FT REPORT – ENERGY: BP laid low by scandal: Speculation… merger with Royal Dutch Shell

FT Headline: Laid low by scandal

By Ed Crooks, Financial Times
Published: Jun 19, 2007

After two years that no one would wish on a bitterest rival, the apppointment of a new chief executive has given BP the chance to make a new start. In the first six weeks of Tony Hayward’s leadership, many of the early signs have been good. But hopes that BP has turned the corner are premature. The company still has a long, hard road ahead.

From the explosion at its Texas City refinery in March 2005 that killed 15 people, the news about BP has been a litany of uncertainty, disappointment and failure.

There has been a succession of investigations and law suits that followed that refinery disaster; an oil spill in Alaska that forced the shutdown of half the giant Prudhoe Bay field; official investigations into allegations of wrongdoing in BP’s US oil and gas trading operations; a further 18-month delay to its flagship Thunder Horse project in the Gulf of Mexico; disappointing production figures, and a boardroom battle over the leadership of the company that ended in Lord Browne, its star chief executive, resigning after trying to suppress allegations about his private life.

Since the start of 2005, the shares have underperformed the European oil and gas sector by 16 per cent. After everything that has happened, the only surprise is that they have not done even worse. At a time when it is getting harder for any international oil companies to make progress, with costs soaring and truculent governments in resource-rich countries flexing their muscles, BP’s predicament looked particularly grim.

Mr Hayward took over on May 1, three months ahead of schedule, when Lord Browne was forced to resign following the revelation that he had lied to a court while trying to prevent allegations about his relationship with a 27 year-old Canadian being published by a tabloid newspaper. It was a humiliating experience for Lord Browne, but it gave the company he had led since 1995 an opportunity to show that it was putting its problems behind it.

Already Mr Hayward has won praise for his more relaxed and informal style, compared with the grandeur that led to Lord Browne being dubbed “the sun king”. The mere fact of his appointment – he was named as Lord Browne’s successor in January, although he was not then expected to take over until August – ended some of the uncertainty hanging over the company.

He has taken judicious steps to re-shape his management team, promoting Andrew Inglis, his deputy in his previous job as head of exploration and production, to replace him. He has also allowed John Manzoni to leave – he was the board member with responsibility for refining and marketing at the time of the Texas City disaster – and replaced him with Iain Conn, a 44 year-old high-flyer who was already on the board.

The board – which has been criticised for inadequate oversight during the last two miserable years, and in the years that preceded them – has been strengthened with the appointment of Cynthia Carroll, the chief executive of Anglo American, the mining group, as a non-executive.

The first big move of the Hayward era, the $900m-plus exploration deal for a vast area in Libya announced at the end of May, also looks very positive for BP. There is a long way to go yet, both in finding the gas that BP hopes is there and in ensuring its profitable development, but the agreement could turn out to be a very good bit of business.

Amid all these points of light, however, the problems BP faces still cast long shadows.

The most immediate concern is Russia: a hugely important business for BP thanks to Lord Browne’s last great triumph – the formation of the 50 per cent owned Russian joint venture TNK-BP in 2003. At the end of last year, TNK-BP accounted for 29 per cent of BP’s oil reserves, which makes the administration’s aggressive moves towards foreign companies a serious concern.

As this special report went to press, the dispute over the licence for the Kovykta gas field, in which TNK-BP has a controlling stake, had not been resolved, but appeared to be coming to a head. Kovykta was an insignificant contributor to TNK-BP’s present, but a potentially important part of its future. Losing the licence would be a blow to its prospects for the coming decade.

In a sign of its importance to BP, Mr Hayward has already visited Russia three times since took over. Talks with Gazprom, the state-controlled gas company, were also unresolved at the time of going to press, but seemed to offer the best hope of leaving BP with a significant presence in Russia that had the political support it would need to grow.

Russia is a particular worry for BP because it is threatened at a time when BP’s performance elsewhere in the world is disappointing. Production is predicted to grow by only about 4 per cent between 2007 and 2009, and only a further 8 per cent between 2009 and 2012.

Production in countries such as Azerbaijan and Angola is on the rise, but the extended delay to the Thunder Horse project in the Gulf of Mexico has looked like a symptom of BP’s failure to deliver the challenging, innovative feats of engineering that are increasingly necessary as the search for oil and gas ventures into ever more difficult environments.

The Thunder Horse saga, the Texas City tragedy and the Alaska spill have prompted Mr Hayward to say that his first priority will be to focus “like a laser” on safe and reliable operations.These problems, and the investigations into Texas City, have suggested that under Lord Browne’s leadership, BP’s grand strategy may have been brilliant but its attention to detail was poor. A series of deals such as the acquisitions of Arco and Amoco in the US at the end of the 1990s were perfectly timed at the low point in the oil industry’s cycle, and turned BP into a world player.

But crucial aspects of safety, for example, were not given sufficient attention, as the BP-commissioned report by James Baker, the former US secretary of state, into its US refineries concluded. Now Mr Hayward has to put those failings right. He also has to work on restoring BP’s public image and credibility, especially in the US, where its mistakes made it a lightning rod for political discontent with “Big Oil”.

But underlying all of these moves is another fundamental question about the company: how can it make money for its shareholders?

BP spent $15.5bn on share buybacks in 2006, and raised its dividend by 10 per cent, but the shares continued to under-perform. With oil prices at $70 a barrel, the constraint on the company’s growth is not shortage of cash, but shortage of exploitable oil and gas reserves, and of the people and equipment needed to develop them.

Speculation has persisted that some radical deal is in the offing. Merger with Royal Dutch Shell was thought about two years ago when Shell was weak following the reserves misreporting scandal, but rejected because of the regulatory nightmare it would create.

Demerger of BP’s succesful upstream from its less succesful downstream has been promoted by some, including JP Morgan Cazenove, but the oil majorsgenerally still see it as important to remain integrated, so they can make profits right across the business. There are, it seems, no easy answers. It wouldbe surprising, however, if these ideas and similar ones were not being considered by Mr Hayward. He needs to show he can translatesix weeks of positive headlines into a genuine improvement in BP’s performance and he will not have forever to do so.

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