BP Annual Report and Form 20-F 2011 - Company Reporting

Business review– In a legal settlement with environmental advocacy groups theEPA committed to propose regulations under their New SourcePerformance Standards (NSPS) for GHG emissions from refineriesby December 2011 and to finalize these by November 2012; the EPAwas unable to meet the December deadline, which may delay finalrulemaking. The EPA has communicated that they are consideringthree options for these standards, energy management, commandand control (source specific emission limits) and benchmarking (e.g. aSolomon-type GHG intensity index or variation).– Legal challenges to the EPA’s efforts to regulate GHG emissionsthrough the CAA continue along with active political debate withthe final content and scope of GHG regulation in the US remaininguncertain.• A number of additional state and regional initiatives in the US will affectour operations. Of particular significance, California is seeking to reduceGHG emissions to 1990 levels by 2020 and to reduce the carbonintensity of transport fuel sold in the state. California implemented alow-carbon fuel standard in 2010 although a preliminary injunction filed inlate December 2011 is preventing its implementation. California issuedfinal rules for its cap and trade programme in December 2011, with thescheduled start of the scheme to begin January 2012, with obligationscommencing in 2013.• Canada has established an action plan to reduce emissions to 17%below 2005 levels by 2020 and the national government continues toseek a co-ordinated approach with the US on environmental and energyobjectives. Additionally, Canada’s highest emitting province, Alberta,has been running a market mechanism to reduce GHG since 2007.Controversy, partially driven by perceived GHG intensity regardingCanadian oil sand produced crude, continues with some jurisdictionscontemplating policies to restrict or penalize its use.• China has committed to reducing carbon intensity of GDP 40-45%below 2005 levels by 2020 and increasing the share of non-fossil fuelsin total energy consumption from 7.5% in 2005 to 15% by 2020. Thecountry’s 12th (2011-2015) Development Programme has set the targetto reduce carbon intensity by 17% within five years, and this nationaltarget has been deconstructed into provincial ones for local actions.Meanwhile, five provinces and eight cities were selected as pilots forlow carbon development, and seven provinces/cities were formallygiven instruction to start emission trading trials. As part of the country’senergy saving programme, the government also requires any operatingentity with annual energy consumption of 10 thousand tonnes of coalequivalent (7ktoe/a) to have an energy saving target for the next fiveyears. A number of BP joint venture companies in China will be requiredto participate in this initiative.Certain definitionsUnless the context indicates otherwise, the following terms have themeaning shown below:Replacement cost profitReplacement cost profit or loss reflects the replacement cost of supplies.The replacement cost profit or loss for the year is arrived at by excludingfrom profit or loss inventory holding gains and losses and their associatedtax effect. Replacement cost profit or loss for the group is not a recognizedGAAP measure.BP believes that replacement cost profit before interest andtaxation for the group is a useful measure for investors because it isthe profitability measure used by management. See Selected financialinformation on page 56 for the nearest equivalent measure on an IFRSbasis, which is ‘Profit (loss) for the year attributable to BP shareholders’.Inventory holding gains and lossesInventory holding gains and losses represent the difference between thecost of sales calculated using the average cost to BP of supplies acquiredduring the period and the cost of sales calculated on the first-in first-out(FIFO) method after adjusting for any changes in provisions where thenet realizable value of the inventory is lower than its cost. Under the FIFOmethod, which we use for IFRS reporting, the cost of inventory chargedto the income statement is based on its historic cost of purchase, ormanufacture, rather than its replacement cost. In volatile energy markets,this can have a significant distorting effect on reported income. Theamounts disclosed represent the difference between the charge (to theincome statement) for inventory on a FIFO basis (after adjusting for anyrelated movements in net realizable value provisions) and the chargethat would have arisen if an average cost of supplies was used for theperiod. For this purpose, the average cost of supplies during the periodis principally calculated on a monthly basis by dividing the total cost ofinventory acquired in the period by the number of barrels acquired. Theamounts disclosed are not separately reflected in the financial statementsas a gain or loss. No adjustment is made in respect of the cost ofinventories held as part of a trading position and certain other temporaryinventory positions.Management believes this information is useful to illustrate toinvestors the fact that crude oil and product prices can vary significantlyfrom period to period and that the impact on our reported result underIFRS can be significant. Inventory holding gains and losses vary fromperiod to period due principally to changes in oil prices as well as changesto underlying inventory levels. In order for investors to understand theoperating performance of the group excluding the impact of oil pricechanges on the replacement of inventories, and to make comparisonsof operating performance between reporting periods, BP’s managementbelieves it is helpful to disclose this information.Non-GAAP information on fair value accounting effectsBP uses derivative instruments to manage the economic exposurerelating to inventories above normal operating requirements of crude oil,natural gas and petroleum products. Under IFRS, these inventories arerecorded at historic cost. The related derivative instruments, however, arerequired to be recorded at fair value with gains and losses recognized inincome because hedge accounting is either not permitted or not followed,principally due to the impracticality of effectiveness testing requirements.Therefore, measurement differences in relation to recognition of gains andlosses occur. Gains and losses on these inventories are not recognizeduntil the commodity is sold in a subsequent accounting period. Gains andlosses on the related derivative commodity contracts are recognized inthe income statement from the time the derivative commodity contract isentered into on a fair value basis using forward prices consistent with thecontract maturity.BP enters into commodity contracts to meet certain businessrequirements, such as the purchase of crude for a refinery or the saleof BP’s gas production. Under IFRS these contracts are treated asderivatives and are required to be fair valued when they are managed as110 BP Annual Report and Form 20-F 2011