Oiling the wheels at BP

No Free Lunch

Oiling the wheels at BP

If you read its Remuneration Report, you’d be forgiven for thinking that BP had a stunning year in 2015. Safety continued to improve. Directors had anticipated correctly that the oil price would be “lower for longer” and adjusted the company strategy early. This included an aggressive cutback in investment and resulted in a strong operating cashflow. The operating profit was strong too. All in all, the company exceeded its own expectations and its pay reflects this.

Chief executive Bob Dudley’s total pay for 2015 was cranked up to $19.6 million. A bit embarrassing, really, when BP made a loss of $6.5 billion. High pay amidst record losses sounds perverse and 59 per cent of BP’s shareholders were sufficiently disgruntled to vote against the remuneration report at BP’s AGM, even though they had almost unanimously endorsed the policy two years ago. Not that the protest makes much difference. The vote is advisory so Mr Dudley will bank his money anyway.

Investors now have a year to decide what they expect of BP’s management. That’s the issue behind the pay policy. Votes on that are binding and the next review is at the 2017 AGM.

Bloated pension, bloated pay

Is Mr Dudley’s pay too high? Every year, his future US pension goes up by 1.3 per cent of his salary (frozen at almost $2m) and, surprisingly, of his bonus. Another year: another $309,000 p.a. until he dies. UK accounting conventions multiply this by 20, transforming it into a cost to profits of… a staggering $6.2 million. That’s because these calculations assume a reverse annuity rate of 5 per cent: if an annuity costs £100 to provide a pension of £5, then 100/5 = 20. BP says this overstates the value of Mr Dudley’s pension accrual. Arguably, it understates it. Maybe it’s time for high earners to fund their own pensions.

Mr Dudley’s pension forms a third of his total pay, total pay which seems excessive by most standards, even without it. Perhaps not, though, when compared to others who run global companies. Nor in the context of the massive ($90 billion) company that he commands. The problem is that finding someone with the right qualities to replace him might involve paying more, for managing adversity is not easy.

More to pay than profits

So what about high pay in times of losses? In fact, strip out the Deepwater Horizon provision last year and BP made an “underlying 2015 replacement cost profit” of $5.9 billion. True, this is less than the cost of the dividend, but the internal target, it transpires, had been $4.2 billion. “Overall, management delivered very well in terms of what they could control,” BP says in its annual report and that’s the point: one year’s profit is hardly the way to judge executives’ performance. If performance assessment is unfair, then so will be the pay that depends on it. What matters is managing for the long term.

BP does this through several criteria, based on its strategic objectives. First: safety. Then: profit and cost control, yes, but also cash generation, investment discipline and project delivery. These measures drive the annual bonus and in 2015, BP beat almost all its stretch targets. This generated a bonus for Mr Dudley, including cash and shares, of over $5m. Too much, he said. And cut it back to $4m.

That’s short term. For longer periods, BP measures success (or otherwise) through three equally weighted performance conditions: strategic measures, cash flow and how BP’s total shareholder return compares to Chevron, ExxonMobile, Shell and Total. The strategic measures consist of: safety, the rate at which reserves are replaced, and project delivery. Over the last three years, it scored highly against most of these performance conditions, releasing 78 per cent of the 2013 share award, originally equivalent to five and a half times Mr Dudley’s salary. This was worth $7m at the 2016 share price.

Same time next year

So BP agreed to pay Mr Dudley $11m based on much wider criteria than simply a headline loss. BP, like many companies, faces claims that their performance conditions are too many and too complex. Are they the most appropriate ones? Does “normalising” outcomes make them opaque for outsiders looking in and are targets too easy to achieve? There’s the gearing of awards to salaries: if salaries go up, performance-related-pay can go up several fold. What safeguards are there? Pay outcomes depend on the share price. Does that add too much volatility? These are the sort of issues underpinning the shareholder vote when pay policies comes up for review.

So why own BP? For many, the high dividend is the pull, so cash flow and debt management matters. So does a long-term stable or rising share price. But what do BP’s senior executives need to do to secure this? What priorities should they focus on? And what pay will they deserve if they succeed? That’s what paying for performance is all about. And that’s what shareholders will really have their say on at BP’s AGM next year.

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