies responded by cutting costs delaying exploration and development, and improving the efficiency of existing operations it changed from chasing barrels to chasing efficiency. By 2018, the price had recovered to $80, which, with their now lower costs, led to higher profits for the oil companies.

Another technological change is the growing use of shale oil, especially in the United States, where one observer has predicted the USA may be self-sufficient in oil by 2025. BP has a large stake in US shale resources, having bought 470,000 acres of shale assets from another company.

Governments with oil reserves on their territory often depend on the technical resources of the worlds major oil companies to recover these reserves profitably. While the oil majors are eager to work there, they acknowledge that this requires them to work with business partners with different political and legal systems, including how they deal with human rights, democracy and bribery.

Oil exploration and production evidently affects the environment even in normal working it can disrupt wildlife, damage indigenous communities, and pollute air and water. The production process itself contributes to carbon dioxide emissions when gas is flared from oil fields. In 2018, it committed itself to maintaining its carbon footprint at current levels for seven years as it would cut emissions from its oil and gas rigs saving about 7 per cent of its current operational emissions.

One observer said:

Improvements in BPs operational emissions, while welcome, are too small to move the needle to prevent runaway climate change (The Guardian, 17April 2018, p.30).

1. Conduct a Porters Five Forces analysis on BP and identify how this may assist the organisation in their decision-making process. (500 words)