BP - From Oil To Energy

May 31st 2021

BP has a simple name that deflects from the complexity of its business. It's a complex business operating in a complex sector. It has a presence in some 70 countries and its businesses often overlap and entwine. Almost like a 3D puzzle but with each piece capable of being autonomous or part of the whole. It's also in a rapidly changing energy environment. Rather than simply examining where it is, I have tried to consider where it's trying to go. And, yes I am a BP shareholder.

Before examining the company more closely, it may make sense to ask where the company believes the energy market is heading over the long term. So let's start with BP's Energy Outlook 2020 (Normally published in February but delayed until September in 2020). This is based on three broad Paris Agreement consistent scenarios for the energy sector: Business As Usual, Rapid and Net Zero (Carbon neutrality). The last two views appear to largely underpin BP's overall strategy. Incidentally, Bernard Looney, BP's CEO, is quite emphatic that the Outlook report defines its strategy, not the other way round.

Importantly, growth in all three of the above is forecast to come from developing countries. While it expects an absolute decline in the use of fossil fuels as a proportion of the energy mix over the next 30 years, regardless of the scenario.

From BP's perspective, a central long-term theme is the decline of a dominant power source. With the consumer having more bargaining power and greater choice, while energy markets are set to become more localised. The concept of integration and optionality is very important to BP - there may be lots of competitors but few have an integrated approach that underpins its ability to provide firm power. It seeks to differentiate itself from pure renewable companies and utilities.

The COVID-19 pandemic obviously had implications for energy consumption. Over 2020, energy consumption patterns changed and demand generally fell. BP seems to believe that working from home is a permanent change while other shifts are temporary. It also raises the question as to whether "Build back better" will accelerate already established trends in the energy transition.

Regardless of the scenario, it believes that oil demand is most likely to fall over the next 30 years. And that fall could be steep based on anything other than Business As Usual.

This appears largely driven by the electrification of road transport and what it describes as efficiencies. While it sees shared mobility interacting with autonomous vehicles from the 2030s to reduce oil demand. With prices for these robotaxi services likely to fall. It goes as far as to suggest that by the 2040s, due to the intense use of these vehicles, some 40-50% of passenger vehicle car kilometres will be powered by electricity.

Natural gas looks likely to have a rosier future over the long term compared to oil. For starters, BP believes that it will act as a bridge for many countries now transitioning from coal, especially India. It also has a role to play in blue hydrogen production and Carbon Capture, Use and Storage (CCUS) and so providing near zero-carbon energy. Should the world go to Net Zero by 2050, BP believes that natural gas will play an even greater role in the overall energy mix when used with CCUS.

As this shows, BP sees the cost of wind and solar energy falling dramatically over the long term. But this does not come cheap and will be the result of huge investment. It estimates that an annual investment of around US$500-750 billion (b) will be required.

But, I would suggest, that these cost scenarios assume no raw material challenges. For example, wind turbines often use rare earth minerals such as neodymium and dysprosium in alloys to create permanent magnets. Markets for both these minerals are controlled by China. That's in terms of production and consumption. While silver's conductivity makes it a key component of solar panels. With production dominated by Mexico, Peru and China.

Incidentally, a theme running throughout its planning is increased electrification. In all of its scenarios, it views electrification as increasing rapidly.

Renewable energy intermittency is a serious issue and it envisages batteries playing a greater role. But as BP points out, intermittency is not just over the short term. It suggests that hydro, hydrogen, natural gas with CCUS and bioenergy will play a significant role in mitigating the problem and providing the dispatchable power that's required to balance supply.

Incidentally, the UK national grid operates on a frequency of 50Hz. From electrical appliances in the home to electrical equipment in factories, they are designed to operate within tight frequency bands. Maintaining this consistency is vital, a deviation of just 1% could cause a blackout. Providing "Inertia" and dampening down oscillations in frequency is vital. A possible solution is battery storage but this appears to require a major leap in technology. While a degree of "Synthetic" rotational inertia from wind turbines is possible, the same cannot be said for solar energy.

Both blue (Using natural gas and CCUS) and green (Dependent on renewable power) hydrogen are likely to play a significant role in both a Rapid and Net Zero scenario. Some sectors such as long-distance freight - both trucks and trains (Requiring batteries with high levels of energy density), steel and cement production (Requiring high-temperature processes), aviation and shipping are difficult to electrify (Decarbonise). So hydrogen provides a viable alternative.

Interestingly, should the world move to a Net Zero position by 2050, BP believes that hydrogen will play a more important role and that will require more natural gas. There will not be enough renewable energy capacity. Very importantly, in this Net Zero scenario blue hydrogen is key.

It may not attract the media attention of other renewables but bioenergy is likely to play an increasingly important role in the energy mix. This includes Biofuels, Biomethane and Biomass.

The Investment Case - Why BP?

The following is largely based upon BP's presentations given in September 2020. In essence, it laid out its long term plans up to 2030. And they are substantial and transition the company from oil and natural gas into energy, largely underpinned by the cashflows from its established core operation. This includes:

• Reducing oil and natural gas production by 40% (This does not include production from Rosneft).
• A 20-fold increase in net renewable generating capacity to 50GW (1-4% of global capacity). But, although it may have developed that capacity that doesn't mean it will own those assets. It could choose to farm down its interests.
• Near 10-fold increase in charging points to 70,000.
• Energy partnerships with 10-15 major cities and 3 core industries.

By 2030, it aims at having around 30% of its capital base invested in the energy transition. Much of the above appears to be based on what it describes as megatrends: Electrification, shared mobility and hydrogen (For difficult to electrify areas such as heavy transport).

It describes its overall approach as:

• Industrialisation (Building scale eg Convenience and mobility in India),
• Innovation and digital (Leveraging technology eg Moving applications from datacentres to the cloud, with the goal of migrating 80% of applications to the cloud by 2025: driving integration, security, scale and reducing costs); and
• Integration (Optimising value chains eg offering clients a mixed energy offering based upon their needs).

The company has segmented its business into three components. These it described as: low carbon electricity and energy, convenience and mobility and resilient and focused hydrocarbons.

Growth In Renewables Underpins Its Move Into Low Carbon Energy

BP views the renewable energy sector as low risk (Compared to the risks associated with exploring for hydrocarbons, it may have a point). It has a pipeline of renewable projects totalling around 20GW (With some 45% of that in the US). Can it achieve 8-10% returns across its renewable portfolio? In short, it points to Lightsource bp. Since 2018, this solar energy business has completed 17 projects and its average returns are in the 8-10% range. It also cites the 50% efficiency improvements in harvesting at its Brazilian bioenergy operations since 2016 as to what it's capable of achieving.

It accepts that it may get 5-6% on an equity basis in a competitive auction for renewable projects. But it argues that it has demonstrated the ability to improve the efficiency of these operations and has a long history of managing complex projects. It also appears to believe that adding leverage and a PPA (Power Purchase Agreement) can increase returns on renewables to around 10%.

Solar Energy

BP bought a 43% stake in Lightsource for US$200m in 2017. Its earlier foray into solar power involved the manufacture of panels. However, Lightsource is focused on managing and developing solar projects. In total, it has constructed 3GW of these projects. It has a further 16GW in the pipeline (Up from 1.6GW in 2018) and operates in 14 countries. BP argues that it can move quickly - from concept to construction in 18 months to two years. It may seem a minor point but my understanding is that BP paid some US$50m on completing the purchase of Lightsource in 2018. The balance was to be paid over the following three years (Presumably linked to performance targets). So the real question is whether it can continue its growth trajectory without that incentivised management? It obviously believes it can.

Incidentally, EverStone Capital and Lightsource bp formed EverSource, a joint-venture, in 2018 aimed at India's green energy market. Eversource has the mandate to manage the Green Growth Equity Fund (With anchor investments from both the Indian and British Governments). BP argues that its deep roots in India, via its natural gas interests, led to this investment.

Offshore Wind

US: At a cost of US$1.1b, BP entered into a partnership with Equinor in September 2020 and obtained a 50% stake in the Empire Wind and Beacon Wind offshore leases. More broadly, the partnership aims to develop the US offshore wind market. It will develop four assets in the two offshore leases. While Equinor remains the operator of both. It's believed that Empire Wind has a potential capacity of some 2GW and Beacon Wind some 2.4GW. Phase 1 of the Empire Wind project is expected to deliver some 816MW of power, with first production expected in 2024/2025. It's worth pointing out that Equinor (Formerly Statoil) had an oil and natural gas alliance with BP in the 1990s.

Putting the potential into perspective. Europe has some 25GW of installed offshore wind capacity while the US has only 50MW. Although the Biden administration has taken steps to restrict oil and natural gas development, it has done the opposite with offshore wind. The US is now aiming for 30GW of capacity by 2030. However, past attempts at growing this offshore capacity have been stymied by permitting restrictions, opposition from coastal communities, high costs and a lack of subsidies. There are also technical issues with much US energy infrastructure designed for non-renewable energy supplies. While in the background is the limited local manufacturing capacity to produce what is very difficult to transport pieces of equipment. Turbine installation ships are also in short supply.

UK: Although the UK is the world's leading market for installed offshore wind generation capacity, it's still growing. The UK is planning to increase production from 12GW as of 2020 to 40GW by 2030.

In February 2021, BP in partnership with the German company EnBW was a winning bidder in Round 4 of the UK's Offshore Wind Lease auction. It won two areas each with a projected capacity of some 1,500MW.

Incidentally, it's worth pointing out that the option fee total for these areas was £462m. After the areas are awarded, this will be paid annually (Up to ten years) until the plans are finalised. It may incentivise speed but any delays could be incredibly expensive.

Onshore Wind

BP Wind Energy has a portfolio of assets in the US. This covers: Colorado, Hawaii, Kansas, Idaho, Indiana, Pennsylvania and South Dakota. In total, it has some 1.7GW of capacity. Taking a quick look at the information provided by the South Dakota Utilities Commission and this appears to be a crowded field. There are some 25 separate projects in operation in that state alone and this could explain why BP is developing its offshore wind business. That said, according to the American Clean Power Association, wind turbines in the US are twice as productive as in Germany and they are also reducing consumers' energy costs. While, according to BP, it has increased EBITDA per megawatt-hour by 60% "Since the middle of the decade".

Bioenergy

BP plans to scale its bioenergy operations - concentrating on biofuels, biogas and biopower.

In December 2019, it acquired a 50% stake in BP Bunge Bioenergia for US$775m. The business combined Bunge's and BP's operations into a single unit. The group has 11 mills in Brazil and an annual crushing capacity of 32mmt of sugar cane. It produces 1.8b litres of ethanol and exports some 1,200 GWh to the Brazilian grid. About 75% of its sugar cane is grown on its plantations. Its core operations comprise: Sugar production, ethanol production, the sale of electricity to the grid (It burns bagasse, the residue of sugar cane in its mills - it's self-sufficient in electricity). The goal is simple: plug-in to Brazil's growing demand for biofuels (Some 70% of its vehicles can run on ethanol) and its need for energy by providing bioenergy.

Interestingly, looking at Bunge's 2021 Annual Report and it says "Our long-term goal is to seek strategic opportunities for our investment in the joint venture". What this means, I'm unsure.

Exploiting the projected growth in air travel, BP is aiming to capture some 20% of the biojet fuel market by 2030 (It currently supplies 11 airports in four countries). And this is a growing market - it expects a doubling of passenger numbers by 2050. BP has partnered with two companies: Neste (Hydrogenated vegetable oil (HVO) advanced biofuel) and Fulcrum BioEnergy to develop the market. However, sustainable aviation fuel (SAF) is relatively more expensive than traditional aviation fuel. That seems to have impeded its take-up. Nevertheless, it offers a lifecycle reduction in carbon emissions of up to 80%. It's also worth pointing out that this is a blended product. At least 50% of the SAF will be traditional jet fuel.

BP has a join-venture (Mavrix) with Aria Energy in the US to exploit the Biogas market. Aria operates the projects and BP markets and distributes the renewable natural gas (RNG) output. Compared to diesel, RNG offers up to 95% less greenhouse gases over the life cycle, according to a US Department of Energy study. A recently announced Mavrix project aims to capture methane from waste at three American dairy farms. This will then be processed into RNG. BP's main role is the marketing of the RNG (It's already the largest natural gas trader in North America) through a 20-year off-take agreement to supply the heavy-duty transport sector; arranged by its low carbon trading unit. Considering that the US agriculture sector accounts for some 10% of the country's greenhouse gas emissions, the market is huge.

Hydrogen

The Danish company, Ørsted, is working with BP on the Lingen Green Hydrogen project to produce hydrogen from water and powered by wind energy for its Lingen refinery in Germany. The aim is for some 20% of current production to be green by 2024 with the ultimate goal of 100% of its current capacity moving to green. The impression given is that it's using innovative electrolysis technology at scale - if successful it can be rolled out. A final investment decision is expected in early 2022. With the prospect of going into production in 2024. The company has made an application to the EU Innovation Fund for funding.

BP is aiming for a 10% share of the clean hydrogen market by 2030 and argues that hydrogen could capture some 20% of final energy consumption by 2050. While in the UK, it's aiming to deliver some 1GW of blue hydrogen production by 2030 (The UK government is aiming for 5GW of hydrogen production by that date and utilising the current gas grid). According to the British Geological Survey, the UK has an offshore geological storage resource for some 70 billion tonnes of carbon dioxide (More than the EU-27 combined). And, of course, it has the expertise and infrastructure of the UK's oil and natural gas industry. At the same time, there could be challenges. For example, insuring against future carbon dioxide leakages may require Government assistance. That said, as the Norwegian Sleipner project has shown. Technically, this is very feasible. And there are three projects with commissioning on the horizon: Acorn (UK), Northern Lights (Norway) and Porthos (Netherlands). Providing these are successfully delivered they could act as an accelerator for other CCUS projects.

Britain's largest blue hydrogen energy venture, BP's H2 Teeside project is now underway. This aims to capture and store up to two million tonnes of CO2 per annum (pa). It builds on an already well-developed energy infrastructure in the region and dovetails with the aim of creating a clean energy cluster in the North East: Net Zero Teeside. A final investment decision is expected in 2024 and limited production (500MW) could begin in 2027. While the technologies that it's researching may capture up to 98% of the carbon emissions produced in the production process.

The potential global CCUS market could be enormous. The International Energy Authority estimates this might be a US$100b pa industry by 2050. Rysted Energy, the Norwegian energy consultancy estimated in 2020 that spending in this area could reach up to US$35b by 2035. As the Hydrogen Council points out, there are now some 228 large-scale hydrogen projects in 30 countries. While it recently stated that its members are planning a six-fold increase in hydrogen investments through 2025 and a 16-fold increase through to 2030. With most of this going into capex.

Although the hydrogen business has certain parallels with the natural gas industry in terms of transport and marketing. There still seems to be technical issues with transportation other than by pipeline. And this is an area that is still developing and there is competition. For example, Shell has its Shell Blue Hydrogen Process. This, it argues, offers simplicity and efficiency and that means lower capex. BP is clearly not operating in a vacuum.

Putting itself centre stage in framing the parameters of the CCUS industry, BP, in a joint venture with Chevron and Petrobras, is part of the Carbon Capture Project - currently in phase 4. This is a long-term research project aimed at making CCS an economically viable and safe proposition. Its findings for the final phase should be published later this year.

Blended and Bespoke Solutions

An important point that BP consistently makes is its ability to deliver firm energy of a type required by its customers. It can provide a blended and bespoke solution to its markets. For example, mixing sources and offsets. In a recent presentation, it gave the example of soya oil from Bunge Brazil that was refined at its Cherry Point Refinery in Washington State in the US. That was then supplied to customers in Oregon and California.

Convenience And Mobility Offering Provides Resilience And Growth

For BP, convenience and mobility include fuels and convenience products sold on forecourts as well as Castrol lubricants, the aviation fuelling business and its electric vehicle (EV) charging points. With a particular emphasis on India, it's scaling up its operations in this sector. In total, its capex for this segment grew to US$2.2b in 2020.

It has a network of some 20,300 retail sites in 21 countries - currently focused on the US, UK and Germany. This includes some 1,900 strategic convenience sites (It aims to have some 3,000 by 2030). These carry BP branded fuel plus one of the strategic convenience brands eg M&S, ampm or Rewe to Go. Key to the concept is differentiating the site in the marketplace. It claims that it sells higher quality and, therefore, higher-margin fuel and so its sites generate more revenue than the industry average. I would have thought that given the scale of the business, it was post-growth. However, the company argues the opposite and believes it will grow in growth markets, such as India, and it will scale up - lower costs and improved margins. It cites a Euromonitor report that predicts the convenience sector growing at around 5% pa and almost doubling in size by 2030. Although it expects a fall in fuel sales to 2030, it suggests that this will be offset by convenience sales. For 2020, it managed to achieve a year-on-year 6% growth in convenience gross margin (While retail fuels gross margin fell by 5.4%).

According to BP, the market for electric energy fuel looks set for a major expansion. It expects it to grow some 30-fold from 2019 to 2030. It now has around 10,000 charging points (With around 8,700 in Europe) but it's aiming to provide some 70,000 EV charge points with a focus on the UK, Germany (Through its Aral Pulse brand, it's looking at building around 500 350kw fast chargers - offering a range of up to 350km with a ten-minute charging time, by the year-end) and China. However, it expects regional variances with some 40% of EV owners charging at home in the UK but just 15% in China by 2030. At the same time, it expects there to be a major increase in shared-mobility usage. It believes that passenger miles in kilometres could double by 2040 but some 25% of this will be due to shared mobility. While the car parc of EVs could increase to some 900m by 2040. Roughly 50% of the total vehicles.

BP Pulse is the UK brand name for its EV charging infrastructure. With around 7,000 public charging points, it's the largest public charging network in the UK. It's aiming to increase that number to 16,000 by 2030. It also intends to increase its ultra-fast charging points (150kW) to 700 by 2025. In terms of profitability, it expects Chargemaster to break even "In the next couple of years" and for it to achieve "Material profitability by 2030".

In April 2021, BP announced that, for an undisclosed sum, it had taken a 33.3% stake in Digital Charging Solutions (DCS), A German joint venture between the BMW Group and Daimler Mobility. DCS offers access to 228,000 charging points in 32 countries via its onboard software. It integrates its charging systems into original equipment manufacturers' (OEM) vehicle operating systems - basically putting BP's offering in the dashboard (It's doing something similar with Volkswagen).

With EV engines requiring fewer moving parts, it seems reasonable to expect a decline in the demand for lubricants. But, Castrol is a premium brand, and BP expects demand for this product to be the same in 2040 as it is today. There are also some 24,000 Castrol branded workshops worldwide. It believes that gives it added resilience. And, of course, it had developed a range of lubricants for EVs and hybrid vehicles.

Convenience and mobility appear to be a very resilient part of its business. It has grown EBITDA by 7% every year since 2014-2019. And it's very focused on what it views as major growth opportunities in this sector:

India: BP paid US$1b for a 49% stake in Reliance BP Mobility Ltd (Operating the Jio-bp retail brand) in August 2020. It aims to grow the Jio-bp brand to some 5,500 sites by 2025 (It currently has around 1,400 units) and will differentiate these sites by quality. This is underpinned by its belief that the Indian vehicle market will increase six-fold over the next 20 years. While it can also leverage up its digital technology - it estimates that India has some 350m smartphone users. BP aims to have some 390m users on its Jio digital platform by 2025. It also aims to increase its Indian aviation fuel footprint from 30 to 45 sites. But BP is not without competition in this area. Rosneft, Royal Dutch Shell and Total are all expanding their convenience and mobility offerings in India.

Castrol is the most popular premium lubricant in India with a 20% market share. It has some 420 distributors serving around 105,000 retailers. While Castrol India is a public company with BP holding around 51% of the equity.

China: BP formed a joint venture with DiDi Chuxing, the Chinese ride-hailing service in August 2019 to develop a network of charging hubs across China for both its drivers and the public. DiDi has about 1m vehicles on its platform and around 550m active users.

Considering that BP expects China to have around 70m EVs by 2030 (Roughly 50% of the world's EVs), the market could be huge. It's aiming to develop some 35,000 charging points in China by 2030 as well as around 2,000 charging sites. In 2020, the venture built 1,400 EV charging points in the country.

Although its Castrol oil brand has a 22% market share in China and is the leading premium brand, it sees great potential for growth outside the major cities. It does not appear to be a post-growth brand.

Mexico

Mexico is another area of focus for the company. It has grown its BP-branded fuel retailing network from zero in 2017 to 540 sites in 2020. In 2018, it had planned on expanding its network to some 1,500 gas stations by 2021. Presumably, its plans are postponed rather than cancelled due to COVID. But there may also be some form of political reaction against the liberalisation of this sector of the Mexican economy.

Value Over Volume Approach To Hydrocarbons

Production for 2020, was 2.4mmboe/d (Excluding Rosneft) against 2.6mmboe/d for 2019. But this was an extraordinary year for the oil and natural gas industry. Globally, oil consumption fell by some 8.8% year-on-year as a result of the COVID pandemic. While natural gas prices gyrated. It estimates that global natural gas demand fell by some 2.5% over the previous year. On a barrel of oil equivalent basis, it received US$26.31 (2019: US$38).

Unsurprisingly its upstream oil and natural gas producing interests are global and cover onshore and offshore. It appears determined to deliver value rather than quantity in terms of production. And it emphasised that it will not carry out exploration in countries where it does not have upstream operations. While it's aiming to reduce its development costs to just US$9 per barrel. For investments in upstream oil and refining, it has a payback period of less than ten years. And for upstream natural gas, it's less than 15 years. Although 2020 was a relatively very quiet year for new developments, it still managed to complete four major oil and natural gas projects: Gulf of Mexico, India, Oman and the North Sea. It's looking at adding an additional 900 mboepd of new production net to BP by the end of 2021 to its 2015 base production. And that's 35% higher-margin business.

Its refining business is, it claims, high margin (Top quartile) and in 2020 achieved 96% availability. However, its Refining Marker Margin (RMM) for 2020 averaged US$6.7/bbl a fall from US$13.2 for 2019. While US Henry Hub natural gas prices averaged US$2.08/mmBtu in 2020 (2019: US$2.63/mmBtu) - the lowest it has been for around 25 years. For 2021-2025, it's looking at break-even prices of: Brent at US40/bbl (Oil), RMM (Refining) US$13/bbl and US$3/mmBtu (Natural gas). None of which seems that outlandish.

In June 2020, after announcing write-downs of up to US$17.5b and as part of its efforts to strengthen its balance sheet and change its debt profile, it issued US$11.9b equivalent of perpetual subordinated hybrid bonds. The rates ranged from 3.25% to 4.875%. My understanding is that these bonds provide a degree of flexibility in terms of allowing BP to defer coupon repayments and can be repaid in five or ten years from issue. They also appear to have a less onerous impact on credit ratings than traditional debt with typically only 50% of the bond treated as debt.

Its US$25b divestment programme is approximately 50% complete with a variety of agreed deals. While it argues that its existing assets are strong with 25 projects in operation. There are a further 19 projects due to come online in the next few years. Since 2010, it has sold some US$60-70b of assets. The sale of its Petrochemical business to Ineos in December 2020 underlined its long term exit from the hydrocarbons business. And, of course, raised a much welcomed US$5b.

Taking the bull by the horns and, in 2020, it also announced 10,000 layoffs by 2022 (As at the end of 2020, it had 63,600 employees). At the same time, it claims to have identified a "Leadership cadre" of 700 people to take the company through its transition.

Although it has streamlined its operations in recent years, BP appears confident that it can drive down costs and improve efficiency even further. This is planned to come in large part from an ongoing push into digital, enabling it to restructure its production and organisation structure - it has 113 separate IT systems and 67 finance and accounting systems (It aims to reduce the latter to 18 by 2023). Putting that into perspective. It has some 35 mboepd of shut-in production. Reducing this deferred production could be very lucrative. The scale of potential savings is also vast. BP as some 21m individual locations that need to be inspected. While it spends some US$3b pa on maintenance and inspections. It believes that it can reduce these costs through rolling out a variety of new approaches such as digital workflows, 3D worksite visualisation, connected workers, delayering (How many layers will it have left?) and a strategic approach to its supply chain (Presumably gaining economies of scale). At the same time, it argues that it can improve its preparation and delivery through the use of robotics and artificial intelligence. It's also driving innovation through investments via its Launchpad and BP Ventures enterprises. To that can be added the relationships that it has with technology companies such as Amazon and Palantir. Zero-based budgeting is part of its approach to cost reduction. But the company does not explain what this means in practice. Will costs be backloaded? For 2021, it's aiming for a break-even price of US$35 per barrel. While the savings are largely driven by investment. At a cost of some US$1.5b out to 2025, it believes that it can reduce operating costs by around US$1b pa by 2023.

As with any other natural resources company, reserves are everything. Including its Rosneft stake and BP has some 17.98 billion barrels of net proved reserves on an oil-equivalent basis at the end of 2020 (A fall of roughly 7% over the previous year - which probably goes some way to explain why its proved reserved replacement ratio is no longer a KPI). Very importantly, it has a strong pipeline of projects. Many close to its operating hubs. But BP believes that its operational growth up to 2025 will be from its oil and gas business. While the contribution from this area will decline from 2025 as its other energy assets kick in. So the central question appears to be whether its current reserve base can see it through the transition?

In line with its philosophy of growing in growing countries

India Gas Solutions is a 50/50 joint venture with Reliance Industries. This sources and markets natural gas in India. With operations off India's eastern shore. It estimates these assets will provide India with around 15% of its natural gas demand by 2022.

On a similar theme, it's expanding its natural gas operations in China. In 2021, it announced what it describes as "A fully integrated gas value chain into China". It has connected its upstream operations, transport and downstream trading. More broadly, it has deep roots in China and stands to benefit from the country's thirst for energy.

Partnerships Are Key To Its Approach

The ability to form and develop partnerships is essential to its overall strategy. To suggest it's a complex organisation is putting it mildly. BP formed its Regions, Cities & Solutions team in 2020, to focus on companies, cities and countries. As it points out, cities account for some 70% of CO2 emissions. While it sees the opportunity to provide “Energy management & decarbonisation as a service.” And points to the new Saudi Arabian city of Neom using only renewable energy as an indication of the size of the market. According to the CDP, a not-for-profit organisation that runs an environmental disclosure system, in 2020, 148 cities were aiming for a 1.5°C-aligned target by 2030 but only 52 reported an interim target. I would suggest that the inference is they will need complex integrated solutions. But there are few companies with the depth and breadth of operations that will be required.

In terms of corporate sectors, it's focusing on high technology and consumer products, heavy transport (Aviation, marine and land freight) and heavy industries (Including cement and steel). It argues that some 80% of companies have plans to reduce carbon emissions but only 25% are on target to achieve their goals. This market has apparently increased dramatically. In 2019, around 20GW of Purchase Power Agreements were made with corporates, a four-fold increase from 2015. It's also looking at partnering with industrial corridors and organisations within its partnering cities.

Much of what is now happening in the energy sector springs directly from the Paris Agreement agreed in 2015. Very importantly, this requires each country to find its own path to achieve zero emissions in the second half of the 21st Century. There is no prescribed formula. The UK is massively expanding its offshore wind sector while Brazil is developing biofuels. The COP26 meeting is due to be held at Glasgow in November 2021 where it's hoped to speed up the ambitions of the Paris Agreement.

BP has a large number of established partnerships and arrangements. So let's take a closer look at a few that may give an insight into its transition into an energy company.

Cities:

Aberdeen City Council

In September 2020, BP was appointed as planning and technical advisor for the council's Energy Transition Strategic Infrastructure Plan. This covers the use of hydrogen (The city is positioning itself as a hydrogen hub) as well as the electrification of fleet vehicles, energy use in the built environment and extracting energy from waste. This four-year agreement is at no cost to the city.

Incidentally, in January 2021, Aberdeen introduced the world's first hydrogen-powered double-decker bus service. It may only be a fleet of 15 vehicles but it's a practical demonstration of the possible. They offer the range, fuel efficiency, emissions (Emitting only water) and can be refuelled in ten minutes. However, this is a heavily subsidised venture with each vehicle costing some £500,000.

City of Houston

In July 2020, it was appointed as strategic planning and technical partner for the city's Climate Action Plan. This focuses on: transportation, energy transition, building optimisation and materials management.

For a city synonymous with America's hydrocarbon industry, it may seem strange that it was hit by serious power outages in February 2021. But does illustrate what extreme weather conditions can cause: Natural gas wells froze, as did pipes, coal stockpiles and even wind turbines. While energy demand rocketed, primarily to keep homes warm. For sure, Texas may not be connected to the other national grids. But there appear to be issues with an ageing US electricity grid infrastructure - The American Society of Civil Engineers (ASCE) produces an annual report card on US infrastructure with grades ranging from A to F. The 2021 Infrastructure Report Card gave the US energy infrastructure a C-. This seems to be a market with a lot of potential upside.

Companies:

Amazon

Partnered with Amazon, in December 2019, it agreed to migrate some 900 key applications from its European mega data centres to Amazon's Web Services (AWS). Around 40% of its digital estate is now in the cloud; it argues this gives it greater resilience. For its part, BP is key to Amazon reaching Net Zero by 2040. At a practical level, it will triple its supply of renewable energy to Amazon. Beginning in 2022, it will supply some 404MW of wind power to AWS Europe. That's in addition to an agreement in 2019 to provide 170MW of renewable power. There also appears to be collaboration at a deeper level with BP plugging into Amazon's digital technology such as BP trading migrating to Amazon Aurora. While Amazon has a US$2b fund to invest in low carbon energy projects.

Microsoft

As with Amazon, this is something of a symbiotic relationship. With BP providing renewable energy to Microsoft and Microsoft extending cloud-based services in BP. With synergy and overlapping interests - Microsoft is promoting "Smart Cities" and has set up a US$1b climate innovation fund while BP is pressing for "Clean Cities". Areas for collaboration include: clean energy parks and the use of CCUS, the internet of things and the consumer energy sector.

Qantas

In January 2021, BP announced a strategic decarbonisation partnership with the airline (Its first in the heavy transportation industry. This covers: advanced sustainable fuels, renewable power, carbon management and related emerging technologies. With an average annual fuel bill of some US$2.7b pa over the last seven years, fuel costs are a major proportion of overall costs for Qantas as they are with any airline. It also claims to have one of the largest carbon offset programmes in the aviation industry. With around 10% of passengers choosing to pay an extra levy and use its "Fly Carbon Neutral" programme.

For anyone not taking climate change seriously, it's worth mentioning a comment made in 2019 by Qantas' CEO regarding wind velocity. He pointed out that on-time performance had been falling for all carriers over the previous three years. He attributed this to wind velocities that were 34% higher than the average over the previous 30 years. In addition, this was a prevailing westerly wind instead of the previous south-south-westerly. Incidentally, to that could be added the issues of runways that were constructed to deal with prevailing winds and temperatures at the time of construction. The overall impact of climate change appears to be to disrupt established aviation business models. That seems to require great skill in managing the energy transition and that will come at a cost.

Uber

The company aims to become a zero-emission platform by 2040 and is looking at spending around US$800m to incentivise its drivers to move to EVs by 2025. All of Uber's vehicles in London are expected to be electric by 2025. BP's bp pulse offers Uber's London drivers a discounted EV charging service. While in Houston, it's working with Uber to develop rapid charging EV hubs. So it's gearing up to work with cities such as Houston and the companies that operate within those cities such as Uber.

Neste

BP supplies sustainable aviation fuel (SAF) produced by Finish-based Neste, the world's largest producer of SAF. In August 2020, BP announced a five-fold increase in the volume of SAF that it would provide to airport customers over 2020 and 2021 compared to 2019. Interestingly, BP pointed out that Norway now requires that 0.5% of advanced biofuel should be blended with jet fuel from 2020. However, this stipulation is for advanced biofuel coming from wastes and residues rather than what it regards as "Problematic" sources such as palm oil. The blending requirement seems to be a way of building a domestic advanced biofuel industry using Norwegian forestry residue. A local solution.

REWE to Go (Germany)

Rewe to Go's convenience retail offering is concentrated in high traffic locations, such as airports, train stations and, of course, BP's Aral petrol stations. Speed of service and clarity appear core to what it does - mainly selling "Food for now" and drinks. Aral has around 2,400 petrol stations in Germany.

Rosneft

BP has a 22.03% stake in the company - it describes it as a "strategic investment". However, voting rights attach to some 19.75%. It received dividends, net of withholding tax of US$480m from Rosneft for 2020 (2019: US$785m). Since 2013, it has received some US$3.95b in dividends. However, it's not simply a passive investor, it has a close relationship. This includes a 20% interest in Taas, where Rosneft holds 50.1%. (During 2020, BP received some US$137m in dividends and paid-in capital from Taas). More broadly, it has been partnered with Rosneft in a Strategic Gas Alliance since 2017 and co-operates in a variety of areas such as health and safety as well as seismic research.

As with BP, Rosneft is a large and complex company. Looked at basically, it's a low-cost oil and natural gas producer with a large asset base and stands to benefit from an attractive tax arrangement with the state. Its production costs for Q4 2020 were US$2.6/bbl. And it's very far from being post-growth. It estimates that its Vostok oil project holds resources of some 44b bbls of oil and has the capacity to produce some 50mt of LNG pa by 2030 and become the world's largest supplier. What is it worth? Well, Trafigura paid €7b for a 10% stake earlier this year.

Northern Endurance Partnership

BP is the operator and is working with five other energy companies (Eni, Equinor, National Grid, Shell and Total) to develop offshore infrastructure to transport and store carbon dioxide emissions in the North Sea.

Launchpad And BP Ventures

Launchpad was started in 2018 and is focused on start-ups where BP is the majority shareholder. It provides multi-year funding and support for rapid growth projects that are expected to have an enterprise value of some US$1b within five years. It currently has four companies in its portfolio. These are LYTT, Fotech, Stryde, Onyx Insight and Finite Carbon. By the end of 2022, it plans on having some 10-15 companies in its stable. Onyx Insight may give some idea of its approach. Onyx has developed predictive maintenance solutions that are used in BP's US wind energy operations. This enables fault detection 12-18 months before failure and so reducing down-time and maintenance costs.

BP Ventures has invested around US$700m over the past 12 years. The fund makes minority investments and has a focus on: Advanced mobility, bio and low carbon products, carbon management, digital transformation and power and storage. It has some 38 businesses in incubation and looks to leverage up the technology from these investments. Its investments include C-capture. A company developing proprietary solvent-based technology to capture CO2 emissions. While CarbonFree is developing patented technology (68 patents issued in 60 countries) to convert CO2 emissions to solids for storage. Rather than wait for a disrupter to impact its business model, BP seems to be part of the disruption. Other investments include StoreDot (Ultra-fast charging batteries) and Freewire (EV charging systems).

Again, using the BP Venture route, BP invested US$10m in China's Nio Capital's investment fund in July 2018. It also has a memorandum of understanding to explore EV infrastructure in the country. While in January 2019, BP Ventures made its first direct investment in China via a stake in Powershare, a hardware/software solutions provider for EVs.

This approach to investing in companies that can augment its core business has paid off handsomely with its stake in Palantir, bought in 2014 for an undisclosed amount. It sold an interest in the company for $443m in Q1 2021 in what it described as "a significant return on our initial investment". However, it has recently signed a five-year deal that will extend its ties with Palantir. So, as an investment, Palantir proved to be a winner but BP has also benefited from Palantir's digital know-how and that fits with the company's mantra of driving digital.

Gulf of Mexico Oil Spill

This still hangs over the company. It will make an annual payment of around US$1.2b in Q2 2021. That leaves some US$10b at today's values outstanding payable over the next 13 years.

Energy Trading and Carbon Offsets

BP is one of the largest power traders in the US. In 2019, it sold 15mt of carbon offsets. While it trades some 250TWh across the US, Europe and Brazil (It plans on expanding that to 350TWh by 2030 and 500TWh by 2050). It argues that its trading capacity creates offtake and risk management opportunities. It's aiming to provide clients with around 100 natural climate solutions by 2025. For example, mangrove restoration and avoiding deforestation. The scale of BP's energy trading allows it to provide a bespoke offering such as hedging and currency services for its clients.

Again, it's not difficult to find synergies and opportunities for cross-selling. The aviation sector is a target industry for BP. Not only does it supply fuel but it can also work with European airlines to navigate the Emissions Trading Scheme. With carbon credits roughly doubling to some €50 per tonne compared to pre-COVID levels, this is now a major concern for European focused airlines. And, of course, BP can provide SAF.

A Complex Transition But Multiple Opportunities Mitigates The Risk

A strategy and a business that could be summarised by the word trust. Firstly, it's a conglomerate of businesses not a single entity. And much of what it plans to do comes down to trust. Investors are placing their trust in the management to execute the strategy. While the company's operations span the globe and many involve partnerships involving a degree of trust.

It may be promoting a green energy vision but it's also highly dependent on its traditional businesses in oil and natural gas to provide the cash flow for the transition from oil to energy.

For sure, there are many issues surrounding BP's transition but the key question may have been raised at last year's BP Week. Why should BP's transformation succeed when, according to McKinsey, 74% of business transformations fail? The answer given was on the lines of this:

• It has clear goals to 2025.
• It possesses the necessary soft skills. Such as leadership, culture, agility, diversity and integration.
• Execution. It has proven project execution skills. It's ranked top quartile in four out of five IPA (Independent Project Analysis) industry project benchmarks.

Broad brush, possibly, but I believe that we are going into a world of electrification. That seems to be a megatrend. Taking two mining companies that I know well and know to be heavy users of electricity and for both, the key priority is reliability or firm energy. Within parameters, they can cope with price rises. A 25% increase in the price of electricity will not break them and a 25% fall will not make them. The key is reliability. Both companies are now constructing solar power projects. And both are doing so for the same reason - reliability. The point I'm making is that I believe the overall returns on renewable energy will be higher over the long term than many now believe. Moreover, this is a very complex area that does not present an easy or simple solution for what appears to be a looming energy crisis. The solutions, in my opinion, will be localised and integrated. While Governments and companies will have an overriding agenda - reliability of supply. They will opt for whoever can provide that reliability at a reasonable price.

Why BP? If we accept that reliability of energy supply, within certain pricing constraints, is key then there are few companies to choose from. BP can present customers with bespoke energy solutions. This could include hydrocarbons, natural gas, solar, blue hydrogen, etc. Put crudely, it guarantees to keep the lights on (And your Government/Board in office). It may not be the cheapest but it will deliver. You have an election coming up next year and you want energy price stability, it has a hedging solution. Shareholders are keen on ESG strategies, it can provide one. A key refinery is out of action, it can pull capacity from elsewhere and arrange delivery. The solutions depend upon a global integrated approach.

Renewables may be of the future but is it profitable? BP has shown an ability to achieve returns of some 8-10% on its solar developments. Compared to hydrocarbons, this is low. But these are very early days. And, it can put together complex packages. It's not simply building a solar farm and selling electricity to the grid. To some extent, it's one plus one equals more than two. A report produced by the International Renewable Energy Agency in February 2021 concluded that power systems were likely to become increasingly complex and difficult to manage. Incidentally, the same report pointed to European oil companies transitioning faster into energy companies than their North American peers.

There are no barriers to entry, why enter a crowded market? With so many companies bidding for solar and wind power licences, the results are predictable - low returns. MISCI, the index provider has also raised concerns about the clean energy investment space and has even suggested parallels with the dot-com bubble of the 1990s. For the year to March 2020, the S&P Global Clean Energy Index rose by 150%, with price-earnings ratios reaching 35. Maybe this is unsurprising considering the boom in clean energy ETFs. According to TrackInsight, their combined assets have increased from US$2.4b in 2019 to some US$22.4b in 2020. I would suggest that the concentrated portfolios of some of these funds raise serious liquidity issues. Say what you will, BP's stock is highly liquid. Investors in this space also appear to be assuming that clean energy technology will work smoothly and effectively. This may not be the case. Extreme weather conditions recently caused wind turbines in Texas to freeze while Ørsted is having to deal with cable issues impacting up to ten of its European offshore wind farms.

As I have said, I think that firm energy is key and customers will pay, within reason, what's necessary to keep the lights on. That raises the issue of dealing with a wide variety of problems (Including so-called black swan events) outside of a company's core competency. This was recently demonstrated in North America with the ransomware attack on Colonial Pipeline; cybersecurity is a key issue in delivering firm energy. The challenges cut across operations and appear to require comprehensive solutions. For sure, BP is not the only game in town but there are very few companies that have the same breadth and depth of operations in the energy sector.

Who is interested in oil and natural gas? It's yesteryear. Based on the figures I have seen, oil is not going out of fashion anytime soon. There are simply too many uses and too much capital that depends on oil from jet planes to tractors. While the backdrop is a chronic lack of exploration to replace depleted resources - with the head of the IEA recently suggesting that all new hydrocarbon investments should be cancelled. There are plenty of forecasts predicting the demise of oil and the prospect of stranded assets with resources and reserves left in the ground. But looked at more closely and the time frames for the replacement of oil are decades rather than years. For example, the cost and power of batteries is a major factor determining the adoption of EVs. According to the Electric Vehicle Outlook 2020 report from BloombergNEF, Lithium-ion battery pack prices fell some 87% from 2010-2019, while average battery energy density is rising at 4-5% pa. And it expects battery prices to keep falling for the foreseeable future. Nevertheless, it still predicts road transport oil demand growing until 2031. As for natural gas, there seem to be few scenarios where it does not play a significant role until at least 2050. The background is a hydrocarbon industry suffering from a chronic lack of investment to replace reserves that are rapidly depleting. JP Morgan recently predicted a US$600b shortfall in capital expenditure between now and 2030. Resulting in a major supply gap.

It may be getting very little media attention but many developing countries are highly dependent on revenues from oil. According to Statista, around 9% of Nigeria's GDP is related to the oil industry. It's also worth noting that Statista predicts Nigeria's population to grow to over 400 million people by 2050. If there is going to be a smooth transition out of hydrocarbons, then politicians and fund managers will need to stop grandstanding and present detailed practical solutions for countries such as Nigeria. There's also the unpalatable truth that National Oil Corporations (NOCs) will simply step in and take up the slack left by the oil majors. I'm unsure why a barrel of oil produced by a Western oil major will have a greater impact on the environment than one produced by a NOC. It may also be worth considering that the recent IEA report that attracted so much attention made the point that should there be a cessation of new oil and natural gas exploration, by 2050, some 52% of the global supply of oil will come from OPEC.

Incidentally, the energy transition scenarios I have come across appear to assume global stability and no key commodity bottlenecks. But if we look at Copper, the price is now edging towards US$10,000 per tonne while around 40% of the world's production for 2020 came from just two countries: Chile and Peru. It's a major component in EVs - a disruption could impede their development. Cobalt is another key material for the transition. Not only is it expensive but some 64% of global production as of 2019 came from the very unstable Democratic Republic of Congo. Which also hosts some 53% of the world's cobalt reserves. That said, steps are being taken to design out the need for cobalt. Taking a sideways view and a semiconductor shortage is hitting the production of vehicles - designing out that bottleneck looks tricky, to say the least. And there are many parts of the world where electrification is not practical. According to the United Nations, some 789m people didn't have access to electricity in 2018, with the bulk in Sub-Saharan Africa. Constructing a gas station, of sorts, in the middle of nowhere is relatively easy compared to connecting up a remote spot to the national grid. And, of course, much is dependent on reciprocity. An EV leaves X to go to Y. How does it get back? Transfer that to the possibility of electrifying trucks and even planes and things get very complicated. So, BP's transition appears to be underpinned by substantial cash flows from oil and natural gas. Its own as well as that from Rosneft. And that looks like a pretty secure demand for the next ten years.

First mover advantage also underpins BP's transition. It's difficult to envisage how new entrants to the energy sector will compete in many of its markets. The capital expenditure will be huge while incumbents will have long-term contractual arrangements - utility companies in the US are regularly buying energy at fixed prices for 20-25 years. And, of course, incumbents can shape the regulatory environment to suit their needs. BP is growing in growth markets. Both China and India have huge and growing energy demands. For 2020, the growth in energy demand was driven by China and that growth was across the board covering oil, natural gas and renewables. BP estimates that China accounted for some 75% of net global energy growth over the year. The next largest were India and Indonesia. Established energy businesses in the big two developing economies strike me as being something that will be difficult for industry newcomers to budge.

As a UK based company, BP has a home team advantage in the world's largest offshore wind turbine market. At the same time, according to the British Geological Society, the UK has around 70 billion tonnes of storage capacity for CO2 under its seabeds. This is more than the EU-27 combined. It also has an established oil and natural gas industry and the infrastructure and capacities that go with that. It strikes me as reasonable that the UK will be a major player in the CCUS market and that will almost certainly give BP a key role. Even the International Renewable Energy Agency expects blue hydrogen to take some one-third of the hydrogen market long-term. If that is the case, then the associated carbon will need to be stored. That seems to put BP in a strong position. It's also worth mentioning that the UK is at the forefront of addressing climate change. In 2008, it passed the Climate Change Act and committed the UK to cut greenhouse gas emissions to 80% below their 1990 levels by 2050. In 2019, this target was subsequently changed to below 100% by 2050.

Can BP maintain its dividend? It argues that at 5.25¢ per quarter, it has a very resilient distribution policy. While, of course, it's committed to share buy-backs now that its net debt is below US$35b and aims to use 60% of surplus cash for the purpose. That's subject to it maintaining its investment-grade credit rating. While it envisages a return on average capital employed to be in the 12-14% range by 2025. And a compounded annual growth rate in earnings before interest depreciation and amortisation to increase by 7-9% up to 2025 (This includes the share buyback programme). Its forecast break-even prices for oil, refining and natural gas through to 2025 seem reasonably modest. And it appears confident that it can remove (Rather than defer) further costs from the business. Incidentally, its assumptions are based on a long-term oil price of around US$50-US$60bbl.

In essence, I believe that over the long-term the energy industry will be dominated by a few major global players. They will span technologies, energy sectors and geographies. Offering complex bespoke solutions. And BP is likely to be one of the key players. The alternative will be chaos.