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BP plc (BP)

Q2 2007 Earnings Call

July 24, 2007 9:00 am ET

Executives

Fergus Macleod - Head of IR.

Tony Hayward - CEO

Byron Grote - CFO

Iain Conn - Chief Executive, Refining and Marketing Business

Andy Inglis - Chief Executive, Exploration and Production

Analysts

Neil Perry - Morgan Stanley

Jon Rigby - UBS

Neil McMohan - Bernstein

Nikki Decker - Bear Stearns

Lucas Herman - Deutsche Bank

Colin Smith - Dresdner Kleinwort

Tim Whitaker - Lehman Brothers

Colin Smith - DKW

Jason Kenney - ING

Robert Castro - Simmons & Co

Mark Gilman - Benchmark Company

James Neil - Citigroup

Irene Himona - Exane

Gordon Gray - JP Morgan

David Kline - ABN Amro

Presentation

Operator

Welcome to the BP presentation for The Financial Community Conference Call. I will now hand the call over to Fergus MacLeod, Head of Investor Relations. Please go ahead, sir.

Fergus Macleod

Good afternoon for those of you listening in Europe and Asia and good morning to those in the Americas. It’s my pleasure to welcome you to BP's second quarter 2007 conference call. My name is Fergus MacLeod and I am BP's Head of Investor Relations.

Before we start, I'd like to draw your attention to a couple of items. First we will refer to slides used during the webcast. Many of you will already have received them by e--mail. If you would like to be placed on the e-mail list for future releases, let us know.

Second, I need to draw your attention to this slide. We may make forward-looking statements which are identified by the use of the words "will," "expect," and similar phrases. Actual results may differ from these plans or forecasts for a number of reasons, such as those noted here, and in our filings.

It’s now my pleasure to introduce BP's new Chief Executive, Dr. Tony Hayward.

Tony Hayward

Thank you, Fergus. Ladies and gentlemen, welcome to our second quarter results presentation. This is of course something of a landmark for me, as these are my first set of results as BP's Chief Executive.

In today's world, it’s become traditional for a new leader to be judged on their first 100 days in office. This is my 95th day, so I hope you don’t mind. If in addition to going through the usual quarterly numbers, I use this opportunity to take stock of the company from the perspective of a new CEO.

It has been a busy period. I have been doing what I promised to do at the outset: focus on the company’s operations. And to that effect, I have been urging everybody to concentrate on the same three things: safety, people and performance.

Whilst my travels to Russia have received a lot of press coverage - I’ll say more on that later - much more of my time has been spent visiting our facilities around the world, especially our refineries in the US, talking to our people. I have been impressed by the dedication and teamwork I have seen everywhere in BP.

However my message today is simple, BP's current operational performance is not good enough. This has impacted our financial performance. I am determined to fix this. The solution is clear. Restoring our operational performance is the best way of restoring our financial performance. Doing this will put momentum back into the business and BP back at the forefront of the energy industry.

I would like to start today with some of the good news. We now have greater clarity over several issues which were creating uncertainty. In the US, following the publication of the Baker Panel Report in January, we are implementing its recommendations and the Board has appointed an independent expert to review that process.

In Russia, we and our joint venture TNK-BP, agreed to examine a strategic alliance with Gazprom and found a way forward for the future of the Kovykta gas field. And in the board room, management succession has been resolved.

These are important issues where I am glad we have made good progress. My executive team is in place and we are enjoying working with each other in our new roles. And I am particularly happy to confirm that Byron Grote will remain as our Chief Financial Officer until the spring of 2009.

Of course there are remaining outstanding issues, but we are working hard on resolving those too. I am also pleased that as well as making significant progress dealing with the short term issues facing BP, the team has also kept its eyes on the longer term. We've maintained our strategic momentum in the first half of 2007 and have taken important steps to further strengthen our asset base.

In our Exploration and Production segment, we sanctioned a series of major projects, including the expansion of our San Juan coal bed methane operations in the US, Skarv in Norway and the expansion of our gas handling terminal in the southern North Sea.

We signed major deals in Oman, where we could access between 20 - 30 TCF of gas resource, and in Libya, which is the biggest ever exploration commitment by BP. We had continuing exploration success in Angola, Egypt and the Gulf of Mexico; and we signed a Memorandum of Understanding to enter into a strategic alliance with Gazprom.

I am particularly pleased about the latter because I do not think enough credit is always given to the success of our Russian operations.

A strategic alliance with Gazprom has the potential to herald the next stage, both for BP and the Russian economy in general. That next stage will likely see the increased importance of “reciprocity”, where instead of Russia simply receiving inward investment, Russian companies themselves start to invest abroad, alongside companies like BP. Reciprocity with Russia, and indeed with many other countries, could become one of the next major trends in our industry.

In Refining and Marketing, we upgraded our European portfolio by taking full ownership of Nerefco and selling Coryton; we expanded our biofuels effort, endowing the Energy Biosciences Institute in the US and signing a deal with DuPont and Associated British Foods for the construction of a bioethanol plant. And we signed a joint venture with D1 Oils to develop a sustainable biodiesel feedstock from Jatropha a drought-resistant plant which doesn’t compete with food crops.

In Alternative Energy we continued our investment and began construction of mega-cell solar plants in Bangalore and Madrid. In wind power, by year end, we will have 450 MW of capacity in the United States and India. We have also signed a joint venture with Rio Tinto to form Hydrogen Energy which will develop decarbonized energy projects around the world. So there is plenty of good news and we should keep that in mind when I get on, in a moment, to where BP is not doing so well, our current operational performance, and the impact that it's having on our competitive financial performance.

Byron will go through the results in detail. The absolute numbers are large, but on most key measures our competitive performance in the first half was disappointing. Our replacement cost profit declined 8% to $10.4 billion compared to the same period last year; and our post tax cash flow fell 22% to $14.1 billion.

Frankly, our financial performance is not good enough. I am determined that it will improve. We should and we can do much better. I recognize that many shareholders will be disappointed by our competitive performance. Let me reassure you, that we share their disappointment. The principal cause of our financial underperformance is missing revenue, either from refinery outages in the U.S. or delayed upstream projects.

We will improve revenues by restoring refining reliability in the US and bringing on line projects, such as Greater Plutonio, Atlantis and Thunder Horse. Byron said at the time of our first quarter results that 2007 would be a year of consolidation of restoring stability. That process is underway.

Some of you will want me to give a precise timetable, to say exactly when we can expect to see a recovery in BP’s performance. But rather than make optimistic predictions, I’d prefer to concentrate on real delivery.

What I will say is that I am determined that we should see progress by the end of the year and that the momentum will build steadily through 2008.

Our production and CapEx guidance for 2007, issued in February, is unchanged, as is our projection of future project startups. However, in the near term I expect to see continued pressure on earnings and free cash flow from cost inflation in the industry's supply chain, and higher depreciation charges. We also plan to make fewer disposals than last year.

By this time next year the picture should be much clearer. I'm going to say more about the changes that we intend to make in order to restore our performance in a moment, but now, over to Byron who would take us through the results in more detail.

Byron Grote

Thanks Tony, and good day to those joining us on this call. Before discussing our results, I'd like to draw your attention to the additional disclosure in our Stock Exchange Announcement related to the effect of IFRS fair value accounting on certain of our inventories.

I've made it clear on a number of occasions that these are only timing effects, that over time they tend to wash out. And that as a result we consider them part of our underlying performance and not as non-operating items. All of that remains true, but I also recognize that in individual quarters these effects can be significant, especially in volatile markets, and that many of you have requested additional disclosure. We’ve responded by providing details on these effects for Refining and Marketing and Gas Power and Renewables on page 10 of the Stock Exchange Announcement. I hope that you find this information helpful

I will now begin my review of the quarter with the trading environment. The table shows the percentage of year-on-year changes in BP's average upstream realizations and the industry indicator refining margin for the second quarter, as well as year to date. Our average 2Q liquids realization of $63 per barrel was significantly higher than the previous quarter but comparable to a year ago.

Our gas realization, of around $4.50 per thousand cubic feet, was also similar to that experienced a year ago, but was 8% lower than 1Q. Taking both oil and gas together, our 2Q hydrocarbon realizations were comparable to last year and 10% higher than the previous quarter.

Refining margins continued to set new records, as the industry entered the driving season with historically low refining utilization and product stocks in the United States. Our second quarter refining indicator margin of almost $17 per barrel was 32% higher than 2Q ‘06. However the margins realized by our own refineries did not increase to the same extent because of our product mix and low refining availability in the United States.

Turning to the financials, our replacement cost profit of $6.1 billion was comparable in absolute terms to 2Q '06. Our profit, including inventory gains and losses was $7.4 billion similar to last year and up on a per share basis, reflecting the benefit of the 5% reduction in our shares outstanding over the past year. These figures include gains of around $750 million from non-operating items. I will describe these items in more detail when discussing individual segment results.

Operating cash flow of $6.1 billion was significantly lower compared to a year ago, primarily as a result of working capital movements. The 10.825 cents per share dividend announced today, which will be paid in September, is 10% higher than year ago. The sterling dividend is roughly the same year-on-year, reflecting the sharply weaker dollar.

As Tony has already indicated, the first half results shown at the bottom of the page are down year-on-year.

Turning now to our segments, In E&P we reported a pre-tax profit of $6.9 billion for the second quarter, which included approximately $400 million of non-operating gains in respect of disposals and embedded derivatives related to certain heritage long term North Sea gas contracts.

Excluding these non-operating items, our underlying result was $6.5 billion compared with $7.3 billion last year. This reflects lower volumes, continued sector specific inflation, greater integrity spend and higher DD&A charges associated primarily with the change to SEC reserves reporting guidelines and increased decommissioning provisions.

Reported production was 3.8 million barrels of oil equivalent per day, a decline of 5% compared with a year earlier. After adjusting for the effect of disposals and the impact of lower entitlement in our production sharing agreements, production for the quarter was down 1%.

Full-year production in 2007 is expected to be in the range of 3.8 to 3.9 million barrels of oil equivalent per day, as outlined in the guidance we provided in February.

Our Refining and Marketing result increased 48% to $2.7 billion in 2Q '07. This included a gain of around $770 million for non-operating items, mainly related to the Coryton disposal gains. Excluding these non-operating items our underlying result was $2 billion, compared to $2.3 billion a year ago. The benefits seen from the stronger margin environment and recommissioning of Texas City, were more than offset by the impact of operational issues at a number of our US refineries.

In particular, lower availability at Whiting, which I highlighted in the 1Q webcast. The operational issues at the Whiting refinery have limited the site's ability to make low-sulphur gasoline from sour crude oil. Repairs are ongoing and we expect to resume sour crude processing in the fourth quarter. Completion of the work will restore the refinery to its full flexibility and crude capacity in the first half of 2008.

In addition, the quarter's result reflects greater integrity spend, lower supply optimization benefits, and favorable fair value accounting effects.

In Gas, Power and Renewables, we reported a pre-tax profit of $190 million compared with around $450 million last year. This included a small charge for non-operating items related to embedded derivatives. Our second quarter underlying result was $226 million, reflecting a lower marketing and trading contribution, growing expenditure in alternative energy, and a favorable fair value accounting effect, relative to 2Q '06.

In Other Businesses and Corporate or OB&C, our second quarter underlying charge of around $200 million was comparable to last year. Our expected full year underlying charge remains consistent with the range that I indicated back in February.

Turning now to cash, this slide compares our sources and uses of cash in the first half of 2006 and 2007. Operating cash flow decreased to $14.1 billion, primarily as a result of working capital movements, due to increasing oil prices. Disposals provided a further $3.7 billion. In total sources of cash were almost $18 billion.

We used this cash to fund $8 billion of organic capital spending, $1.2 billion of acquisitions, plus $8.5 billion of shareholder distributions. Our net debt ratio remained flat and at the bottom end of our targeted band of 20% to 30%.

In the current environment we expect to remain in the lower proportion of this range. Shareholder distributions for the first half of the year were $8.5 billion dividend payments have totaled $4 billion and we've bought back $4.5 billion of shares.

The pace of our share buyback program in 2007 is slower than in the last two years. The level of our share buyback is determined by our free cash flow, which is currently missing several big revenue generators. In addition, 2005 and 2006 benefited from high disposal proceeds, including the sales of Innovene. We don’t expect such large disposals in 2007.

Our financial framework is unchanged. We remain committed to distributing 100% of excess free cash flow to investors, other factors being appropriate.

That concludes my remarks. Now back to Tony.

Tony Hayward

Thank you, Byron. As I have already said, over the last few months I have spent a lot of time visiting our operations, I have enjoyed talking to our people and hearing what they had to say.

Based on those conversations and what we have seen around the organisation, my team and I have developed an agenda based on three very simple priorities - safety, people and performance.

First: safety. We are ensuring that we have consistent, safe reliable operations across BP. We are implementing the Baker Panel recommendations. We are also in the early days of establishing a new way of operating in BP with a progressive roll-out of a common group, wide Operating Management System. Both of these actions are aimed at improving the capability and consistency of our operations.

Second: people. We are focused on increasing our operating capability through investing in training and recruitment. We are in action deploying people from the office into the field, expanding our operating workforce and ensuring we have the right people in the right place - and keeping those people in position longer. To support all of this we are also putting in place a new training program “Operating Essentials” for all levels in the organization.

In terms of culture we are focused on increasing openness and transparency throughout BP. We need to listen to people on the front line, to recognise that bad news told early enough to act on is good news. I want to create a culture where everybody has a voice and where every voice is heard.

And finally, we need to restore pride and confidence in our company.

In the midst of the difficult events over the last few years, we should not forget that BP, like all companies is not just a collection of assets but a group of people working hard every day, providing energy for the basic necessities of life. I am proud of what they do and they should be too.

In terms of performance, the focus is two-fold; first we will restore revenues by bringing the refineries in the US back to capacity and by starting up our major upstream projects. The second focus is on simplifying our organization, reducing complexity and eliminating unnecessary activity. We will improve the efficiency of the group. We can be more efficient, leaner and fitter, by ensuring we have a common and consistent way of doing things, by reducing our overheads and doing a better job at managing our third party spend.

For now though the priorities are clear, the focus is on safety, people and performance. Through delivering this agenda, we firmly believe that BP will rediscover its winning ways.

In summary, BP has great fundamentals. Our strategy has been hugely successful in building an asset base that is the equal of any in the industry. When we are good, we are really very good. Azerbaijan and Russia are great examples, but we are not consistent enough - we will change that.

Our financial frame work is robust and we remain committed to distributing all excess free cash flow to shareholders. What we need to do now, is to get the plant running and to keep it running every where. We are gaining our momentum by focusing on the three priorities of safety, people and performance.

Thank you for listening. Vivienne, Byron, Andy, Iain and I will now be very happy to take questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Fergus Macleod

Thank you operator and now we'll go to the first question, and that question comes from Neil Perry at Morgan Stanley. Good afternoon Neil.

Neil Perry - Morgan Stanley

Afternoon Tony, you talked a lot about restoring the operational performance, but since you have been Chief Executive and looking not just to the upstream but the downstream as well, what do you think are the causes of BP's operational under performance? And why did you get into this situation, because it surely affects it? You have to look at the problems and determine whether there has been some sort of systemic issue in the way projects have been executed or plant has been run in the past. And then just sort of sideline, you have not mentioned Thunder Horse in your comments. And I just wondered whether we can assume from that, is everything is still on track for end 2008 on Thunder horse?

Tony Hayward

Thanks very much Neil. Just to get the Thunder Horse question out of the way. Everything is on track. Nothing has changed with respect to Thunder Horse and we have made good progress hitting milestones that we have set out for ourselves this year. It remains on track for startup before the end of 2008. I think if you look at our operating performance, it is exactly what I said Neil, it is not consistent. So our issue is one of insuring real consistency. And that is about capability and competence in the organization, and that's what the program is about.

So we are tackling it through two axis, as I described, first we are making certain that we have common and consistent standards that are implemented everywhere. And secondly, we're ensuring that we have people with competence and capability everywhere across the organization. So I think you are quite right, you have to look at the root cause of operational issues, and I think we've done that and understood what they are and we are taking action to put it right. To be fair I think we've been at this now for at least 18 months, and I would expect that program to begin to pay real dividends for us.

I think if we just compare it with projects, I think we made enormous progress on projects in the last three or four years. Back in 2002, we set up a different way of doing projects in BP and we've seen the benefits of that in Azerbaijan and Trinidad, it's about standardization, it's about common component parts, it's about repeatability. We're still living with a legacy of a couple of things that started before that program was put in place. But I think we are very clear about what we need to do.

Fergus Macleod

Thanks Neill. We'll now go on to Jon Rigby at UBS. Jon, are you there?

Jon Rigby - UBS

First is on the downstream, thanks for introducing clarity over the accounting issues there. But obviously now we can drill that a bit further, I just wonder whether you are able to give some indication of the earning shortfall in the quarter as in regards with Texas City and then also with Whiting. But you can then sort of split that between what do you think the opportunity loss was of having problems of those from Whiting. And also what is the ongoing costs to infrastructure rebuild at people site which will go away once that operation is initiated that lead to refinery to restore full operation. And then the second question I have occurred it to Tony, you kind of focus on little internal stuff is that going to continue to be the main possible timeout, or do you have time to get your head up and look around strategically, clearly in the sector and these sector things are changing very rapidly?

Fergus Macleod

Okay. Jon thank you for that. Let me ask you and to talk about refining and we are trying to give you as much clarity as we can about where we are and what it’s like going forwards.

Iain Conn

Well, Jon thanks for the question. I think first of all on the first part the earnings short fall in the quarter I think the only indication we have given and are prepare to give is the indication Byron gave at the end of first quarter about Whiting which is that the overall impact of the prevailing margin of the time would be about a 100 million a month. And we'd expect that sort of impact to continue until the Sour crude capability starts to come back of Whiting in the fourth quarter.

Now we are not trying to leave the audience and using very much public information, Whiting is currently running at about 250,000 barrels a day, and is running sweet crude when it should be running a mixture of sweet and sour. Texas City is running at 240 a day and it should be running a mixture of crude, so you can probably gain a pretty good idea of the impact from both of those refineries being out in the prevailing environment to the end of 1Q simply by so the doubling of Whiting number, and I don't believe that's anything other than common sense.

In terms of the opportunity loss in totaled therefore I think that give you a sense because that's majority of the outages we have had. As far as looking forward to concern we don't give indication of what's going to happen in the second half, but I can help you a little bit with just for qualitative points. The first one is, in the second quarter our refining availability was 1% up on the first quarter and that was despite Whiting being down. So there is some underlying momentum there.

Secondly, the hundred months that Byron indicated, which clearly will be falling as the sour capacity comes up. Texas City’s impact will also be falling as we get towards the 400,000 barrels a day we’ve reconfirmed will hit by the end of the year that’s due to the second crude train coming up in the fourth quarter. And finally our turnaround schedule which we don’t publish to details of in the second half, will be lighter however than the first half. All of that should give you some sense of momentum.

Tony Hayward

Thank you Iain. In terms of your question Jon, I clearly have been spending a little bit time internally, but also spent as you all have noticed if you read the newspapers, at the time in Russia, which is very different; it has been above the external agenda. And I think, I’d like everyone to know that, as well as fixing the issues we have operationally, where every bit is focused as you would expect just to be, on ensuring that we make the right strategic moves for BP going forwards.

Jon Rigby - UBS

Okay. Thank.

Iain Conn

Thanks.

Operator

Now I’d like to move to Nikki Decker of Bear Stearns. . Good morning Nikki.

Nikki Decker - Bear Stearns

Yes good afternoon, everybody. Just on the downstream theme here. I’m trying to translate what you were talking about that Whiting in terms of restoration to utilization and product yields and it sounds to me like utilization at Whiting will not rise by the end of the year, nor will product yields. Maybe you could talk about how those will rise in the restoration process. Also at Texas City the expected processing capability by the end of the year is 400,000 barrels a day that is below rated capacity. Do you expect Texas City to be fully operational by the end of the year?

Tony Hayward

Let’s get back to Ian, so if we can shed more light on, the best for everyone.

Iain Conn

Okay. I think firstly all thanks Nikki, Whiting is currently running at about and I see a question on the web, so I will just try to answer that at the same time. Whiting is currently running at about 250 a day, against what is an effective capacity in clean fuels world of about 360 a day. And but it's currently running sweet crude oil where off course we would like to be able to sour. So, two things are going to happen as we move towards the end of the year, firstly we are going to get as Byron indicated about 300 day on crude and secondly we going to progressively introduce sour capability into the mix as we bring on the first sour train, we don’t expect to bring on the second sour train until some time in the first of '08 as we indicated.

So what you will see is an increase in overall production which means you will see higher gasoline and middle distillate production, and we will see a higher conversion rate as we take in more sour crude. So the yields will progressively be restored to more of an upgraded refinery based on sour, but in fact we do have quite high gasoline yield at the moment, because we are running all on sweet. So up shot of all of that is you probably won’t see so much on yield but you will see quite a bit on throughput.

As far as Texas City is concerned, we are currently running at about 240 a day. We are running only one of the two big distillation units. In the third quarter we will be bringing up a product crossed over that will consist of some distillate desulpharization units. Somewhere else we are bringing on hopefully one of the other [crackers] that's going to increase the yield in advance of bringing on the second crude train in the fourth quarter. So both refineries will see an increase in yield and an increase in overall volume which I think gets back to Jon Rigby's question about momentum.

Final part of your question was will we see full restoration to name plate Texas City which is about 460, 470. The answer is no. We indicated before that we would see full beneficial production at Texas City in '08. And the remaining upgrading units that will give us that final 50,000 to 60,000 barrels a day won't happen until the first half or middle of '08. That will be my guess right now. Thanks.

Nikki Decker - Bear Stearns

I have one more question on Whiting. You had talked about a year ago of $3 billion investment in that plant. And I saw some headlines talking about that investment. Is that something that is currently in your plans?

Iain Conn

It is absolutely, we are completely committed to upgrading Whiting to predominant diet of Canadian crude and that investment involves a new distillation column and a very large new [concurrent] and various other units. We still plan to go ahead with that in 2008 as indicated.

Nikki Decker - Bear Stearns

How far are you on that project?

Iain Conn

I am sorry.

Nikki Decker - Bear Stearns

Where are you on that project? Are you in the design phase?

Iain Conn.

I can't confirm it. Not in the design phase, but we have ordered some of the long league items which is public knowledge.

Nikki Decker - Bear Stearns

Very good. Thank you.

Fergus Macleod

Thank you Nikki. Now back to London to Neil McMahon at Bernstein.

Neil McMohan - Bernstein

Two questions, the first one really for Tony. How will we or what could we see as being milestones going forward in terms of you fixing operations. But what should we be looking forward really over the next six to nine months in terms of you making quarterly announcements and the press releases that will give us a sense of where you are getting from the operational performance of the company or do we have to wait for the quarterly numbers to come through. And secondly, do you think that, was this main focus on operational performance you need a COO to help you really get things kicked off, for at least say the first year, of your CEO tenure.

Tony Hayward

Thank you for the question Neil, I will take the second one question first, as far as I am concerned, I have three CEOs each one of them running the principle business and Ian was running ANT, Iain Conn running RNM and Vivienne running gas power and renewable. So I don't think we need a CEO, we need to make sure everyone is focused on the operating performance.

I think we won't be issuing press releases or anything such along those lines. We’ll be letting the numbers, to just speak for themselves and what you should expect to see is as we’re saying as we go through the second half of this year and into 2008 momentum progressively building in terms of that underlying operating performance.

Neil McMohan - Bernstein

Great, maybe just one last question, just on Russia, in terms of the subsoil getting develop, they don’t know if any of your conversation when you have been negotiating with Gazprom how sort of underpinned what is going to happen going forward, I suppose more specifically what the current TNKBP assets base so well you would expect anymore changes of the ownership of assets that you currently owned.

Tony Hayward

Well I think, or I can say and that scope nearly is that we were very happy with that 50% we intend to keep it and continue to invest into TNKBP on that basis. And of course our shareholders, our fellow investors and shareholders AAR have to talk from themselves.

Neil McMohan - Bernstein

Thank you very much.

Fergus Macleod

Thank you Neil. Now I am going to pass to Tim Whitaker at Lehman, are you there?

Tim Whitaker - Lehman Brothers

Yes, good afternoon, and welcome to this quarterly update process study. I would like to ask a few questions about your trading business, you said in your slide you had lowest supply optimization contribution, I think it's pretty well known, quite number of your trade is left in recent month. Could you say by how much that the trading contribution fell and could you say to us your philosophy around that trading may have changed in the new leadership era? And also have a quick question around CATS, if you can update us on the operational progress around the CATS outage?

Tony Hayward

Let me start on trading then I will go to Byron and then I will ask Andy Inglis to talk about CATS. I think first and foremost I would say and this is been true forever, this is primarily about supply optimization, and the trading is something we do over and above satisfying optimizing supply around our asset base. I think in terms of our losing people there is no doubt that we've lost a few more people than we would have ideally wanted to just go around, but anyone who follows this particular market will know it say today it's very a hot market for good traders, and it's simply a case of we’re seeing moving into this area a large number of the investment banks. So while we don't like to lose people, we are not going to do, is pay silly sums of money to retain people. Byron anything you will like to add?

Byron Grote

Yeah Tim, Tony said the hard of it, we lose traders, we recruit traders this happens all of the time. We obviously are very experienced in physical markets and therefore some of the attraction of the people whom we've lost over the course of last quarter or so, but we've got deep bench strength on the team. And there is nothing that is occurring, that is in anyway reshaping the way that we manage our business and the activities we are involved in.

Let’s just get Andy to give you an update on CATS.

Andy Inglis

Yes, hi Tim. On the CATS we have literally got a team of divers now on location who are inspecting the pipe as we speak. And then clearly the forward plan in terms of the nature of repair, whether a repair is required will depend on that assessment. I think we will know more in about a week from that inspection and will update folks then. But it would be sort of premature to speculate on any other basis than that. So inspections are going on and probably within about a week we can give you an update. And you should sort of have in your head that sort of any repair will take several weeks.

Tim Whitaker - Lehman Brothers

And Byron could you give an indication of about how much these supply optimization contributions fell?

Byron Grote

We don’t provide that disclosure and we won’t on this occasion either.

Tim Whitaker - Lehman Brothers

Okay.

Fergus Macleod

Thanks and we actually got one question on the web which I suspect is directed at Andy which is from Thomas Hackel at Hackel Asset Management, United States.

What impact will have on your production profile when Atlantis and Great Plutonia come on stream by the end of this year

[technical difficulty] Implementing the Baker panel recommendations and to take the integrity spend. Are you perhaps finding that, that is taking a little bit longer and costing more than originally expected? And finally when you talk about near term pressure on free cash I was just wondering how long the time frame might me? Thank you.

Tony Hayward

Thanks Irene. Let me ask Andy to talk about the upstream costing inflation, I'll covered integrity spend and what I meant by near term.

Andy Inglis

Yes, hi Irene, We think we are still continuing to see pressure in the upstream. If you look on the capital side, it is probably sort of over 10%, I would said we would see the market probably moving in sort of close of 14% and we are still able to mitigate more on a 2% of it. As Tony has talked about some of those mitigation methods, it's about standardization of the concepts which we were pulling through now. Standardization of components, and actually creating a greater longevity of some of the contracts that we have with our supplies to create greater buying power.

So those things are on going and I think we are managing to sustain I think some improvement versus the market. On the operating cost side it is probably sub 10% at the moment. But certainly close to it, I mean the market is probably moving at sort of nineish, and we are probably mitigating maybe a 1% of that so its 7%-8%.

And again its similar sort of processes to try and create greater buying power through the way in which we operated in our big centers in North America and the growing sort of trend we have in Azerbaijan, Trinidad etcetera. But on the operating side, you are clearly seeing a real wage inflation coming through which is sort of a major under penning feature. So I think it is sustaining and it is a real issue, I think in a high priced world today. Driving cost efficiency is as big an agenda as we have and that’s fundamentally about how you execute and using the fundamental strategic approach of having larger fields to develop to drive greater cost efficiency.

Tony Hayward

Okay thanks Andy. On integrity, Irene we are going to be investing around $5 billion across the group on integrity investments this year. It’s about two thirds of OpEx and one third capital and that’s up from under $4 billion in 2006.

In terms of what do I mean by near term, it is the second half of the year because what we won’t see is the big new sources of cash, either in terms of upstream project start up or the two big refineries coming back into the fourth quarter. So it’s through the second half of this year. As we go into 2008, of course we will have significant new sources of revenues which would significantly strengthen the group cash flow.

Irene Himona - Exane

Thank you.

Fergus Macleod

Thanks Irene. Now I would like to move on back to the United States to Robert Castro of Simmons & Co. Hi Robert.

Robert Castro - Simmons & Co

Hi good afternoon. Quick question on your taxes. It looks as though for the second quarter in a row you have got favorable some cash tax benefits. Wonder if you might highlight the reasons why those transpired in the second quarter and then provide an update to your guidance in the long term for cash tax rate.

Tony Hayward

Thanks Robert. Let me go to Byron to give us the.

Byron Grote

There is nothing particularly unusual about the tax payments. I realize that they are down from the second quarter of last year. But if I could step back from the timing of cash payments which by its very nature is choppy to the effective tax rate throughout our operations, I've said at the start of the year that they would be in the 35% to 37% range for this year that continues to be our view and in spite of a small dip of it in the second quarter and that sort of range at least as we look at it today seems robust for looking out across the end of the year in to 2008 as well.

Robert Castro - Simmons & Co

Byron then you expect by default working capital detriment on balance for the second half of the year, as you catch up on a cash basis?

Byron Grote

I think that’s a reasonable expectation again to some extent the cash tax paid is a combination of timing as well as various considerations that would impact our payments and that will be always running at a slightly lower rates then the effective tax rate, what you are suggesting as far as catch up is typical for a calendar year and 2007 should be not different than that. So you are right on in your general direction.

Robert Castro - Simmons & Co

Thanks very much.

Fergus Macleod

Thanks Byron, I'll send United States with Mark Gilman at the Benchmark Company.

Mark Gilman - Benchmark Company.

Gentlemen, good afternoon. I had a couple things if I could please, first Andy give us an update if you could where we stand on the potential section of development project block 31 and Angola. Secondly, reading between the lines a little bit in terms of looking at rest of world gas volumes and also the minority interest on the income statement, looks to me is that there might be a shortfall in Trinidad gas production in the second quarter of some substance and was wondering if you might be able to address that thirdly for Tony, regarding the Kovykta arrangement. I'm curious if you could be specific as to whether there was any quid-pro-quo in that arrangement relating to the development of other Russian assets? And why it is that perhaps you did not walk away from that with a minority interest without the call at market price similar to what we saw evolved in the situation with [Shaklin 2] and Shell? Thanks

Tony Hayward

Are you still there Mark, you just sort of disappeared. Looks that you were in Trinidad.

Iain Conn

In Trinidad, yes, so, about Trinidad first, certainly no shortfall in gas volumes delivered Mark, the upstream performed pretty well. What we probably didn't get the full operational efficiency on Train four in the quarter. So, I'll say a very small amount of volumes were down. But I think, in terms of the overall supply position, it was pretty solid.

In terms of Block 31, the first projects, the price was complete, we were into the select phase of the project and that means that we are out for bid currently for the major components, the sub-sea equipment, the raises the FPSO's. We expect those conversations to continue with contractors through the second half of the year. And with Senegal the expectation is that we would sanction the first project in the program in the first half of '08. So we’re making a good progress on that.

Tony Hayward

Let me come back to Kovykta Mark. The deal on Kovykta is as we disclosed, we are not in a position to disclose anything else as of this point. And I would say, that we are satisfied that this was a deal that was acceptable to all parties.

Fergus Macleod

Alright, thanks very much, Mark. We'll now come back to Colin Smith at DKW. Colin?

Colin Smith - DKW

Afternoon, I have questions for Tony, really. You’ve talked about reducing complexity and increasing efficiency. Now Tony, if you could explain exactly how that might be achieved. And what I’m thinking here is whether you’re feeling that the change in the way you structure BP organizationally as required, because these things obviously are often quite easy to say but much more difficult to accomplish, unless there is something a bit more structural going on in the way the business is being actually organized and managed?

Tony Hayward

Great, thanks Colin. We didn’t engage in any wholesale restructuring, Colin. What we are doing is looking at where we have build capability, particularly in the functional areas over the last few years and ensuring that we don’t have duplication. We’re looking at how we hold functional capability and where it should be deployed, what level in the organization it should be held at. So there won’t be any wholesale restructuring, but there is no doubt that we’ve got duplication and overlap in a number of areas which we are going to go and sort our.

Colin Smith - Dresdner Kleinwort

But what I was thinking was does this mean any change to the business unit concept, because I thought the whole point of that kind of thing was to re-function capability were it needed to be. So I am sort of intrigued as to why you now find or perhaps found that you mentioned you’ve got duplication and so on going forward in the business as it stands?

Tony Hayward

Well the fact remains, we do believe we have got duplication as we build capability over the last three or four years and you are quite right we need to decide where the boss should most appropriately reside, in some cases it should reside very close to the front line and engineering, be a good example? And in some places it’s better to reside more centrally, finance, control accounting is a good example of that so I think sort of horse for courses here. I am being very clear, to ensure that we haven’t duplicated.

Colin Smith - DKW

Okay. Thanks.

Fergus Macleod

Thanks Collin. Now Jason Kenney at ING.

Jason Kenney - ING.

Good afternoon gentleman. Tony as very interesting your theme of reciprocity and I was wondering if you could maybe expand on the possible internalization of Gazprom by the JV with BP, does this include kind of a nock-to-nock support in Libya or a man with your new positions there. Are we looking at other regions for Gazprom to enter into I thought of Russia?

Tony Hayward

Well I am sure you would not expect me to go into the details of what we have in mind at this stage Jason because it is not yet been agreed. But I think it’s clear from what I said today and what I've said in last couple of times on publicly on visits to Russia that the concept of reciprocity seems to me and the team at BP to be an important element of the future for BP in Russia. We are not in position to divert exactly what that might mean at this point.

Jason Kenney - ING

I am glad you think that, I mean you were speaking in terms of $3 billion asset or larger internationally.

Tony Hayward

I think, it's fair to think of the $3 billion as a starter pack. If we can make that work, then who knows what else we might be out to do but think of that as a place to start, not a place to finish.

Jason Kenney - ING

So $3 billion in an international territory I though of Russia?

Tony Hayward

Well what we have agreed and what we have said publicly is $1.5 billion from each side. So you can figure that as well.

Jason Kenney - ING

And off course the business division sort of upstream, downstream, midstream.

Tony Hayward

I don’t remember of saying there was anything on or off limits.

Jason Kenney - ING.

Okay, just for the record now everybody sees $100 by the way were significantly lower in three to five years time particularly if dollar strengthened. Should I say that?

Tony Hayward

Thanks Jason.

Fergus Macleod

Thanks a lot Jason. Okay now on to James Neil at Citigroup. James.

James Neil - Citigroup.

Hi good afternoon. It would be interesting getting your thoughts on how the transaction Global Centre Fame merger might put further cost pressure on the drilling market and sector upstream cost.

Fergus Macleod

Okay James. Let me ask Andy to say a few words about that.

Andy Inglis

Yeah James, I think it is too early to give you a view on that and I think we have not a chance to evaluate the proposed transaction in any detail, and yeah there could be some benefits, there could be some disbenefits to the industry. So I think it is too early to comment.

James Neil - Citigroup

Thanks and can I also ask what are you going to do in your next five days?

Tony Hayward

What I am going to do in my next five days? That’s for Tony. My next five days, well I can tell you I am going on a holiday on Friday and between then and there I actually have the top 80 people in BP together for a couple of days at the end of the week to review where we are and get very clear on the program forward. So that’s probably the bulk of my next five days.

James Neil - Citigroup

Your first 100. Thanks.

Tony Hayward

Thank you.

Fergus Macleod

Thanks James. I'd like to come to the last two callers and I just like to thank them for their patience and for waiting. And first of them is Lucas Herman of Deutsche Bank.

Lucas Herman - Deutsche Bank

Fergus thanks very much. Tony, really a question for Byron and then one for Andy. Byron going back to the financial framework initially or at the start of 2006 I think that it was laid down in a $60 environment you felt you would be capable of returning $65 billion of the '06 - '08 period to investors. When you talked today, it sounds a little more qualified I mean you talked about other factors being appropriate.

And I just wondered whether that the delays to projects and whether the issues with the refineries affect are which were appropriate to reconsidering the scale of that return, that's the first. Secondly, Andy, just in terms of cost and cost inflations, to what extend is the inflation that you have seen in the industry and continue to see starting to impact on the timing or decision of taking [FID] on project sides what extend you are just backing off announcing no we are not doing things at this level, they don’t make sense any longer. And just briefly on Kovykta, following the agreement with Gazprom is there any impact on gas volume term TNK as reported through and the P&L?

Tony Hayward

Okay, lets go first to Byron.

Byron Grote

First I'll point out that distributions are made up of two components; one is our dividend, which we have continued to grow at double digit rate for sometime and it was up more than 10% this quarter relative to a year earlier, as far as share buybacks go its about having excess, a cash flow and yes it, it has been impacted by a number of things, certainly we didn't envision the scale of refining outages, we didn't envision the scale of the delays on Thunder Horse and Atlantis, we didn't envision the scale of sectors specific inflation, we didn't envision some of the increases in government take which have occurred in the interim. That having been said we have distributed by my account $32 billion over the course of the first to 18 months for that period. So we remain relatively on track to deliver an amount in that range. It will automatically be determined by the ability to get these big revenue generators back on stream, the scale of divestments and just the general environment in which we operate in. But I think we are making some pretty good progress towards distribution and the underlying philosophy we have has not changed at all.

Tony Hayward

Yes Lucas and on the issue of cost, I think there are couple of things to think hard about at the moment and in a current environment. One is absolutely the impact of cost on fundamental economic in some of our projects and the other is the tightness in the supply industry I think which makes it harder to execute execution risk. So, I think the basic approach is about ensuring we move projects forward in their natural pace, I think its real premium for doing high quality engineering, real premium for high quality planning and all of which result in high quality front-end loading. And that’s the kind of approach we are taking on Block 31 at the moment, and to ensure that we got the right concept, we can sort of design one and built many and that’s taken little longer to do that upfront, but it does allow you I think to drive fundamentally a more efficient structure.

And then, you do get a points where I think you find that the current concept is when you get the engagement of the supply industry in place that the cost are too large. And that was certainly the case, when we looked to the Hardy gas project, there where number factors, which are sort of cost, tightness of supply, execution risk, we decided that we have the wrong approach. So, we stopped, we didn’t move into execute and we have gone back now to reexamine the concept, and come up with a better way of developing that resource. So I think you can see our behavior now, really one about driving efficiency in the current environment. That's huge important competitive edge.

Byron Grote

And finally on Kovykta. Lucas, no change to gas volumes in TNKBP following the Kovykta agreement?

Lucas Herman - Deutsche Bank

Okay. I mean the gas that was being produced for the local market. Well was that being consolidated through the other international businesses (inaudible).

Byron Grote

Yeah Lucas it was literally deminimus something was deminimus. You won’t see it, it’s deminimus. It was about enough to run your barbecue.

Lucas Herman - Deutsche Bank

Okay.

Fergus Macleod

Thanks Lucas, Gordon Gray at JP Morgan

Gordon Gray - JP Morgan

Thanks, I appreciate this is not the time or place to give longer term guidance, but Tony I wonder if you can just give us your thoughts on two issues. Firstly given the opportunities that you see, do you think the current level of organic CapEx is broadly appropriate for the future obviously adjusting for the current inflation effects? And secondly given the scale of the non-proved resource base, and Can you raise, where confidence is on the reserve replacement outlook. Thank you.

Tony Hayward

I think inflation notwithstanding and none of us know quite what that would be. I think we are confident on the activity side that we are undertaking is appropriate for the capabilities affirmed and is appropriate to drive production volume growth over the next four to five years. Nothing going beyond that would be something inappropriate to state.

So the activity levels are about right or that translates into in terms of capital on the annual basis, is of course a function of two things, inflation and mostly dollar pound exchange rate is doing so. We’ll have to see when we get a bit closer to 2008 and exactly what that number would be. But in terms of the activity and the nature of the activity, we think it’s about right. And forgot what your second question was?

Gordon Gray - JP Morgan

Hope for some of the reserve replacement

Tony Hayward

Yeah sorry, I think as you said we have a tremendous resource base, we've done a good job I think of pulling it through over the last four or five years and there is nothing that would lead us to believe that we won't continue to be, how to do that. So we feel pretty confident about a 100% reserve replacement out through the end of the decade. And again I think seeing beyond that was a little tricky, but it looks pretty good.

Gordon Gray - JP Morgan

Okay. Thanks very much.

Fergus Macleod

Thank you Gordon, and we have just one very, very final question from David Kline at ABN Amro.

David Kline - ABN Amro

Good afternoon. I wondered if I can just ask for a little bit of clarification on something that was mentioned earlier. On the performance related measures you said you are targeting now, you mentioned simplification, standardization, illumination of duplication, reducing overheads. But I think in Q&A at one point you said that there were no major cost cutting initiatives that we were targeted. Wouldn’t it be natural to expect cost savings or mitigation of cost inflation to flow from some of those measures?

Tony Hayward

They may will do, but we are not targeting it, what we are targeting is the complexity. If we get some benefit in terms of reduced cost out of it that’s great. But what we are really looking for is increased effectiveness in the organization. Okay David.

David Kline - ABN Amro

Thanks.

Tony Hayward

Thank you very much. Ladies and gentleman, thank you very much for the usual comprehensive set of questions and off course Fergus and his team will be ready, willing and able to deal with any further questions you may like to ask and we look forward to seeing you all in the course of the remainder of the year. Thank you very much.

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Source: BP Q2 2007 Earnings Call Transcript
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