Royal Dutch Shell Plc .com: Spectres loom for booming BP

Lord Browne has turned the failing oil giant around, but as he prepares to step down old questions are resurfacing, writes Oliver Morgan

Sunday July 9, 2006
From The Observer/Guardian Online

It is difficult to picture it, but in the years before John, now Lord Browne, became chief executive of BP, the company was widely thought to be in terminal decline. His predecessor-but-one, the overbearing Sir Robert Horton, was forced out after presiding over a slump in performance that saw the company make its first quarterly loss, sparking rumours of an ignominious takeover by Hanson. Lord Simon, his successor, stabilised things but, by the mid 1990s when Browne took over, BP was still seen as a ‘two pipeline company’ raking in cash (circa $30bn of revenue) from the Forties field in the North Sea and Prudhoe Bay in Alaska – both discoveries of 20 years standing.

Fast forward a decade, and BP generates $260bn of revenue, producing 4 million barrels of oil a day, and has exploration and production activities in 26 countries. With oil prices high, this means record profits are now routine. Shareholders have feasted on dividends and buy-backs.

But despite admiration for BP and Browne, these are not easy times for either. Last year the company’s reputation for safety was hit by an explosion at its Texas City refinery. Along with the reputational damage, the incident wiped $700m off BP’s profits. There have been oil spillages and more recently BP has been accused by the US Commodity Futures Trading Commission that its traders tried to corner the propane gas market.

Perhaps most significantly, last week Browne admitted that production fell for the fourth quarter in a row, down 2.5 per cent on a year ago. Questions over where future production would come from began the erosion of confidence in BP in the 1990s. The company is transformed, but, as Browne prepares to step down (he reaches the company retirement age in spring 2008), the questions are beginning to reappear.

He points to emerging problems such as oil nationalism in South America. Analysts, while admiring BP’s early move into Russia via a 50:50 joint venture with TNK, also underline geo-political risks there, highlighted by the fate of Yukos, whose assets were allegedly misappropriated by oil giant Rosneft, and now comprise 70 per cent of its income. Rosneft will float this week in London with an $11bn price tag and a string of pending lawsuits from Yukos investors. BP is considering taking a $1bn-$2bn stake.

Meanwhile, analysts at Sanford Bernstein recently looked at prospects for the global oil majors and concluded that their fortunes will depend on more ‘upstream production’. They needed to do deals with national oil companies (essentially government departments, so fraught with political risk), break into resource-rich non-OECD countries (again high risk) or obtain reserves of unconventional oil, such as oil-sands, in regions such as Canada. They note: ‘Overall, we see the winners for the next decade as ExxonMobil, Chevron, Total, Shell and BG, with BP, Conoco-Phillips, Marathon and ENI probably requiring further actions to support 2015-2020 production.’

Whatever moves BP tries to make, it can be sure of competition not just from Exxon et al, but from emerging nations such as China and Malaysia. Where once Western majors dominated resource auctions in producing countries, now contests are fiercer and prices are higher. Like others, BP must take what it can, when it can, which is why it is seriously considering a Rosneft stake, not merely for financial benefit, but for the political clout it would buy in future.

The view contrasts strongly with BP’s current eminence. Tom Ellacott of oil industry consultant Wood MacKenzie says: ‘One of the defining factors about BP is just how well it has performed on exploration and production in the past few years.’

As a result, he adds: ‘This is a company with a differentiated portfolio. TNK-BP for example, was very much a defining move, and as a result they have significant exposure to Russia, an area that is going to be extremely important.’

Indeed the deal with TNK, though criticised as high risk, has high potential return. It is the only significant corporate deal between a Russian and Western oil company giving access to Russian reserves. Last year total production, including gas, was 2 million barrels of oil equivalent. BP received a ‘dividend’ of $1.95bn from the venture.

Another point of differentiation, says Ellacott, is that ‘it has a very focused portfolio’. BP has targeted long-lived high production basins such as the Gulf of Mexico and the Angolan coast. A third point is that it has shone by avoiding mishaps such as the reserves scandal at Shell which resulted in the writing off of a quarter of the company’s reserves. BP boasts that last year was the 13th in a row where its reserve replacements were 100 per cent or above. It has also demonstrated PR deftness on issues such as the environment, giving it an advantage in sensitive political negotiations over, say, Exxon, which refuses to acknowledge climate change.

Meanwhile, BP pushes forward operations in Azerbaijan, Algeria and Indonesia and looks to extend its position in Russia via further exploration with TNK and a joint venture with Rosneft on Sakhalin Island where it claims ‘significant future potential’.

Nevertheless, as Neil McMahon at Sanford Bernstein wrote recently: ‘Russia is simply not enough.’ The TNK deal reversed a production decline from 2003, while Thunder Horse in the Mexican Gulf and Kizomba off Angola will keep production up for another five years. But BP production falls from some 4.5 million barrels per day in 2010 back to 4 million barrels per day by 2020.

McMahon notes that in the Mexican Gulf , projects are becoming more challenging. He adds that Russian discontent with Western majors poses questions over projects there. By contrast, Shell and Exxon, the largest of the three, peak later, though they see fall-offs by 2020.

Shell, for example, now receives recognition for its diversified portfolio. As one analyst says: ‘There is a virtue in not having all your eggs in one basket.’ At the same time, it has invested in non-conventional extraction. It is a leader in the Athabasca oil sands project in Canada, where analysts expect to see considerable future value. BP has little activity in unconventional oil extraction.

The firm points out that it plans to spend $8bn on alternative fuels in the next 10 years, and Browne has emphasised the importance of new research. However, that figure compares with $50bn invested in the past five years in exploration and production, leaving aside spending on refineries and its global network of service stations.

Despite the problems of the past year, Browne remains one of the most respected business figures. But, as he says, companies must keep moving to survive.

The tantalising question now is that, with a few clouds on the horizon, will he attempt one last transformational act? Take China, for example: BP has invested there before, making money last year by selling a stake in Petrochina that it bought in 2000. One analyst asks: ‘Does he has one more move up his sleeve, one more deal left in him?’

Browne’s transformation act

Lord Browne consistently tops surveys of Britain’s most admired businessmen. Joining BP in 1966 from Cambridge, where he read physics, he has become synonymous with the company he has transformed in the past decade to the point that it now has a major headache in finding his successor.

Dapper, diminutive, single, and with an interest in pre-Columbian art, Browne is a BP lifer, having worked his way up the group’s exploration and production division to become chief executive in 1995. He has brought transformation through major acquisitions in the US and Russia. Tom Ellacott, of oil industry consultants Wood MacKenzie, says: ‘His track record in terms of beating the industry and establishing first leader advantage is remarkable. The acquisitions of Amoco and Arco of the US and the formation of TNK-BP in Russia were ground-breaking deals that transformed the company.’

The Amoco and Arco deals gave BP refining and marketing presence in the world’s biggest-consuming nation, while positioning it for expansion into the Gulf of Mexico, a key production zone. The company now has 40 per cent of its assets tied up in North America.

But while the US moves gave BP new scale, there were still questions over future production. The deal with TNK gave it a 50-50 stake in a major Russian producer through a one-off deal which other majors cannot now replicate. With the Middle East effectively closed to corporate deals giving companies operational, commercial and financial freedom, getting into Russia, the world’s second-most significant oil and gas region, was a major coup. ‘That sealed Browne’s reputation, not only as a skilled dealmaker but as a political player as well,’ says one analyst. The deal is still considered risky, and the involvement in Russia is not free of blemishes; before the TNK deal, BP bought a stake in another company, Sidanko, which proved disastrous.

He clearly wants to add China to the portfolio. Last autumn BP confirmed it had held talks with the Chinese government about a stake in Sinopec, the country’s largest producer of oil products. A foothold in China will give access to the world’s fastest-growing market, quite a swansong for the man who says he will continue in business life beyond petroleum.