Disappointing Performance

Oil companies, by the nature of their business, face significant social and environmental challenges. In addition, there is little publicly available information relating to social and environmental concerns outside of the U.S. and Europe. As a result, comparing one company to another from a social perspective is difficult. While many areas of concern exist, we are able to evaluate BP and its peers using only a limited range of available indicators.

Nonetheless, we are concerned by the litany of reports about negligence and mismanagement at BP. The actions attributed to the company are egregious: Fifteen workers killed at a refinery explosion in Texas in 2005, caused by (in BP’s words) “significant deficiencies in the work and safety culture”; significant fines for safety violations at an Ohio refinery; alleged price fixing in BP’s propane trading operations; oil spills from inadequately tested and maintained Alaska North Slope pipelines. Further allegations include oil and gasoline price-fixing and corrupt practices at the Alyeska Company, which operates the Trans-Alaska Pipeline System, of which BP is the majority shareholder. Operational difficulties such as delays at the Gulf of Mexico deepwater oil rig, Thunderhorse, also raise concerns about BP’s management systems.

Walden considers a range of environmental metrics, such as a company’s toxic releases, to be indicators of the effectiveness of a company’s environmental management program. The Environmental Protection Agency (EPA) collects data on U.S. refineries in the Toxics Release Inventory (TRI). The TRI displays the total quantities of toxic chemicals that are released at facilities over the course of the year, both planned and accidental. Walden has compared the toxic releases on a per-barrel-ofthroughput basis from BP’s refineries to those of Chevron, ConocoPhillips, ExxonMobil, and Sunoco. Based on 2004 data, BP’s total releases from its refineries are significantly higher than its peers (see chart, page 6). We are in discussions with BP to determine if this may be a result of inaccurately reported data from its Texas City refinery.

Additional analysis of 2003 data from the EPA’s Biennial Reporting System, which tracks hazardous waste generation, shows BP’s hazardous waste, on a per-barrel-ofthroughput basis to comprise more than 30 times the sum of the total contamination produced by the other four companies. We consider the performance of these refineries to be a possible indication of a company’s overall effectiveness, or lack thereof, in managing environmental concerns.

The Investment Case

Confronted with compelling evidence of average to below average performance on indicators of environmental management, what is the rationale for continuing to invest in BP? We believe the answer is threefold: portfolio diversification, BP’s demonstrated strategic and public policy leadership on social and environmental issues, and management’s responsiveness in addressing its serious problems.

From an investment perspective, major integrated companies serve as the highest quality and lowest risk vehicle for addressing concerns over the future scarcity of petroleum and are a classic hedge against inflation. Major integrated oil and gas companies can also help reduce the investment fluctuations that arise from unexpected events in the global political economy, particularly in the Middle East. In addition, these companies' share prices are less likely to decline than other energy stocks when oil prices decline. BP is among just a handful of energy companies that meet these criteria.

In the public policy arena, BP has been a champion for climate change action. In a speech at Stanford University in May, 1997, BP CEO John Browne stated:

The time to consider the policy dimensions of climate change is not when the link between greenhouse gases and climate change is conclusively proven, but when the possibility cannot be discounted and is taken seriously by the society of which we are part. We in BP have reached that point.

This momentous statement broke BP from the ranks of the other global integrated oil companies on the issue of climate change. Its actions helped to transform the debate and to legitimize climate change as a concern for business leaders. BP has also set internal limits with respect to greenhouse gas emissions, and has incorporated emissions reductions into its long range planning for operations.

A range of other initiatives have pointed towards BP’s strategic leadership on environmental concerns. BP Alternative Energy was launched in 2005, with a commitment to invest $1.8 billion over three years, split equally between solar, wind, hydrogen, and combinedcycle- gas-turbine power. An additional $6.2 billion was committed to these initiatives over the next 10 years. BP is currently one of the world’s largest solar manufacturers and marketers. In addition, the company committed $50 million over the next 10 years for research on biofuels. On related issues, BP was the first to market lower sulfur fuels. The company has also stepped away from the groups lobbying to open the Arctic National Wildlife Refuge on Alaska’s North Slope.

In addition, BP has a number of social policies and practices that we view as superior relative to typical industry practice. The company is a participant in several voluntary global initiatives such as the United Nations Global Compact, and a signatory to the Extractive Industries Transparency Initiative, The Universal Declaration on Human Rights, and the Voluntary Principles on Security and Human Rights. BP utilizes the Global Reporting Initiative guidelines, the current highest standard in sustainability reporting, to develop its extensive reporting on its social and environmental performance.

Finally, we are somewhat reassured by the high level of responsiveness and engagement demonstrated by BP’s top management. BP CEO, John Browne, CFO, Byron Grote, President of BP America, Robert Malone, and other top management met with concerned investors, including Walden’s Tim Smith, in July 2006. BP replaced the management at the Texas City refinery, where the explosion occurred, as well as those responsible for the trading infractions. BP also appears to be acting to manage emerging concerns with the Trans- Alaska pipeline and its offshore operations in the Gulf.

Going Forward

We are well aware that, until new management processes take effect, there may be more disappointing news concerning BP. Repairing a poorly maintained infrastructure will take time, even under the most dedicated new leadership. BP has also, through its environmentally focused advertising campaign, “Beyond Petroleum,” encouraged media interest in its environmental failings. Smaller troubles, such as a relatively minor chemical spill in Long Beach, California, that normally wouldn’t make the paper, are now headline news. Speaking with shareholders, taking responsibility for problems when they occur, being involved in beneficial public policy work, and giving credence to major global environmental challenges are important. An ally on environmental issues in the energy industry is invaluable. However, we would like to ensure that BP is “walking the talk.”

Acting with our clients, Walden is able to push to elicit better social performance from client companies. Walden is now re-focusing its dialogue with BP, pushing it to measurably improve and report on key metrics for its U.S. refinery and infrastructure performance. We believe that BP can go beyond ‘Beyond Petroleum’ and beyond its current difficulties.

—M. Benton with T. Smith