Opportunity for BP to Exercise Strict Financial Oversight in Earnest

BP's capital allocation framework, which focuses on disciplined spending within a $13-15 billion annual capex range, has come under scrutiny from investors who believe it falls short of being fully aligned with the Paris Agreement's goals.

Over the past five years, BP's upstream capital expenditure has been six times greater than its low carbon capital expenditure, a fact that research deems the current framework flawed, enabling expenditure that exceeds a Paris-consistent framework.

Investors, managing nearly £5 trillion in assets, have sent a letter to BP's Chair, expressing concern over the company's capital allocation strategy. The letter, published in the Financial Times, was signed by 48 funds, including Generali Group, Royal London Asset Management, and Robeco.

The investors' letter calls for BP to review and disclose a strategy consistent with the Paris Goals and the consistency of each new material capex investment with the Paris Goals. It also emphasizes the need for more decisive and accelerated investment shifts away from fossil fuels towards renewables and low carbon technologies.

BP's current framework, while integrating some green investments, remains heavily weighted (~60%) towards traditional oil and gas projects. This contrasts with investor demands for a radical reallocation towards renewables and net-zero consistency.

The letter from investors reflects growing pressure from large asset owners for BP to adopt capital allocation frameworks that are explicitly Paris-consistent, beyond incremental transition steps. If every oil and gas company used BP's methodology, projects amounting to more than 1,000 Gt of emissions would be deemed Paris-aligned, a fact that raises concerns about the long-term viability of these projects under low-carbon scenarios.

BP's CEO has committed to "fundamentally" resetting its strategy. However, a retreat from capital discipline without consulting shareholders is concerning for investors, as it may increase their potential exposure to stranded or value-destructive assets.

In 2018, a shareholder resolution was filed on behalf of Climate Action 100+, which received management support and more than 99% of investors at BP's 2019 AGM. The resolution called for BP to review and disclose a strategy consistent with the Paris Goals.

The supposed return to the halcyon days of oil and gas is a mirage, as oil and gas has been the worst performing MSCI sector over the past 15 years. Pursuing these projects by BP is unlikely to be profitable under low-carbon scenarios and poses significant risks around value destruction for investors.

The carbon budget for a 1.5°C temperature outcome is 172 Gt, and for a well-below 2°C outcome is 429 Gt. BP's methodology, which uses a price-based methodology, fails to correlate modelled oil and gas prices with temperature outcomes, making it non-stackable within these carbon budgets.

ACCR used a least-cost methodology to evaluate BP's pre-FID gas portfolio and found it compared poorly to peers, with the ten largest projects sitting above the 60th percentile from a cost perspective.

Elliott Management has built a near 5% stake in BP. The letter from investors to the Chair of BP suggests that the 2019 resolution provides a firm basis for BP to be allocating capital in a disciplined and Paris-aligned manner.

BP aims for a dual strategy balancing profitable core oil and gas operations and strategic energy transition investments, projecting over 20% annual free cash flow growth through 2027. The company emphasizes margin expansion, cost cutting, and selective divestments to fund green projects like hydrogen and sustainable aviation fuel, targeting 30-40% of operating cash flow returns to shareholders via dividends and buybacks.

However, these efforts may not be enough to appease investors who are pushing for a more robust capex framework from BP, including disclosure of where projects sit on the global cost curve of producing assets. The retreat from capital discipline without consulting shareholders is concerning for investors, as it may increase their potential exposure to stranded or value-destructive assets.

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