Companies Competing in the Oil

Companies competing in the oil and gas industry today are faced with a two-fold dilemma. On the one hand, they have invested enormous sums in an infrastructure that it specifically designed to identify and extract fossil fuels in the most efficient manner possible and most have entered into long-term contractual agreements with other countries where the proven reserves are located. On the other hand, the world's supply of fossil fuels is rapidly being depleted, and many experts caution that the days of cheap oil are about to end. In this environment, determining how variations in the price of oil tend to affect oil and gas companies' strategies has assumed new importance and relevance. The purpose of this study was to develop such an analysis to provide a strategy proposal and specific recommendations for its implementation for use by British Petroleum. To this end, a comprehensive review of the relevant peer-reviewed, scholarly, governmental and organizational literature was combined with a statistical analysis of historic oil prices and corresponding fluctuations in British Petroleum's stock prices to identify trends and patterns that might reveal what investment initiatives were more effective at one point in time than others. A synthesis of the resulting findings is presented in the concluding chapter, together with salient conclusions and recommendations for the leadership team at British Petroleum.

Table of Contents

Chapter 1: Introduction

Statement of the Problem

Purpose of Study

Importance of Study

Scope of Study

Rationale of Study

Overview of Study

Chapter 2: Review of Related Literature

Chapter 3: Methodology

Description of the Study Approach

Data-gathering Method and Database of Study

Chapter 4: Data Analysis

Chapter 5: Summary, Conclusions and Recommendations

The Effect of Oil Price Variations on Oil and Gas Companies' Strategies, and a Strategy Proposal and Recommendations for Implementation for British Petroleum

CHAPTER ONE: INTRODUCTION

The oil and gas industry is at a historic crossroads today, with some conservative observers suggesting that the world's supply of these fossil fuels are about to reach their mid-point level of exhaustion, while others place the available reserve levels slightly higher. Nevertheless, the important point for the oil and gas industry is that its days are numbered and it is vitally important at this juncture to identify the best approach to maximize existing available reserves while continuing the search for new sources. Indeed, it is no longer a debate over "if" peak production will be reached, but a matter of "when" it will be reached. According to Odland (2007), "The debate surrounding Peak Oil is about 'when' rather than 'if.' It entails a range of opinions concerning how much oil remains to be discovered and extracted and how soon we face a gap between consumption demand and the oil production rate" (p. 2). Despite an increased focus on these issues in recent years, there are a sufficient number of unknowns involved to make accurate predictions particularly difficult. For instance, Odland also notes that, "We do not know whether the world oil production curve will end up a peak, a bell, or a plateau. But based on historical production curves for oil fields and regions, it is safe to assume that after the first half of the ultimately recoverable oil reserves have been consumed, the world will be at or near its maximum oil production" (p. 2). The overwhelming majority of recent assessments place the world's original endowment of recoverable oil at no more than about 2,400 billion barrels; the average estimate is 2,000 billion barrels, an estimate that is regarded as being congruent with the cumulative production plus reserves reported in British Petroleum's annual statistical review (Odland, 2007).

Other important trends are also affecting the oil and gas industry in ways that are going to inevitably affect their ability to remain profitable and competitive in the future, including growing concerns over the impact that fossil fuels are having on global warming and the overall quality of the environment, as well as the emergence of burgeoning and energy-hungry economic powerhouses such as China, Brazil and India whose demand for oil and gas will place unprecedented demands on the finite resources remaining. Moreover, as Cuervo (2008) emphasizes, "The price of oil and hydrocarbon reserves are not the only important economic issues. Crude oil prices and inflation, the impact of the Chinese and Indian economic growth, and excessive liquidity in the international capital markets partially caused by higher oil prices are some of the risk factors for the international economy" (p. 433).

In recent years, crude oil prices and production distribution have also become foreign policy and energy security issues and sensitive matters that are inextricably interrelated with war and peace. Variations in those prices will serve to determine the futures of many single commodity producing countries, as well as the entire Middle Eastern region. Moreover, the economic growth and stability of the world's primary energy consumers, i.e., the United States, Japan, China, and the European Union, heavily rely upon dependable and stable oil and gas supplies to operate their economies. To date, efforts to exert any substantive control over energy sources by the United States through military expeditions and adventures have threatened the legitimacy of the United Nations, and have created issues involving international laws and institutions (Cuero, 2008). Furthermore, according to an analysis by Shojai and Katz (1998), the results of their study do not conclusively support the hypothesis that oil price variations consistently resulted in trade fluctuations; however, their study found that a unidirectional causality relationship from oil price changes to terms of trade movements among 12 of the countries they studied. Without a doubt, concerns over energy supplies represent a paramount issue for the entire international community and a growing number of countries are resorting to true resource diplomacy to achieve their respective goals (Cuervo, 2008). Despite these constraints, some oil and gas companies continue to enjoy enormous profits that have allowed them to expand their search for new reserves while making their existing operations safer, more efficient and environmentally responsible. Foremost among these companies is British Petroleum whose operations span the globe and provide energy resources to tens of millions of consumers around the world today.

Statement of the Problem

If there are any still around, oil industry analysts in the 22nd century will likely look back on this juncture in world history in one of two different ways. The first way will be one of amazement that the world continued down a headlong path to energy depletion despite the countless wake-up calls that emphasized the world was rapidly running out of fossil fuels and action must be taken sooner than later in order to avoid a catastrophe of global proportions, including wars fought over dwindling supplies of fossil fuels. The second way would be one of admiration that acknowledged the foresight and implementation of energy policies that managed to avoid the fossil fuel wars by careful investments in what resources remained while aggressively pursuing alternative and renewable sources of energy to replace the world's dependence on oil and gas. These trends have been borne out in the historical record as well. For instance, according to Woloski (2005), "When historians speak of doomed civilizations, they often point to Easter Island, a society that based its culture and economy on the natural resource of wood -- until the consumption of the final tree. Many fear today's global civilization is heading down a similar path, this time brought about by the depletion of current energy sources and of the atmosphere" (p. 40).

The 2004 British Petroleum Statistical Review of World Energy determined that based on current projections, the world's oil reserves will be depleted by 2045, and the peak supply of cheap oil will be exhausted at some point earlier than that, of course, perhaps within the next 5 to 30 years (Woloski, 2005). With current oil prices hovering around $3 per gallon and skyrocketing heating costs, renewable energy sources have become an increasingly attractive alternative for U.S. consumers. Yet renewable sources, such as wind, geothermal, solar, and hydroelectric energy, as well as biomass, comprise less than 4% of U.S. energy consumption. The increasing prices have been driven by various factors including unease in global markets, but a long-term concern about continued fossil fuel use is the expectation that oil reserves will be exhausted by 2045 (Woloski, 2005).

Purpose of Study

The purpose of this study is to determine how variations in the price of oil tend to affect oil and gas companies' strategies in general and British Petroleum's in particular and to provide a strategy proposal and specific recommendations for its implementation for use by the leadership team at British Petroleum.

Importance of Study

Today, most energy is produced by the burning of fossil fuels (coal, oil, and natural gas), which can be extracted more easily and cheaply than most other types of energy. Overusing this non-renewable source of energy will not only lead to its exhaustion, or at least to significant increases in its cost, as angry customers at gasoline pumps may have noticed; it may also lead to profound changes in societies the world over. The burning of fossil fuels affects the environment, leading to air pollution, global warming, severe climate changes, and health problems such as asthma. Alternative sources of energy may be more expensive or more difficult to obtain, but the negatives seem to pale in comparison to this generation's responsibility to ensure livable conditions on Earth for future generations.

Given the rocketing prices of gasoline and the prospect that oil and gas resources will be depleted within the foreseeable future, the search for alternative energy sources is indeed becoming an increasingly desperate enterprise (Woloski, 2005). In the meantime, companies competing in the oil and gas industry have enormous sums already invested -- and much more planned -- in a global infrastructure that will not be easily replaced and it is therefore vitally important that effective and timely strategies be developed that can make the most of these resources while the supply of fossil fuels exists while balancing the investment in alternative and renewable sources of energy for the future. Certainly, the changeover would involve a lot of new investment and this might be one way in which currently unemployed people could find work. The changeover might also provide more sustainable employment -- less threatened by the economic ups and downs resulting from, for example, oil price variations. Not surprisingly. trade unions have shown interest in such possibilities. Indeed, some trade union groups were in the vanguard of the notion of committed more resources to the changeover to "socially and environmentally appropriate production," as evidenced by the campaign mounted by trade unionists at Lucas Aerospace in the UK in the 1970s (Elliott, 1997). It was the position of these workers that instead of being forced to rely on defense-related production, they could achieve improved job security through a transition to products and system that were socially needed; in support of this goal, workers formulated their own version of an initiative that they wanted to pursue that included production of wind turbines, solar energy devices, and fuel cells (Elliott, 1997). A number of additional UK trade union groups developed comparable plans of their own in response, as well as their counterparts in the United States where workers likewise introduced their own "defense conversion" approaches to help American society while also benefiting themselves (Elliott, 1997).

Taken together, these initiatives and others being planned suggest that there are a number of benefits to be gained from investment in alternative energy sources, some of which may be realized later than sooner. For companies competing in the oil and gas industry today, the question arises concerning at what point the value of further investments in oil and gas infrastructure becomes prohibitive and investments in alternative energy sources provide superior returns. Strategic decisions made today will therefore have an inordinately pronounced impact in the future, with the right decision providing the outcome that will be needed to survive the energy environment of the future.

Scope of Study

Although the study's scope is global in nature and an examination of companies competing in the oil and gas industries in different countries are used, there is a specific focus on British Petroleum and the United Kingdom.

Rationale of Study

Time is running out and there is no longer room for false starts. The actions taken by oil and gas companies today to identify, secure and extract the remaining supplies of fossil fuels in the most efficient and environmentally responsible manner possible will have long-term effects on the global economy and the lives of billions of people in the future. Likewise, identifying at what point further investments in oil and gas extraction becomes less attractive than alternative energy sources just makes good business sense.

Overview of Study

This paper used a five-chapter format; chapter one introduced the topic under consideration, a statement of the problem, the purpose and importance of the study, as well as its scope and rationale. Chapter two provides a critical review of the relevant and peer-reviewed literature, and chapter three presents the study's methodology, a description of the study approach, the data-gathering method and the database of study consulted. Chapter four is comprised of an analysis of the data developed during the research process and chapter five presents the study's conclusions, a summary of the research and salient recommendations for the policymakers at British Petroleum.

CHAPTER 2: REVIEW OF THE RELATED LITERATURE

Introduction

This chapter provides a review of the juried, scholarly and organizational (e.g., current company information and market analyses) concerning the oil and gas industry in general and British Petroleum in particular, how regulatory issues affect the strategic policy-making process, and the industry's current efforts to transition into alternative and renewable energy resources. A summary of the chapter is followed by Chapter 3 which describes more fully the methodology used by the study.

Background and Overview

BP p.l.c. (hereinafter alternatively "BP" or "the company") is a multinational corporation with significant interests in the Trans Alaska pipeline system, the Forties pipeline system, the Central Area transmission system pipeline, and Baku-Tbilisi-Ceyhan pipeline, as well as in LNG plants located in Trinidad, Indonesia, and Australia (BP company profile, 2009). This business unit delivers fuel that is used for transportation, energy supplies used for heating and lighting, retail services, as well as the entire range of petrochemicals products and by-products (BP company profile, 2009). In addition, the company has entered into a joint development agreement with Martek Biosciences Corp. For research into improved ways of producing microbial oils that are used for biofuels applications. The company was founded in 1889 and is headquartered in London (BP company profile, 2009).

The company competes through three business units as follows:

1. Exploration and Production. This business unit is responsible for finding, producing and transporting oil and gas products to market. This business unit is also responsible for oil and natural gas exploration, development, and production; in addition, Exploration and Production is tasked with marketing and trading of natural gas liquids, liquefied natural gas (LNG), and gas and power. This business unit features exploration and production activities located in a wide range of geographically diverse setting, including the United States, the United Kingdom, Angola, Azerbaijan, Canada, Egypt, the Russian Federation, and Trinidad and Tobago, as well as in the Asia Pacific, Latin America, and the Middle East (BP company profile, 2009). In addition Exploration and Production owns and manages crude oil and natural gas pipelines; processing and export terminals; and LNG processing facilities and transportation (BP company profile, 2009).

2. Refining and Marketing. This business unit is responsible for supply and trading, refining, marketing, and the transportation of crude oil, petroleum, and chemicals products that are destined for the company's wholesale and retail customers under the Amoco and BP brands (BP company profile, 2009).

3. Other Businesses and Corporate. This business unit produces and markets rolled aluminum products, as well as providing alternative energy through wind, solar, biofuels, hydrogen, and gas-fired sources (BP company profile, 2009).

Today, BP has operations in 29 countries and employs more than 20,000 people (BP company profile, 2009). The company's stated business strategy is to invest in ways that increase the company's production of energy more efficiently by:

1. Focusing on accessing, finding and developing the largest fields in the world's most prolific hydrocarbon basins.

2. Building leadership positions in these areas.

3. Using technology to improve productivity and support new access.

4. Managing the decline of existing producing assets (BP 2009 Strategy Presentation).

In order to extract oil and gas, it must first be located of course and the engineers and technicians at BP have enjoyed good success in recent years in this upstream activity; such activities involve oil and natural gas exploration and field development and production (BP 2009 Strategy Presentation, 2009). According to the company's most recent strategic policy announcement (2009), BP participated in three of the 14 major discoveries that were reported from around the world in 2008. In addition, BP improved its performance in several primary growth areas, including the Gulf of Mexico, Egypt and Angola. The company's success in oil and gas exploration was also responsible for identifying new sources in its maturing exploration zones, including two new discoveries in the UK North Sea (BP 2009 Strategy Presentation, 2009). The progressive development of these newly discovered fields will allow the company to continue to preserve its replacement record for exhausted reserve sources; further, these discoveries built on a previous record of major project start-ups, with nine new major projects coming onstream in 2008, including Thunder Horse in the Gulf of Mexico and its Deepwater Gunashli platform located in Azerbaijan (BP 2009 Strategy Presentation, 2009).

One of the company's biggest investments in terms of commitment of resources for the long-term involved TNK-BP, BP's Russian subsidiary. The company's initial strategy in 2003 for this business unit was to combine the Russian company's expertise in facilities operation with BP's technology and capability, a marriage that has proven particularly effective in the intervening years (BP 2009 Strategy Presentation, 2009). By any metric, TNK-BP's operational performance has been outstanding since 2003. In terms of the contribution of TNK-BP to BP overall:

1. Production has grown by 30 per cent

2. The five-year average reserve replacement is around 200 per cent

3. Proved reserves have increased from 1.8 billion barrels of oil equivalent to 3.6 billion barrels of oil equivalent

4. Total resources have increased from 11.6 billion barrels of oil equivalent to 18.9 billion barrels of oil equivalent, excluding Kovykta, bringing the resources to production ratio to 56 years

5. The foregoing has underpinned TNK-BP's five-year average finding & development cost of less than $3 per barrel (BP 2009 Strategy Presentation, 2009).

By and large, the Russian BP investment has provided strong returns. For instance, the company's Strategy Presentation for 2009 states, "Since 2003, and based on our latest estimate for 2008, TNK-BP has generated total income exceeding $25 billion and distributed dividends exceeding $20 billion, while investing around $14 billion into future growth and paying more than $90 billion in taxes and excise duties. Return on capital employed is the highest in the Russian oil industry. 2008 was also another strong year" (p. 6). The following highlights are cited by the company in support of these projections:

1. Production grew 1.5 per cent

2. Reserves replacement was 136 per cent

3. Dividends paid were in excess of $4 billion (BP Strategy Presentation, 2009).

Moreover, the TNK-BP is well situated to take advantage of its past successes in terms of applied expertise and ongoing investments in this region that will help it overcome current challenges in the industry for the near future (BP Strategy Presentation, 2009). According to the Strategy Presentation, "Capital is expected to be reduced in 2009 to around $3 billion to ensure the company remains self-financing. Production is expected to be broadly flat with the last few years. The weaker ruble is already resulting in lower costs and stronger cash flows. Changes to the fiscal regime will reduce the tax burden and the volatility of quarterly earnings. In the market conditions experienced so far in the first quarter of 2009, we expect TNK-BP to return to profitability" (p. 7).

Concerning the sources of underlying performance improvement in 2008 and how the various parts of the portfolio contributed, the size of the performance gap at a global indicator margin (GIM) was $7.50/bbl. The company identified an underlying performance gap in earnings of $3.5-4.0 billion pre-tax; in its efforts to reduce approximately 50% of this underlying performance gap in 2008, the main contributors were as follows:

1. Safety: underpinning the reliability and margin capability of its operations, the company's safety performance has improved on almost all input and output measures and the company has materially de-risked its operations. Four major manufacturing sites (two refineries and two petrochemical plants) are currently being operated pursuant to the company's operating management system but the company's leadership emphasizes that this area needs much more work in the future.

2. Refining operations: The company has worked to reestablish full operation at its Texas City and Whiting facilities; in addition, over 91% Solomon availability globally from the company's refining portfolio in 4Q 2008, the highest level since Texas City shut down in 3Q 2005.

3. Simplification: The company has reorganized its Refining and Fuels Supply and Marketing businesses into six regional integrated Fuels Value Chains, and are well advanced in focusing its marketing coverage and penetration.

4. Margin-capture capability: BP's margin-capture capability across the portfolio has strengthened with excellent performance in its International Businesses and strong supply optimization and trading.

5. Costs: BP has managed to fully contain its cost base despite material inflation, higher energy costs and adverse foreign exchange effects. This all represents a good start, underpins solid momentum as the company completes 2009 and is something the leadership team at BP believes represents a solid foundation for the future (BP Strategy Presentation, 2009).

In spite of a number of challenges concerning the demand environment, the company's Fuels Marketing and Supply parts of its operation increased their pre-tax profits by $800 million to $2 billion; the majority of this increase was achieved through improved margin management integration along the entire supply chain, healthy performance in supply and trading as well as cost-containment efforts on the part of the company's management (BP Strategy Presentation, 2009). The increase in pre-tax profits was also facilitated through significant refinements in its Fuels Value Chains through improved integration and simplification of its methods. Besides the foregoing, BP has also succeeded in capturing margin in both marketing and trading in a highly dynamic price environment (BP Strategy Presentation 2009).

During 2008, the company's average capital employed was adversely impacted by the impact of a diminished working capital level, as well as the decapitalization of the company's chain of convenience retail establishments in the United States combined with highly dynamic prices for its products. The company's latest Strategy Presentation points out that, "Overall the pre-tax returns in this part of the value chains therefore improved materially. Looking forward to 2009, full year demand is likely to be down on last year and [BP] may not capture as much margin in a less volatile environment, and so it is currently expected that BP's marketing and supply results will decrease by the end of 2008 (BP Strategy Presentation, 2009, p. 7).

In the company's Refining unit, the good news was that BP significantly improved the efficiency of its operations; however, the bad news was that the financial results were not as positive as expected. In this regard, the Strategy Presentation reports that, "Capital employed rose mainly as a result of the increase in the carrying value of the Toledo refinery in relation to the Husky transactions, and from the early investments in plant and equipment associated with the Whiting Refinery Modernisation Project. Pre-tax earnings fell from a profit of $1.2 billion in 2007 to a loss of $(700m) in 2008 representing a $1.9bn degradation" (BP Strategy Presentation, 2009, p. 7). Consistent with the announcement contained in its most recent Form 4-Q filing with the Securities and Exchange Commission (SEC), the company also notes that there have been improvements made in refining delivery that are expected to help overcome these shortfalls. Generally speaking, the company's refining operations experienced reasonably positive results during 2008; moreover, now that Texas City and the Castellon Coker are operational, these additions should continue to provide positive returns in this area well into 2009 (BP Strategy Presentation, 2009). In this regard, the Strategy Presentation emphasizes that, "Financially, much depends on margins of course. This year margins began strongly but have weakened in the last fortnight. As Tony said, the outlook is not strong and it is likely we will see lower margin levels than in 2008. With Texas City on stream, better overall availability and some cost efficiency, the company expects to see refining return to profitability in 2009" (BP Strategy Presentation, 2009, p. 8).