BP's (British Petroleum) origins can be traced back to but the first oil discovery was made in the Middle East in 1908. In 1935, the company prospered and was renamed the Anglo- Iranian Oil Company. Later on, the Anglo-Iranian Oil was renamed to British Petroleum Company (1954). (Anon, 2010)
1.2 Company Overview
BP is one of the largest vertically integrated oil and gas companies in the world having a strong presence in more than 100 countries. The company operates through three business segments and its operations include the exploration and production of gas and crude oil and also the marketing and trading. BP is headquartered in London, and the workforce is about 92,000 people in 2008. In the same year, BP's worldwide network consisted of 22,600 locations branded BP, Amoco, ARCO, and Aral. (Anon, BP p.l.c, 2010?)
1.3 Why choosing BP for the essay / What we will discuss
It had to be a firm based in the UK or Europe and I wanted to find a company with large revenue and much data available for analysis. I choose BP because the company is very profitable, even during the economic crisis and recorded revenues of $361,143 million during the FY ended December 2008. There is easy access to all their financial documents (annual year reports etc) and I think it will be interesting to do an analysis on BP's performance the last 10 years by incorporating micro and macro economic factors, given the instability and fluctuations within the economy.
In the microeconomic analysis we will discuss theories of consumer demand, price elasticity, oil market structure and government legislations about fair competition and carbon emissions.
In the macro economic analysis we will discuss how current and future prospects of the economy have an effect on BP and we will focus on GDP grown and inflation rate.
In the conclusions part we will summarise what we have said in the analysis and also state our recommendations.
2.1 Microeconomic analysis
2.1.1 Consumer demand, price elasticity and BP revenues for FY 2008
We will take one example here to analyse the law of demand and how it applies to BP. For this specific example we will use petrol as product. In general, the law of demand states that the quantity demanded of a good falls when the price of the good rises (assuming other things equal). To represent this change, the demand curve is used. It is a graph that represents the relationship between the price of a product (petrol in this case) and the quantity demanded. (Begg & Ward, 2006)
demand.JPGAs you can see in 1, when the price increased from P1 to P2 the quantity demanded dropped from Q1 to Q2. Changes in the demand curve can be caused by many factors such as the consumer income, the price of substitutes and others. There are 2 categories of goods. The ones that the demand doesn't change a lot when price is changed and those that even a small price change will result in a huge change in the demand. This is called the elasticity of demand. The price elasticity of demand for petrol is inelastic (price elasticity <1) and we can put all the goods necessary to people in this category. This means that even if the price of petrol increases dramatically, people will still continue to buy it as it is necessary for let's say driving to work.
You can see here that an increase in price (p1 to p2) leads to a decrease in quantity (q1 to q2) that is proportionately smaller.
This results in an increase of the total revenue of the company.
BP recorded revenues of $ 361.143 million in the year 2008 compared to $ 284.365 million in 2007.
Percentage change from 2007 to 2008= X2008- X2007X2007×100=
= 361.143-284365284365 ×100 = 76778284365 ×100= + 27 %
This large revenue increase is partially due to the very high oil price. Peter Sutherland (BP chairman) said in his speech in February 2009: “There are few precedents in history for such a rapid and dramatic change in the business environment. In the space of a few months we went from a record oil price of more than $140 per barrel, and BP reporting two consecutive quarters of record profits for the group”. (annual report, 2008)
The operating profit of the company was $36,347 million during FY2008, an increase of 9.2% over FY2007. The net profit was $21,157 million in FY2008, an increase of 1.5% over FY2007. This profitability in 2008, in theory can be based to the “price effect” which states that after a price increase, product (petrol) sells at a higher price, which tends to higher revenue. (Begg & Ward, 2006) The “sales effect” doesn't apply here because we are talking about inelastic demand. Producing and selling oil products which are used by billions of people is one of the reasons BP secured their performance during the economic climate change.
2.1.2 Oil Market Structure (supply curve, market equilibrium, total surplus)
It's difficult and most times inaccurate to try and analyse the supply curve for inelastic products. A supply curve illustrates firms' willingness to supply at particular prices. But in the oil industry there are exogenous factors that affect the prices. When a factor changes we say we have shifts in supply. That can be anything, for example a change in the number of firm selling petrol, a change in the price of a factor input (oil exploration expenses) or a change in technology. In our case, the supply is not affected by customer's willingness to buy. Someone will buy petrol at any price in order to cover their needs (e.g drive to work). But in theory, the more quantity requested, the higher the price set by the firm. In the case which the price has reached the level where quantity supplied equals quantity demanded, we use the term “equilibrium”. On a graph, it is the price at which the supply and demand curves intersect. The total surplus refers to the total net gain to consumers and producers from trading in the market. IT is the sum of the producer and consumer surplus. But in practice the things are a little bit different. There is always need for more petrol (or oil products generally). This means that BP and other firms can produce as much petrol as they want. The boundaries here are if the petroleum firms can produce more petrol. It's clear that the firm that can sell more barrels of oil, they will generate more revenue and gain more market share.
BP's performance in the last 10 years has been exceptional well. They improve and increase the production every single year and that's due to increased refining availability (read description in 4).
As you can see in the diagram (4), the production was high but a bit lower that the year 2006. This is due to the unstable economy and prices in the last 2 years. BP still managed to increase their profits by improving their processes. The highlights of the year are: replacement cost profit of $ 25.594 million (up 39%), capital expenditure and acquisitions of $ 30.700 million and share price increase. The complete table with data will be attached in the appendix. (annual report, 2008)
2.1.3 Government legislation (competition policy and carbon trading)
The competition policies are different from country to country. We will talk about the policies in England as the BP is a British firm. In the UK there is the role of “Director of fair trading” and their job is to supervise the behaviour of companies. If they think that a firm is doing something is not supposed to do then they can refer those firms to the “Competition Commission” for investigation. The maximum market share that a company can hold is less than 25% of the total market. If it exceeds this limit the Director of fair trading can refer the company to the Competition Commission. Also, firms are not allowed to collude because this way they restrict the competition by setting prices. Also, because many companies operate in Europe or worldwide, there are other organisations that keep an eye on firm's strategy. (Begg & Ward, 2006)
In the oil industry the top 3 competitors are : Exxon Mobil, Royal Dutch Shell and BP. BP is the second largest refining and fuel retailing firm in the UK and third in the world. In their effort to become the largest petroleum and offer high variety of products, BP merged or acquired other firms over the past few years.
To produce their products, firms utilise big amounts of energy. This energy usually comes from burning fossil fuels. For example, oil and coal are used to generate electricity. By burning these fuels, greenhouse gas is emitted in the atmosphere. Carbon dioxide is a pollutant and the European governments have set rules to try to reduce the emissions. (Begg & Ward, 2006) The reason the firms don't care much about pollution is because they maximise profit by reducing their costs. Nowadays though, they have to pay big amounts of money depending how much they pollute the environment (surplus permits).
“BP is helping to meet the world's growing demand for sustainable and affordable energy, building alternative energy businesses with the potential to grow and compete far into the future”. gas.JPG . (annual report, 2008)
It is also impressive how much money BP invests in alternative energy, $ 1.4 billion just in 1 year. The total cost they are willing to invest is $ 8 billion. Alternative sources of energy BP is experimenting with are: Wind (432MW), Solar(162MW) and Biofuels. (annual report, 2008)
Moreover, they are running a project called CCS that stands for Carbon Capture and Storage. What CCS does is capturing the CO2 emitted during the burning and processing of fossil fuel. Then, it is transported and stored in deep geological formations such as gas or oil fields. CCS technology is supported by the government and the target is a worldwide implementation that will help reduce the problem of global warming. (annual report, 2008) Governments have the authority to charge big fines to companies not following the regulations. BP is concerned about this as they spent a lot of money already to buy extra emission allowance. Their strategy is spending more money now on technology improvements to reduce CO2 emissions and avoid having to money in case they get fined in the future as this could possibly result in performance drop.
2.2 Macroeconomic Analysis
2.2.1 How do GDP changes affects BP ?
GDP measures the rate of economic growth. A decrease in GDP means the economic growth rate will decrease. Governments can take measures and try to control the GDP rate but it's a very complex process. (Begg & Ward, 2006)
Is GDP affecting BP as a total or not? The answer is yes, but not much.
Let's look at the diagram on the left (6). GDP reflects the total output produced by an economy. More output requires more energy, thus the energy consumption increases when GDP increases.
So, as we've seen in the previous page, GDP growth leads to more energy consumption which results in larger consumer demand for energy. And that's true for the overall picture. But if we look close at BP's products we will see that there are two different things happening.
The GDP changes over the last 10 years haven't affected BP's performance in terms of oil barrels production. What GDP affects is what products of BP the customers will buy. That means that when there is economic growth, customers tend to buy BP Premium products such as Castrol oil and BP Ultimate petrol. Increased revenue is achieved this way. When GDP decreases, BP still keeps the production at similar levels but the difference is that customers will not choose premium oil or premium petrol for their car. On the other hand, there is always the risk of customers leaving BP and choose an even cheaper alternative. Looking at the statistics though of the last decade, BP is constantly in the top 3 petroleum companies in the world and that means they have their customers trust.
2.2.2 BP profiting from recession and the negative impact to the workforce
When inflation rate is high, the purchasing power is decreased and so the consumer demand. When the inflation is high for long period of time, it has negative effects to the overall economy. (Begg & Ward, 2006) The downsides for the company are the fact that it's difficult to budget or make long-term plans as the situation is unpredictable. All companies and BP in our example moves the focus away from their products and try to reduce costs, minimise losses and on top of that, if possible to retain profits.
You can see in the graph (5) that the inflation was high for the last 3 years with a small exception in 2009.
This fact, made companies to reconsider their strategy and take action to prevent the worst outcome.
BP followed the same strategy: they cut back on workers and froze some of the projects. Uncertainty discourages investment and saving as well.
BP's workforce was over 100.000 people back in 2000. This number continued to drop. If you look both graphs ( 5,6) you will notice that the highest inflation rate was at the end of 2007 and BP's employees in the same year were 98.100. In the effort BP made to reduce operating costs in 2008 they cut back 6.100 workers bringing the number down to 92.000. It worth mentioning that BP kept expanding over the last 10 years (acquiring other businesses or expanding their own) and you would think the workers number will have an increasing rate. But from over 100.000 employees back in 2000, BP only has 92.000 (march 2009). This is another negative effect of inflation; it generates unemployment thus more problems in the economy.
Last thing to mention here is the employee satisfaction. The reason it drops is, due to the inflation all the prices are going up making the cost of living more expensive for the people. The people ask their employers to give them a pay rise to help them cover their needs. On the other hand, the employers want to cut down salaries or at least keep them at the same levels. This implication results in arguments between the 2 sides and the employee satisfaction drops down. Further outcome could be reduced productivity and production levels, thus reduced revenue for the company.
In our case, BP had increased revenue and profits as you saw earlier on in our analysis. (annual report, 2008)
The purpose of the analysis was to assess BP's performance by incorporating micro and macro economic factors and explain how the theory applies into practice.
In the microeconomic analysis we explained the consumer demand for petroleum products (including price elasticity), the oil market structure and government legislations in the world energy sector. During our analysis we came to the conclusion that petroleum products are inelastic meaning that a price change will not affect much the demand for these products. Looking at BP's annual report we saw that their total revenue for FY2008 was $ 361.143 million and after we compared it with the previous year revenue and we noticed BP increased their revenue by 17% in one year. Then we looked at the market structure and BP's performance in terms of oil production, refining availability and tried to identify if theories like supply curve and market equilibrium apply in our case. The outcome was that these terms don't quite fit in this industry because products like petrol serve customers' needs and they are willing to pay any price in order to cover this need (e.g transport). The last thing we discussed in this section was about how BP behaves in a competitive environment including some of other businesses acquisitions and also the carbon emission legislations they follow as well the techniques used to reduce the emissions.
The macroeconomic part of the essay tried to analyse the argument if the GDP affects BP's performance and if yes, how. After taking consideration of both arguments and had a close look at the data available, we concluded that GDP has only a minor affect to the BP group. The last topic we discussed and the most interesting in my opinion was how BP made profits in a recession where the economy is very unstable. Their strategy was profit oriented that was successful but with negative impact to their workforce.
Anon. (2010?). BP p.l.c. Retrieved December 1, 2009, from Energy Business Review Web site: http://www.energy-business-review.com/companies/bp_plc/
Anon. (2010, January 3). BP plc. Retrieved December 1, 2009, from Wikipedia Web site: http://en.wikipedia.org/wiki/BP
Begg, D., & Ward, D. (2006). Economics for business (2nd ed.). NY: McGraw-Hill.
services, B. D. (2008). BP Annual Review 2008. BP Distribution services.
BP annual report 2008.pdf [online] available from http://www.bp.com/liveassets/bp_internet/annual_review/annual_review_2008/STAGING/local_assets/downloads_pdfs/BP_annual_review_2008.pdf