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Gulf-Scarred BP Was Ready For Oil Price Slump

There's almost as much red ink as oil flowing at BP today.

One of the UK’s flagship businesses has reported what, by some measures, is its worst loss for at least 20 years. On a replacement cost basis, the oil industry’s preferred reporting standard, the company made an annual loss of $5.2bn, compared with a profit of $8.1bn a year earlier.

That is even worse than the $4.9bn lost in 2010, the year when BP was battered with write-downs and charges related to the oil spill in the Gulf of Mexico, a hugely traumatic event for the company.

The big difference between then and now is that the price of crude oil was more than twice what it is today.

BP is not alone in showing its scars from the collapse in crude prices: Chevron (Swiss: CVX.SW - news) , America’s second-largest oil producer, last week announced its first quarterly loss in 13 years.

Eni (NYSE: E - news) , Italy’s oil major, has been forced to cut its dividend. And Exxon Mobil, the world’s largest oil company and the goliath of the sector, today reported its worst quarterly profits for more than a decade – although the 58% fall in fourth quarter profits, to $2.8bn, was not as bad as Wall Street had been expecting.

Ironically, the pain that BP went through following the Gulf of Mexico disaster has in some ways helped prepare it for today. The ‘shrink to grow’ strategy put in place following the spill saw it sell an array of peripheral assets, many at prices better than they were valued at in BP’s books, in order to concentrate on its most important properties. With the benefit of hindsight, that looks like ideal preparation for the calamitous fall in oil prices that has since materialised.

As a result, operationally speaking, BP is not in bad nick: the company pumped 5.4% more oil per day in 2015 than it did in the previous year and, during the final three months of the year, daily production was up by 8.3% year-on-year. That is in spite of the fact that BP’s costs have come down by $3.4bn during the past 12 months, a reduction seen most clearly in the way that it is now cutting jobs aggressively, with some 3,000 jobs already earmarked to go in the upstream – exploration and production – parts of the business, along with 4,000 positions in the downstream – refining and marketing – operations.

However, the shares have fallen by some 9%, with news that BP reported a loss for the final quarter of the year taking the market by surprise. Apart from the effects of the lower oil prices, there are yet more write-downs and restructuring charges, including another $443m related to the Gulf of Mexico – taking the total payouts so far from this calamitous event to more than $55bn. This shake-down by the US legal system is something to bear in mind when, as they did at the weekend, some US governmental sources complained about American tech companies receiving unduly harsh treatment from European tax authorities.

By far the biggest positive in today’s results is the fact that BP has kept its dividend unchanged. The company’s pay-outs no longer account for £1 in every £6 worth of income received by UK pension funds, as was the case at the time of the Gulf of Mexico spill, but it still accounts for about £1 in every £13 received – making the income it generates vital for every man, woman and child in Britain, not to mention more than a quarter of a million private investors who own the shares directly.

The cost of paying that dividend will be more than covered by the cash the company generated in the final quarter of 2015 alone but, should the oil price continue to languish at current levels, investors will begin to question the sustainability of keeping it at current levels.

That is why, for all of its efficiency drives and cost cuts, BP will be hoping that the oil price recovers during 2016.

One person who believes it will be is Bob Dudley, the company’s chief executive since October 2010, who has worked in the oil industry for nearly 40 years. He argues that, having seen many oil price cycles in the past, supply and demand will come back into balance later in the year – although, as sanctions against Iran are partially lifted, that will bring extra daily production of around half a million barrels of oil onto the global market.

At the same time, stockpiles of crude are building everywhere, which mean it will take time for extra demand to mop up surplus production. The thousands of workers whose jobs depend on the North Sea, one of the world’s most expensive places to produce oil, will be hoping that it won’t take too long.