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BP reeling from crude challenges

The Herald
DOUGLAS HAMILTON February 09 2009

Lower oil prices, problems in the United States and higher taxes will make life difficult for BP during the next 12 months.

Last week, BP reported its first quarterly loss in more than seven years as a spreading global recession sapped demand for crude oil while TNK-BP, its troubled Russian unit, was hit by a $700m tax and foreign currency charge.

The $3.3bn (£2.2bn) fourth-quarter loss by Europe’s second-biggest oil company, which compares with a $4.4bn profit a year ago, has compounded a growing sense of crisis in the oil industry, which has been reacting to plunging oil prices in recent weeks by cancelling projects such as investment in the western Canadian oil sands, and eliminating thousands of jobs.

Globally, about $100bn worth of oil and gas projects have been either delayed or scrapped in recent months because of the financial crisis and weak oil prices, according to the Paris-based International Energy Agency.

Tony Hayward, BP’s chief executive, told investors a few days ago that the company was facing a “challenging” two years and blamed its weak performance on “the recent dramatic fall in the world price of crude”, which had slipped from a record high of $147 a barrel last July to about $40 now.

Hayward said that BP, which employs 90,000 staff around the world, was responding to the downturn by intensifying a cost-cutting drive that would lead to the loss of more than 5000 jobs by the middle of the current year – more than expected. The group managed to lower overheads by $500m in the last three months of 2008.

BP is the latest big oil group to announce sharply lower profits for the end of last year. Royal Dutch Shell recently announced its first quarterly loss in 10 years. Total, of France, and Conoco Philips, the US group, have also reported sharp falls in earnings and have made thousands of job cuts.

City analysts say BP needs an oil price of at least $50 to $60 a barrel – more than 20% above current levels – to be able to pay for its capital spending programme and dividends without borrowing.

However, crude oil futures are unlikely to rise above $40 a barrel unless there is a serious supply problem such as conflict in the Middle East or in another key oil-producing area.

London-based petroleum industry experts say the global slump will keep demand for oil depressed for much of 2009 and perhaps beyond.

As well as grappling with a reduced demand for its products, BP will face higher taxes and difficult downstream operations.

BP told the City last week that its annual tax rate would go up to between 36% and 39% – not exactly reassuring considering the company also reported a loss for its downstream refining and marketing business.

“Concerns will remain that this business is not making any progress,” said analysts at investment bank Credit Suisse, “despite thorough restructuring efforts”.

There are other warning signs that the company’s performance is sluggish at best. BP’s announced quarterly replacement cost profit of $2.6bn came in below forecasts. An avalanche of export duties in Russia hit BP’s TNK-BP joint venture with a pre-tax loss of nearly $1bn, while exploration and production did not bring in as much money as hoped.

According to analyst Gidmund Halle Isfeldt, of Norwegian bank DnB NOR, BP’s high exposure to shale gas assets in the United States meant it had fallen victim to the country’s oversupply of gas relative to demand. He added that BP’s high proportion of upstream revenues relative to downstream made it a slightly less defensive stock than Royal Dutch Shell.

Russia is also a problem area for BP. In the fourth quarter, the firm took a $517m writedown on its investment in oil company Rosneft, which has suffered from dwindling investor confidence, while TNK-BP was saddled with export duties that were effectively paid in arrears.

“They fell all at once,” said a spokesman for BP.

The Russian shareholders of TNK-BP wrestled for control of the joint venture in 2008, but in September both sides agreed to a new structure that made the chief executive role less powerful.

A new chief executive is expected to be announced after former chief Robert Dudley’s departure.

As to investing in BP or not, ING analyst Jason Kenney is not bullish on the company. He recommended opting for France’s Total instead, and said it was the most profit- able of Europe’s big oil players.

Some analysts have suggested BP could seek to merge with US rival Exxon as industry conditions become more hostile and new oil reservoirs become harder to find. Exxon is understood to have run a slide rule over BP as it seeks possible acquisitions.

Despite the constant stream of grim economic data and negative comments from analysts, BP is trying to sound upbeat about 2009. The company raised $5bn in debt last year and with only 21% gearing, at the bottom of its target range, the firm is not rattled by the diffi- culties of the credit crunch. It is sticking to plans for capital expenditure between $20bn and $22bn this year, compared with $21.7bn in 2008, and will be looking for potential acquisitions.

As if plunging oil prices and other problems were not enough, BP’s search for a new chairman is not going as smoothly as planned. The hunt for a suitable replacement for Peter Sutherland, who will step down in March, has been dragging on for 18 months with no end in sight.

Sutherland had said he would stand down at the annual meeting in April, but has now said he will stay until autumn. Why? Because questions are suddenly being asked about the suitability of the man who had looked like a shoo-in for the job before Christmas – Rio Tinto chairman Paul Skinner.

Skinner has an impressive track record over 30 years at Shell, but some major BP shareholders have voiced concern that in his current role at Rio Tinto, he has presided over a couple of howlers: the firm’s all-cash acquisition of Alcan for £28bn at the top of of the market, and the rejection of what now looks like a generous £43bn takeover offer from BHP Billiton. Is this, they seem to be asking, the man we want as chairman of our firm?

Skinner will probably overcome investor hostility and get the job but the whole selection process is looking like a shambles.

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