BP Takes It Slow and Steady

Stung by recent missteps, the oil and gas giant will adopt a more cautious approach and reduce production targets, incoming CEO Tony Hayward says

by Stanley Reed

We have been burned, and we're turning conservative. That was the message communicated by results and comments from the once-swashbuckling, wheeling-and-dealing BP on Jan. 6. In one of his first public appearances since being tapped as CEO designate, Tony Hayward announced a sharp paring back of BP's future production estimates, while also sounding a note of caution on deals.

The company had said it would increase production at around 4% per year, but now Hayward, until recently the exploration and production chief, is warning that output will be flat this year, at about 3.9 million barrels per day. That will increase ever so slowly, to more than 4.0 million in 2009—a big drop from the roughly 4.8 million barrel-per-day 2009 estimate of a year ago.

Why the big change? BP (BP) has been hurt by a range of events, from nasty accidents to slower-than-expected startups of important projects such as the giant Thunderhorse field in the deepwater Gulf of Mexico. With a new chief executive officer coming in, the company seems to be gearing down and taking a close look at its operations, some of which have been troubled. BP may even be trying to ease the pressure on Hayward by lowering expectations. The market was disappointed by the new no-growth outlook. BP's stock fell by 1.2% to $63.02 in early trading Feb. 6 on the New York Stock Exchange.

Tapping the Brakes

Like all of its competitors, BP is finding that high oil prices, meaning anything above roughly $40 per barrel, are a mixed blessing. With capital investment up across the industry, it's now jockeying with its competitors for the limited numbers of skilled contractors and equipment available. BP has the reserves in place; it just can't round up the people, rigs, steel, and the rest to develop them as fast as it might like.

"Trying to go at the pace of two to three years ago would be unwise, not safe," Hayward said. He added that a lot of the people being hired by oil-service companies such as Halliburton (HAL), which are essential contractors to the majors, are "sort of green."

For BP, costs are rising at an annual rate of about 14%, Hayward said, with drilling-rig rates alone rising by 44% in 2006, although BP was able to hold the increase to 34% through long-term contracts. Hayward also said governments were taking advantage of the high price environment to push up tax rates. He mentioned Britain, Alaska in the U.S., and Venezuela as examples.

Playing Defense

Hayward has also learned a harsh lesson from watching the pummeling his predecessor, John Browne, has taken in the media and from U.S. politicians this year. Browne, who has been struggling with the fallout from the March, 2005, explosion that killed 15 people at a BP refinery in Texas City, Tex., recently announced he would step down at the end of July, 2007, rather than at the end of 2008 as planned.

Other operational issues, such as leaks and production shutdowns in Alaska, have also darkened the twilight phase of Browne's 12-year tenure. Hayward said that in the coming months he would be "focusing like a laser on safe and reliable operations."

In an indication of how much Browne's luster has faded, Hayward was almost forced by reporters' questions to come to his predecessor's defense. "John has done an absolutely outstanding job leading this company for a decade or more," he said.

Despite the controversy over U.S. operations, it's still clear that Browne has built a profit machine at BP, which generated $28.2 billion in net cash flow for 2006, a 5% year-on-year increase. Production has almost tripled under his tenure, and reserves have more than doubled.

Eye on Russia

Still, the company came under some pressure in the fourth quarter, largely because of a 5% drop in production volumes and lower prices. Sharply lower margins in refining and marketing, not BP's strong suit, also hurt. Replacement cost profits were down year-on-year by 14%, to $3.89 billion for the fourth quarter, but cash flow of $5 billion was actually up 17%. Prices of natural gas, where BP is a big player, were down $4 per barrel, equivalent to $35.21, compared to the fourth quarter of 2005.

BP put a brave face on the issue that's worrying investors most—the fate of its Russian joint venture, called TNK-BP. The company's CEO, Robert Dudley, brushed away concerns that BP might suffer the same fate as Royal Dutch Shell, which was recently pressured into ceding a majority of its centerpiece Russian project, Sakhalin 2, to Gazprom. Dudley says that his company was "operating in the sector without difficulty." He also says he was having "constructive discussions" with Gazprom on developing the giant Kovytka gas fields in East Siberia, though he warned that the project, whose end customer is likely to be China, was "complicated and going to take a long time."

With Browne sitting by his side, Hayward didn't give many clues about where he will be taking BP. He indicated he would continue to follow Browne's strategy of seeking out giant discoveries that offer economies of scale. On the issue of mergers, Hayward said that he had learned from Browne that M&A was just a tool for implementing strategy. He said that thanks to recent high prices, there has "been more value in selling than in purchasing" assets.