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BP Upstream Oil Operations

BP

A corporate strategy article by Thunderbird students Timothy Houston, Timothy Mayberry, Adam Yestrepsky, Matthew Allred and Bhawin Khanna

The changing environment of the upstream crude oil procurement industry and recent catastrophic accidents have created numerous issues for British Petroleum (BP). International oil companies such as BP face the challenge of entering markets which are dominated by national oil companies that receive subsidies from local governments and beneficial treatments. BP also has a tarnished public reputation driven by the Deepwater Horizon gulf oil spill, which makes global and domestic operation even more difficult. The recent disasters within the oil procurement industry also have driven tighter environmental regulations that require new approaches and techniques to crude oil isolation. BP has developed a comprehensive program to tackle these new hurdles for its upstream oil procurement division. This plan is known as “Project 20K” and involves new technology, unique approaches to regulations, and new business strategies.

British Petroleum’s ability to grow as a publically traded company is determined by its ability to secure crude oil reserves. The typical development time for upstream operations, exploration and construction of well infrastructure, is 5 to 8 years. This means the investments made today will impact growth and profitability for the next decade. In 2007 national oil companies (NOCs) controlled 75% to 80% of the world’s proven oil reserves, while international oil companies (IOC’s) and smaller producers compete for less than 20% of the world’s known reserves (1,2). BP and the other four major oil companies only own roughly 4% of the world’s crude oil reserves. The disproportionate share is due NOC’s preferential access to large government acreage.

The ability for BP to find low cost productive oil reservoirs is hindered by the shift of NOC’s, mainly Brazil and China, from predominant suppliers to consumers. There is an estimated 50 billion barrels available near Rio de Janeiro that has been restricted from exploration since 2007 (3). Bidding on the reserve blocks will open in year 2012, but Petrobras will maintain 30% share, Brazil will receive 30% royalties and IOC’s like BP will still need to compete with Brazil’s state owned oil companies.

The two most common IOC strategies are mergers and acquisitions (M&A), gaining a portion of the remaining 20% of reservoirs, or accepting the taxes, royalties, and technology transfers to oil rich governments. Following the oil-price collapse of 1998, BP used the M&A strategy to combine reserves with Amoco (4). The current price of oil is upwards of $94, and this strategy is only profitable if the market price of oil is significantly low to offset the potential returns on exploration and drilling. Another inherent risk of acquiring a small remote oil companies are inheriting corruption and human rights violations. With an already shaky reputation, BP needs to avoid acquiring social conflicts for the sake of reserves. The social Issues with small oil companies also exist with oil reserve controlling nations. Take Libya, Russia, Iran, and Iraq for example. These countries have a history of violence and weak governments, so there is a high risk of technology and supply infrastructure being destroyed or nationalized.

In order to secure oil reserves for future profitable growth and to maintain a competitive advantage in the upstream crude oil industry, BP should focus its investments in drilling and exploration technology. NOC’s and their host nations control large known oil reserves because they were easily located and extracted. BP’s downstream operations, delivery and refining, combined with current upstream operations create large free cash flows. This money should be used to develop advance exploration technology. Finding new oil reserves is the first step, but these will be in deeper and more difficult to extract locations. BP will need to concurrently design advance rig and drilling capabilities to extract oil in the less explored regions of the world. These will need to be capable of reaching to the deepest parts of the ocean and resist over 15,000 pounds of pressure. Furthermore, the drilling technology can be used as leverage while negotiating rights to current crude oil reserves. The technology is needed for NOC’s to improve production efficiency.

BP’s operations are conducted in environmentally sensitive locations where the consequences of oil spills, explosions, fire are greater than in any other locations. These operations are subjected to safety regulations and failure to comply with them or any incident which breaks these regulations leads to huge fines and financial implications as well damaging reputation. The Gulf of Mexico oil spill (the incident) combined with other past events like rig explosion in 1996, has damaged BP’s reputation. There are lots of risks associated with these past events which may make it harder for BP to buy/ explore natural reserves in future. There is an ongoing threat for BP of paying citations / fines on these catastrophic events due to their breach of safety or environmental regulations. Moreover due to these breaches there is a threat to BP on a possible impact on their license to operate and ability to access new opportunities. There is uncertainty in the liability and costs to BP associated with the “incident” and the rig explosion. Finally there might be changes in the regulations which might hinder BP’s ability to grow and explore new possibilities. These events had and will continue to have impact on BP’s business, financial growth, competitive position, cash flows, prospects, liquidity, shareholder returns.

CSR (Corporate Social Responsibility) is seen by some to be limited to adopting strategies which generate profits for the firm and its share holders whereas other argue that CSR strategies taken by a company shall be focused towards protecting the interests of national government and people. Companies must shape their CSR so that they portray an image of being socially responsible as well as the CSR strategies must be in line with their business practices. BP’s CSR shall be focused on being an environmental responsible company. BP shall partner with organizations, such as cleanenergy.org which focuses on clean renewable energy and protecting the quality of life. Bp shall invest in technologies which will help reduce its carbon foot print. Moreover BP shall partner and promote with organizations which fight against diseases such as lung cancer. They can organize walks to create awareness against lung cancer. This will help build an image for BP of being an environmentally sensitive company.

Changes in regulations and increased environmental protections will have the impact of making it more difficult for BP to find future reserves. Much of an oil firm's ability to secure drilling rights comes from their perceived reputation (5). The challenge that BP will face going forward will be in securing rights to future drilling sites. Further, BP will need to demonstrate their willingness and ability to not only pay for existing environmental damage as a result of the Gulf of Mexico oil spill but to show their preparedness for future spills. Moreover, BP will find that securing financing in the future will be more difficult. As a result of the oil spill, BP has seen its credit rating drop. This will result in BP being required to pay a higher interest rate on financing or find that financing is unavailable. This may impact BP's ability to proceed with exploratory drilling at the same rate prior to the Deepwater Horizon accident.

Despite these significant headwinds BP does have options. First, BP must continue to operate as a deep-well driller. Exploiting this particular niche is something that BP does well. These types of drilling projects can be particularly problematic and carry a high degree of risk. This is not something that many other oil firms do. Their expertise in this particular field has only been increased as a result of the Deepwater Horizon oil spill. While the oil spill has certainly been traumatic to BP's future, much of the restrictions on new oil well exploration have been lifted. One of the impacts on new wells in the Gulf of Mexico is a new emphasis on blowout preventers (6). These safety devices are expensive to put in place, but do demonstrate a material means of preventing another Deepwater Horizon type oil spill.

There is great competition with other oil firms that have deeper pockets, better credit, and a cleaner reputation. BP's future is tied to deep water well drilling. In this area they can avoid competition with other oil firms. BP can come out of their disastrous Deepwater Horizon experience if they learn from their mistakes, and have proper safeguards in place.

BP’s Upstream Operations strategic challenge for the future is to successfully extract a dwindling supply of hydrocarbons at affordable extraction costs (exhibit 1, 2). Many oil and gas executives agree. In a study sponsored by Deloitte’s Oil & Gas Industry Group, 56% of senior executives at large petroleum companies said they believe the world would “run out of reasonably priced oil in the next 50 years” (8). This view is also expressed directly by BP, which “expects aggregate energy demand to rise by up to 40% by 2030, nearly all of it from emerging economies” (9, slide 6). In order to meet this need, BP will face a significant strategic challenge of finding new sources of hydrocarbons for its upstream operations, divided up into 3 areas: Exploration with focus on Deepwater; Gas value chains; Giant field and unconventional resources (10, slide 42.). All are challenging, but none more so than 20K, the “next challenge in deepwater” (10, slide 45). Over the last few years BP has had considerable success in exploring deeper plays in some of their established basins…but each also has a material upside that “sits beyond the industry’s current development capability due to high reservoir pressures”. To address this undevelopable resource, BP is outlining a project to develop a high pressure capability to drill, develop and produce resources beyond 15,000 pounds per square inch or 15kpsi - called Project 20K” (10, slide 39 and exhibit 5). BP is pursuing such new deepwater explorations, like 20K, to protect their deep-water drilling capabilities since “the majority of (BP’s) top assets are waterflooded oil reservoirs in world class basins. Optimizing recovery from these requires operating experience at scale, advanced surveillance techniques and the application of high end technology, one of BP’s strongest assets” (9, slide 4). Due to the industry’s inability to get to depths beyond 15K, this is a potentially lucrative “blue ocean” strategy for BP, far ahead of its competition.

However, in order to attain success at this external strategic challenge of extracting hydrocarbons from new ultra deep water locations, currently considered outside the technical ability of the industry, what are the challenges BP must overcome to accomplish its goal? As opposed to citing BP’s self-perceived challenges, let us instead identify challenges with respect to the most significant failures that occurred with the Deep Water Horizon (DWH), taking an industry insider’s perspective which may reveal issues that BP itself is unwilling to acknowledge. What I believe is the greatest challenge that BP must overcome is removing an internal social dysfunction it’s suffering from called “Groupthink”. This occurs when a group (i.e. BP Upstream Operations) makes faulty decisions because group pressures which lead to a deterioration of “mental efficiency, reality testing, and moral judgment”. Groups affected by “Groupthink” ignore alternatives and tend to take irrational actions that dehumanize other groups. A group is especially vulnerable to groupthink when “its members are similar in background, when the group is insulated from outside opinions, and when there are no clear rules for decision making”(7). NASA eventually identified this as their primary reason for an inability to prevent the Shuttle disasters. BP has yet to make this realization.

The first Groupthink dysfunction is BP’s inability to realize it will never be able to make all the right decisions internally. The official BP accident summary report failed to point out many of the issues were the result of BP’s actions, which exacerbated the drilling operation dangers (16, exhibit 5). BP’s investigation team “did not identify any single action or inaction that caused this accident. Rather, a complex and interlinked series of mechanical failures, human judgments, engineering design, operational implementation and team interfaces came together to allow the initiation and escalation of the accident. Multiple companies, work teams and circumstances were involved over time” (14). The report failed to point out that as the leasing agent of the Rig, BP company managers had consistently exercised a significant “final say” throughout the drilling operations. BP managers counter-directed the crews during well verification procedures, tests, cement preparation, and pressure checks, all of which were counter to the procedures used by the Transocean Rig crew, Halliburton contractors, Schlumberger engineers, and the Department of the Interior's Minerals Mining Service staff (16, exhibit 5), even though only 2 BP employees were officially assigned to the Deep Water Horizon vs the 79 employees of Transocean (12, page 11). Also, when the Deepwater Horizon exploded, “no one in the BP engineering team had been on the job for more than six months" (15, 16). Yet, during the actual DWH crisis, BP was unable to provide a clear hierarchy for who made the final decisions, and the result was simultaneous control of operations by both BP and Transocean Rig owners which ultimately caused a breakdown in understanding of who was actually in charge or knew what the right solutions (16). In 2004, the American Petroleum Institute estimated that the oil and gas industry would face a 38% shortage of engineers and geoscientists and a 28% shortage of instrumentation and electrical workers by 2009 (8, 15). Unfortunately, this fact that industry expertise is reducing has been met with an even tighter grip over operations by BP via their implementation of “Global Rig acceptance and start-up procedure” (9, slide 12) which will give BP more authority over Rigs and contractors, rather than embracing contractor subject matter expertise.

The other major Groupthink dysfunction is related to the issue of safety. BP believes that preaching safety is the same as enforcing safety. BP had a personal stake in just offering safety fixes since BP employees were graded annually on how much money they save the company, under the evaluation category “Every Dollar Counts and Simplification” (16). Yet, implementing safety standards is not the same as having a safe working environment. The DWH had 390 repair jobs backlogged, amounting to 3,545 man hours past due, and 4 years behind for the Blow Out Preventer (BOP) (13). Unfortunately, to date, BP’s solution is more of the same…increasing its safety Groupthink by a “25% staff size increase through a major recruitment program building expertise in key focus areas…such as Quality Management...developing improved standards and working with our suppliers to eliminate defects” (9, slide 9), and little to no change to newer BOP (exhibit 3). Based on this analysis from the DWH disaster (12, 13, 14, 16), it seems that BP managers are still significantly confident in their ability to resolve problems and keep a Rig operation safe, even though new complex drilling operations like 20K will require more cooperation with joint organizations than ever before.

BP is faced with a number of challenging obstacles to growing their upstream oil operations, but there are numerous actions that should be taken by the company in order to adapt and drive growth in these challenging times. BP needs to utilize new technology, enter into mergers with NOCs, establish a recognizable CSR program and stick to its “bread and butter” business of deep-well drilling. BP is poised for growth in the face of some adversity and implementation of the strategies described herein and proper execution of Project 20K will position them above the pack moving into the future.

 

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General Sources:

  1. Deloitte, Oil & Gas Reality Check; Top 10 Issues for FY10. www.deloitte.com, 2010.
  2. Victor, Nadejda Makarova, On Measuring the Performance of National Oil Companies. Program of Energy and Sustainable Development, 2007.
  3. Deloitte, Oil & Gas Reality Check 2012. www.deloitte.com, 2012.
  4. Stevens, Paul, Oil Markets. Oxford Review of Economic Policy, Vol 21, No. 1, 2005.
  5. "BP Annual Report and Form 20-F 2011." BP Annual Report and Form 20-F. N.p., n.d. Web. <bp.com/annualreport>.
  6. Plunkett, Jack W. "Energy Industry Introduction." Energy & Utilities Industry. Plunkett Research Online, 5 Dec. 2011. Web. 18 Aug. 2012. <http://www.plunkettresearchonline.com>.
  7. 7. Groupthink: Psychological Studies of Policy Decisions and Fiascoes; Janis, Irving L; © 1982; Second Edition; New York: Houghton Mifflin; archived @ http://www.psysr.org/about/pubs_resources/groupthink%20overview.htm
  8. Deloitte’s Oil & Gas Reality Check FY09/10 Top 10 global oil and gas issues; © 2011 Deloitte Global Services Limited; archived @ http://www.deloitte.com/assets/Dcom-Guam/Local%20Assets/Documents/oil_gas_reality_check_2012.pdf
  9. BP 2011 results and strategy presentation: Upstream break-out (Operating model); February 2012; slide numbers listed were cited; archived @http://www.bp.com/assets/bp_internet/globalbp/STAGING/global_assets/downloads/B/upstream_operating_model_improv_execut_capability.pdf
  10. BP 4Q11 Results and 2012 Strategy Script and slides; February 2012; slide numbers listed were cited; archived @ http://www.bp.com/assets/bp_internet/globalbp/STAGING/global_assets/downloads/B/bp_fourth_quarter_2011_results_presentation_slides_and_script.pdf
  11. BP 2011 results and strategy presentation: Upstream break-out (Longer term investments play to our strength); © slide numbers listed were cited; February 2012; archived @ http://www.bp.com/assets/bp_internet/globalbp/STAGING/global_assets/downloads/B/upstream_longterm_invest_play_strengths.pdf
  12. BP- where did it all go wrong? Andrews, Paul; Andrews UK Publisher; Amazon Digital Services for Kindle; © July 4, 2010
  13. 13. Gulf oil spill: Deepwater Horizon had ongoing maintenance problems; Rong-Gong Lin II and Cart, Julie; July 19, 2010; archived @ http://latimesblogs.latimes.com/greenspace/2010/07/gulf-oil-spill-deepwater-horizon-had-ongoing-maintenance-problems.html
  14. Deepwater Horizon Accident Investigation Report, Executive Summary; September 8, 2012; archived @ http://www.bp.com/liveassets/bp_internet/globalbp/globalbp_uk_english/gom_response/STAGING/local_assets/downloads_pdfs/Deepwater_Horizon_Accident_Investigation_Report_Executive_summary.pdf
  15. [Industry Insider PerspectiveAs Workers Age, Oil Industry Braces For Skills Gap; Brady, Jeff; April 20, 2012; Archived @ http://www.npr.org/2012/04/20/150871935/as-workers-age-oil-industry-braces-for-skills-gap
  16. [Industry Insider Perspective] Fire on the Horizon LP: The Untold Story of the Gulf Oil Disaster; Konrad, John and Shroder, Tom; First Edition HarperLuxe, New York: HarperCollins; © March 15, 2011