Let the battle begin over black gold

Last Tuesday night, as darkness fell across London, the British Museum was bathed in floodlights of purple and green. In the great atrium, with the stairs sweeping up to the Moctezuma exhibition, the energy industry's great and good raised a glass of champagne to celebrate a birthday. BP was 100 years old.

As Tony Hayward, BP chief executive, walked to the microphone, a group of Mexican guitar players, complete with ponchos and sombreros, brought to an end their serenade. They had perhaps been chosen for a reason, with a nod to the giant oil find the energy company had recently announced in US waters in the Gulf of Mexico that could hold as much as 4bn-6bn barrels.

A giant picture of Moctezuma, the last Aztec ruler before the arrival of the Spanish invaders in the early 1500s heralded the birth of the modern Mexico, overlooked proceedings.

"BP lives on the frontiers of the energy industry," Hayward said. "The more volatile the markets, that's the time when you see BP at its best." There was a confidence in the air as guitars struck up again and at the back of the auditorium Lord Browne, the former chief executive of BP credited with transforming the image of the company but who also saw safety disasters in both Texas and Alaska during his time in charge, chatted to assembled guests. Was this really the return of Big Oil?

Thousands of miles away from the glamour of the British Museum, deep under the Atlantic Ocean, lies a $4bn (£2.43bn) pool of sticky black stuff that raises many questions about how the global energy market is developing.

The reserve looks set to become the battleground of this year's most hostile fights for natural resources between one British, one American and one Chinese company.

For the last 12 months, the global market place has been all about China's voracious energy grab, with its state companies gobbling up oil, gas and coal reserves in Iraq, Kurdistan, Nigeria, Colombia, Syria, Libya and Australia.

But now, just six weeks away from the Copenhagen summit on climate change, BP looks ready to engage in a crucial scramble for prize fossil fuels. At stake is Ghana's newly-discovered Jubilee field in a competition that may pit BP against its larger rival, ExxonMobil, and the cash-rich China National Offshore Oil Corporation (CNOOC).

This week, the west's energy giants, including BP, Royal Dutch Shell, ExxonMobil, Conoco Philips, Chevron and BG Group announce their third-quarter profits, as the oil price reached a 12-month high last week.

They have not been enjoying a particularly happy 2009, leaving the City hesitant to announce the full recovery of the energy industry.

BP's third-quarter net profits, according to analyst consensus gathered by Bloomberg, are expected to be in line with expectations, but not spectacular, at around the $3.2bn mark – higher than the first two quarters of this year, but not approaching the $8bn seen 12 months ago.

After the record-breaking $147 oil price in July 2008, barrels of crude have been selling for 40pc lower over the last nine months.

And despite a more buoyant oil price in recent days, the super-majors must still contend with severely depressed natural gas prices and weaker refining margins caused by higher costs.

Analysts at Morgan Stanley even predict a full-scale crash in the gas price over the next few years, as new, technologically advanced gas production from the US floods the market and storage tankers floating offshore fill up across the globe.

So why – when profits are still mediocre and the commodity prices uncertain – does the time now seem ripe for BP and its rival, Exxon, to be looking for acquisitions?

Francois Laurus, vice-president and senior credit officer at Moody's, the ratings agency, believes the big Western oil companies have little choice but to put up an increasing fight for available reserves, paying higher prices for scarcer assets.

"The Western oil majors will have to deal with increasing competition from the Chinese and other national oil companies," he says. "We've seen relatively limited acquisitions in the industry so far this year, certainly fewer than we expected, but for the Western oil majors it's been a matter of price."

The question will indeed be whether BP can afford to make such an expensive play for a 23.49pc stake in Ghana's Jubilee field, after the company cut its capital expenditure budget to less than $20bn this year.

While prices remain volatile, investors are still not over their jitters about the super-majors, partly driven by concerns about a possible crash in the gas market, but also their binding pledge to pay hefty dividends quarter after quarter. As a result, there has been a spate of downgrades by analysts.

"We see downward pressure on crude prices over the next two to three months," said HSBC analyst Paul Spedding in a recent note, cautioning that oil could fall to $50 a barrel in coming weeks. The global bank cut its rating on BP to neutral from overweight and Royal Dutch Shell drew a downgrade to underweight from neutral.

Most worryingly of all for investors, the bears have been warning that the traditionally stable dividends of BP and Shell – which account for 20pc of all FTSE 100 pay-outs – could be under threat if the oil price dips again next year. In a stark warning sign, Britain's best performing fund manager Neil Woodford, who manages £18bn at Invesco, dumped his stakes in BP and Shell that previously made up 8pc of his fund over fears that both will have to either pay their dividend off balance sheet rather than cash flow next year.

However, most industry experts anticipate that the leaner BP will fare a little better than its arch-rival, Shell, over the coming year.

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Royal Bank of Scotland analysts point out that operational improvements will mean its refining profits are less bleak than most and Citigroup notes that the company is materially less exposed to weak European gas markets than its competitors.

Mr Hayward, the reliable geologist who has led BP for the last two years, has also proved a consummate cost-cutter. He even surprised the market last quarter by announcing that BP had already exceeded its 2009 target of $2bn and was targeting an extra $1bn in savings in the second half.

Having pared back the company for the last few years, BP went into the recession in better shape than Shell, which is only now enduring a round of painful job cuts, reorganisations and cost-savings.

In contrast, BP's worst wound during the current crisis has been to warn in March that the lower oil price may mean that it freezes this year's dividend at last year's level.

So does this mean that now, while the company seems healthier than Shell, is the time for Hayward to elevate his leadership from the acceptable to the exceptional by making some clever acquisitions?

One long term BP-watcher, a senior investment banker and consultant in the energy industry, believes the next few years will shape a historic war over reserves between the Western oil majors and the state-run national oil giants from Russia's Gazprom to China's numerous natural resources companies.

"The industry is at a real cross-road, making it an incredibly exciting time for new acquisitions," he says. "BP and Shell really need to be buying up all the mid-market exploration and production companies that they can in politically open countries. There are so many off-limits areas, from Iran to Saudi, that it's really crucial."

Ultimately, partnerships – like BP's joint venture with a consortium of Russian oligarchs and its new alliance with the Chinese in Iraq – will become the most successful mode of operation, he says.

"No one should be in any doubt that the oil majors will continue their desperate quest to maintain reserves," he adds, "which are only currently growing at a crawl of 1pc-2pc per year."

If BP can pull off a mischievous attempt to derail Exxon's acquisition of the Jubilee oil field, it may be connected to its apparent willingness to find local partners.

The African country's government is thought to disapprove of Exxon's bid for the stake, currently owned by the private-equity backed Kosmos Energy, and could prefer a bidder willing to join forces with the Ghana National Petroleum Corporation.

BP was also the only Western oil major to make a successful first-round bid for a contract to develop Rumaila, the jewel of Iraqi oil fields, which it will now develop together with CNPC, the China National Petroleum Corporation.

Although margins from the field may not be as high as usual, after BP was forced to lower its offer from $4 to $2 per barrel, the contract has set it up for a promising relationship with the world's third biggest holder of oil reserves.

It also gave the first hint that the company is in a shopping mood.

But with the Copenhagen Climate Change summit just six weeks away, is this really the right time to be making a new dash for oil and gas?

It appears that at last BP – which adopted the green-friendly tagline Beyond Petroleum 10 years ago – is getting bolder about publicly re-enforcing oil and gas as its core priority, after years of trying to drive home its image as an environmentally-conscious company.

Apart from its investment in US windpower and experiments with biofuel products, BP has this year been withdrawing from renewables projects in China, Turkey and India, while shutting up its Alternative Energy division in London.

This cooler attitude towards renewable energy sources was in evidence at the Oil & Money conference in London last week, where Mr Hayward insisted that oil would be the dominant transport fuel for decades, cleaner gas-fired power stations should play a dominant role in helping replacing dirty coal plants, and carbon mitigation technologies like capture and storage would not be viable for another 10 years at least.

Despite the threat of even tougher climate change targets at Copenhagen, executives at the oil majors are known to have been privately briefing ministers and opposition MPs that Rumaila even the current targets of reducing emissions by 80pc by 2050 are unrealistic.

In fact, the message of the supermajors from BP to Exxon appears to be that this is the age of going for natural gas as well as oil, despite its current rock-bottom prices.

The challenge now is to persuade global governments that this fossil fuel, which emits half the carbon dioxide of coal, should form the linchpin of climate change action rather than unreliable wind and nuclear.

"We believe this is an important political step, making gas a transitional fuel in cutting back carbon dioxide emissions and making up a shortfall in renewables," says Christof Rühl, chief economist for BP. "We do our fair share of renewables but globally they will be too small to make a real dent in the targets. That's why we think it will be useful to get a carbon price to give gas a new role in the fight against climate change. Two things I would look for to come out of Copenhagen are a dose of realism and debate over details like what kind of carbon price mechanism to use."

His comments echo the words of Richard Guerrant, Exxon Mobil's director for Europe, who insists that gas-fired power is the most reliable, proven and cheap way of reducing emissions – not to mention a huge opportunity for those in control of rich gas fields.

"Natural gas can transform the global energy outlook," he urged this week. "It's here. It's now. It's cleaner. It's more affordable. What are we waiting for?"

Climate change campaigners have calculated that BP, Exxon, Chevron and ConocoPhillips spent a third more on lobbying in Washington this year in the run-up to the Copenhagen summit, dishing out a combined $60.8m on persuading politicians that fossil fuels still have a dominant place in the energy mix.

Whether or not the US and Europe listen, the oil industry is still more than conscious that emerging markets are only in the early days of their love affair with hydrocarbons.

According to industry predictions, the growth of demand for oil will increase by 1m barrels per day each year driven mostly by Chinese demand. Statistics show that while the US has 800 cars for every 1,000 people, China has 30 cars per 1,000 – a figure that is growing at the alarming rate of an extra 1.2m car sales per month.

However, fossil fuel production in countries outside members of OPEC, the oil-producing cartel, has reached a plateau and 70pc of the countries that produce oil have already peaked.

John B Hess, boss of the $20bn Hess corporation, warned last week that Western oil majors need to break further into the OPEC nations and other emerging producer countries.

"We will ultimately be at risk of supply rationing demand through skyrocketing prices that will threaten economic stability and prosperity," he said. "If we do not act now, we will have a devastating oil crisis in the next five to 10 years. The price of $140-per-barrel oil was not an aberration. It was a warning."

His voice was also one of the most overt critics of renewable energy, claiming that it "does not have the scale, time frame or economics" to change the fact that 85pc of the world's energy comes from fossil fuels.

"Emissions targets to limit global warming to no more than two degrees are unrealistic," he says. "To meet this target, global annual CO2 emissions would have to be reduced from today by more than 80pc by 2050. With world population growth and rising living standards, holding global carbon dioxide emissions flat by 2050 would be a huge achievement in itself."

It is one more sign that Western oil companies are increasingly ready to play on fears about energy security – in a world where OPEC is sitting on 80pc of the world's hydrocarbons – above political concerns about climate change.

Abdalla Salem El-Badri, the secretary-general of OPEC, has shown signs that the alliance of oil-producing nations will be ready to supply any country that has a need for fossil fuels if there is the demand, pouring cold water on the G20's reliance on cleaner energy.

"Just wait for one catastrophe and that will be the end of nuclear," he says. "And as far as I'm concerned who really thinks biofuels will really work in the long run? You can't have food as an energy source."

For the oil companies, the dilemma of whether to side with the developed nations, where fossil fuel consumption is declining, green concerns increasing and resources running out, or the developing ones, where natural resources are both more plentiful and expertise in extraction is desperately needed, is a no-brainer.

"Any company without assets in the Middle East and Russia is going to struggle," says one long-term major institutional investor in BP and Shell.

"BP has done absolutely the right thing by partnering with emerging national oil companies in both places," he says.
"It is smart enough to knows which side its bread is buttered on."