All trumps at the pumps

Blue Chip: From the Gulf of Mexico to the Shetland Isles, BP has become a smooth performer

The deal last week between British Petroleum and British Gas to settle outstanding North Sea take-or-pay contracts, under which BG pays for gas whether or not it uses it, has cost BG pounds 250m. In exchange, BP has agreed to cancel some of its supply contracts to the company, and cut its price from 16p a therm to 14p a therm on others.

Despite a small rise in BG's shares, and a slight fall in BP on the day, it is unlikely to sway investors over the respective merits of the two companies. BG remains traumatised by its unresolved struggle with the regulator, Ofgas. BP, by contrast, after a nasty dip in the early 1990s, has recovered its poise, to be hailed as a model of modern management style in tackling the complexities of international oil and gas exploration and production.

Since 1993, BP's shares have rocketed and only committed optimists would argue for further undiscovered value at BP. Much of the gains have been fuelled by the rise in the oil price; Brent is selling for $24 a barrel, almost double its level two years ago. There is also growing recognition that the plans instituted over the last five years should create a platform for successful growth in years to come.

Even Bob Horton, bundled out of the company after his ruthless management style had alienated the board, can take some of the credit. Horton had taken over after years of heady expansion under chairman Sir Peter Walters in the 1980s. Debt stood at pounds 10bn and the company was exploring in 30 countries. When profits slumped from pounds 1.2bn to pounds 112m, things had become critical.

The work started by Horton has been continued by new chief executive John Browne, to create a company shorn of fat and focused on its core activities.

BP's latest innovative move has been to merge its European downstream retail operations with Mobil of the United States. The $5bn (pounds 3.2bn) merger will link the two groups' fuel and lubricants business in 43 countries, with combined sales in excess of $2bn. In the UK, BP will own 2,000 petrol stations, comfortably ahead of its two great rivals, Shell and Exxon.

Mr Browne wants profits to grow at 10 per cent a year, with a target for profits to hit $4.5bn by the turn of the century.

In that scenario, cost-cutting will play a diminishing role: since 1990, the company has more than halved staff levels, from 112,000, to around 53,000, with half of the reductions coming from selling off parts of the business.

Over the same period, Mr Browne has set a target for capital expenditure to increase to no more than $6bn a year by 2000, from its current level of $5bn. The dividend payout will be the generous equivalent of 50 per cent of underlying earnings.

The transformation is evident in the return on capital, which has risen from 7 per cent in 1992, to 15 per cent at the end of 1995. It is currently running at a little over 16 per cent.

Some of the gains will be achieved through higher upstream productivity. BP expects to be pumping out 1.8m barrels of oil equivalent - that is, including gas - a day, by 2000, from 1.4m barrels a day at present.

Nor is the pace of exploration and discovery relenting. There are several major fields under development, including those in Colombia, the Gulf of Mexico, and west of the Shetlands where two of its most exciting discoveries are located. There, the Foinaven field, discovered in 1993, and the Schiehallion fields, represent two of the most important UK offshore finds since the heyday of the North Sea in the early 1970s.

Both are deep-water fields - 375 metres for Schiehallion and 500 metres for Foinaven, compared with 222 metres for the deepest existing North Sea field - which makes lifting the oil all the more challenging.

Foinaven will produce its first oil early next year, with a capacity of 85,000 barrels a day, of which Shell has a 25 per cent share.

Even BP's older reserves, however, have surprised the company with their longevity. The giant Prudhoe Bay in Alaska was expected to hit serious decline in 1986, but is still going strong. Prudhoe Bay is currently declining at the rate of 10 per cent a year, but BP is reluctant to pinpoint a date when the oil may run out. "It would be foolish to try and predict that," says a spokesman. The field has been granted a new lease of life with peripheral finds.

With the replacement cost of oil to BP running at a touch over $4 a barrel - down from $9 a barrel in 1991 - the company seems to be in an invincible position, with production costs at $3 a barrel. Its downstream refining business has been less profitable, but even there margins are up from $1.7 a barrel, to $2.2 a barrel this year.

Some argue BP is taking over - from Shell - the mantle of safest investment in the sector. Certainly Mr Browne's cautious, deliberate approach has won him many friends in the City. His impact on the bottom line has been dramatic, although luck, in the shape of stronger oil prices, has helped.

At their current levels, BP's shares look vulnerable to sudden shocks or corrections, and there is clearly more speculative fun to be had among the smaller stocks in the sector. But given the efforts of Mr Browne and his colleagues, it would be churlish not to view BP as a core holding in any long-term portfolio.

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