BP - 20-F annual report

During these difficult days your board focused on three critical objectives.

First, we ensured the response team had the resources it required to stop the leak, contain and clean up the damage, and provide financial support to those affected. This was an unprecedented response to an industrial accident, with some 48,000 people involved at the height of the effort. We have set up a $20-billion fund to show our willingness and capacity to pay all legitimate claims for compensation. For the long term, we have committed $500 million to a 10-year independent research programme that will examine the environmental impact of the oil spilled and dispersants used. BP will continue to help restore the environment and economy of the Gulf, however long that takes.

Second, we resolved to understand what happened on and below the Deepwater Horizon, to apply the lessons learned and to make our findings available publicly. BP’s comprehensive internal investigation concluded that a sequence of failures involving a number of different parties led to the explosion and fire.

We are implementing the report’s recommendations. We have established a powerful safety and operational risk function, and we have enhanced risk management through the restructuring of our upstream business. We are also conducting a wide-ranging review of when and how we outsource operations.

Third, we moved to secure the long-term future of BP and our capacity to meet our financial responsibilities in the Gulf of Mexico. Decisive action was required here because events in the US led to a crisis of confidence in BP within the financial markets. In response, we made the difficult decision to cancel three dividend payments. We do not underestimate the effect of this on small and large shareholders alike. However, there is no doubt in my mind that this action steadied and strengthened our position at a critical point.

I am pleased that we have been able to resume dividend payments promptly. The dividend for the fourth quarter of 2010, to be paid in March 2011, is 7 cents per share (US$0.42 per ADS). The scrip dividend programme approved last year is in operation once again, and this presents an opportunity to take the dividend in shares or ADSs rather than cash. We intend to raise the level of the dividend as the company’s circumstances and performance improve.

BP is able to help meet the world’s growing need for energy, but we can only do this if we have the trust of society. To achieve this, we must ensure that safety and responsibility are at the heart of everything we do. We must show that we can be trusted to understand and manage our risks. And we must demonstrate that we respect the environment and the needs of local communities and society as a whole.

The many strengths of BP are united in our remarkable people, who showed in 2010 that they can rise to the sternest challenge. I thank them for their efforts.

While we face substantial challenges, shareholders must be in no doubt – BP has the determination and strength needed to restore its reputation and deliver long-term shareholder value. Through its refocused strategy, the company is working to become more agile and more competitive, with strong emphasis on realizing value rather than building volume and scale. We will not be afraid to develop new and innovative approaches that redefine the model of an international oil company, as our recently announced partnerships with Rosneft and Reliance demonstrate.

I want to end by thanking shareholders for their support. You have been steadfast through one of the most testing periods in BP’s long history. We have learned many lessons about ourselves over the past 12 months, and these will never be forgotten. I believe we will emerge a stronger, wiser company with a very important role to play, for many years to come.

Carl-Henric Svanberg
Chairman
2 March 2011

Following the accident, a search-and-rescue operation was carried out by the rig’s owner, Transocean, together with BP and the US Coast Guard. This continued for four days and covered 5,000 square miles. On 22 April 2010 the Deepwater Horizon sank, and a major oil spill response was activated. At its peak this involved the mobilization of some 48,000 people, the deployment of around 2,500 miles of boom and the co-ordination of more than 6,500 vessels. Field operations brought together experts from key agencies, organizations and BP. Thousands of our people flew in from around the world and stayed and worked for weeks and months. Nearly 500 retirees from BP America called up to say they wanted to help. This was an extraordinary response.

As the response developed, the problems grew in complexity and scale. Tackling the leak on the seabed demanded groundbreaking technical advances and dauntless spirit. We also found ourselves in the midst of intense political and media scrutiny. We received incredible support and faced tremendous criticism, but our priorities remained clear – provide support to the families and friends of those 11 men who died, stop the leak, attack the spill, protect the shore, support all the people and places affected. We also committed to carry out an immediate and detailed internal investigation.

As a responsible party, under the Oil Pollution Act, we knew we would face wide-ranging claims and potential fines, but we resolved to go beyond what the law required of us. We made swift payments to support local economies, and gave a total of $138 million in direct state grants during 2010, which included behavioural health programmes. We set up the $20-billion Deepwater Horizon Oil Spill Trust to meet individual, business, government, local and state claims, and natural resource damages. We provided $500 million for the Gulf of Mexico Research Initiative, which is funding independent research to investigate impacts on affected ecosystems. And we contributed to a $100-million fund to support rig workers hit by the drilling moratorium.

To meet our financial commitments, we announced the sale of up to $30 billion in assets and, by the end of 2010, had agreed to $22 billion of disposals. We have also cut back on discretionary capital spending and secured additional credit lines. The sound underlying performance across our business continues to give us a solid foundation, and speaks volumes for the inner strengths of BP and our people.

As part of our response, we took the decision to cancel further dividends in 2010. While we know that many shareholders rely on their regular payments, we also had to protect the company and secure its long-term future. The board of BP took this decision with a heavy heart, but I believe it was the right thing to do in truly exceptional circumstances.

Our investigation report was published on 8 September 2010, and found that no single factor caused the accident. The report stated that decisions made by multiple companies and work teams contributed to the accident, and these arose from a complex and interlinked series of mechanical, human judgement, engineering design, operational implementation and team interface failures.

We have accepted and are implementing the report’s recommendations. We are also sharing what we have learned with governments and others in our industry, and we are co-operating with a series of other investigations, inquiries and hearings.

2010 stands as an inflexion point for BP and our industry, and it is right that we should help lead the development of better ways to operate in deep water. Good risk identification and management is integral to becoming safer, and we are working with governments, service contractors and industry peers to take risk management and equipment design to the next level. Within BP, we have introduced more layers of protection and resilience, with our new safety and operational risk function empowered to intervene in any operation. To enhance our specialist expertise and risk management, we have re-organized our upstream business into three divisions – Exploration, Developments and Production. To encourage excellence in risk management throughout the organization,

BP is also partnering with another organization, Husky Energy, to develop a further important resource of energy – Canada’s oil sands. These represent the second largest reserves in the world after the oilfields of Saudi Arabia. We will work with this resource in a way that fits with our long-term responsibilities and objectives, using steam assisted gravity drainage to extract the oil, and an efficient, integrated system to transport it. Our approach will have a relatively small footprint and should not be confused with opencast mining – we will not engage in mining. On a well-to-wheel basis, greenhouse gas emissions from Canadian oil produced this way are expected to be slightly higher than those from conventional crudes imported to North America.

Along with providing the hydrocarbons required over coming years, we are helping to build the sustainable options needed to meet growing demand for lower-carbon energy. Our natural gas operations will help to provide a lower-carbon bridge from oil and coal to renewables. We are building a material business to produce biofuels in Brazil, the US and the UK. We are becoming a leading player in wind energy. We have a long-established solar business. And we have made substantial investments in carbon-capture-and-storage technology. Lower-carbon resources are the fastest-growing sector in the energy market, and BP intends to develop its portfolio in step with this growth.

As to the immediate future, I expect 2011 to be a year of consolidation for BP, as we focus on completing our previously announced divestment programme, meeting our commitments in the US and bringing renewed rigour to the way we manage risk. There will also be an increasing emphasis on value over volume, as we sharpen our strategy and reshape the company for growth.

Looking back over recent days and months, our thoughts return to the men who lost their lives, to those who were injured and to the communities hit hard by the spill. I have heard people ask “Does BP ‘get it?” Residents of the Gulf, our employees and investors, governments, industry partners and people around the world all want to know whether we understand that a return to business-as-usual is not an option. We may not have communicated it enough at times, but yes, we get it. Our fundamental purpose is to create value for shareholders, but we also see ourselves as part of society, not apart from it. Put simply, our role is to find and turn energy resources into financial returns, but by doing that in the right way we can help create a prosperous and sustainable future for everyone. This is what people rightfully expect of BP. This is what will inspire and drive us over the next 12 months and far into the future.

Bob Dudley
Group Chief Executive
2 March 2011

People

Employee satisfaction (%)

The overall Employee Satisfaction Index comprises 10 key questions that provide insight into levels of employee satisfaction across a range of topics, such as pay and trust in management. We use a sample-based approach to achieve a representative view of BP.
     Our 2010 employee survey was delayed to allow for organizational changes to be reflected in the survey construction, with the survey expected to be carried out in summer 2011.

Number of employees^a(thousands)

Employees include all individuals who have a contract of employment with a BP group entity.
     In 2007 we began a process of making BP a simpler, more efficient organization. Since then our total number of employees has reduced by approximately 18,000, including around 9,200 in our non-retail businesses.

Diversity and inclusion (%)

Each year we record the percentage of women and individuals from countries other than the UK and US among BP’s top leaders. The number of top leaders in 2010 was 482, compared with 492 in 2009 and 583 in 2008.
     BP has maintained the percentage of female leaders in 2010 and remains focused on building a more sustainable pipeline of diverse talent for the future.

focus on managing risk, delivering common standards and processes and building personnel and technological capability for the future. The Exploration division is accountable for renewing our resource base through access, exploration and appraisal activities. The Developments division is accountable for the safe and compliant execution of wells (drilling and completions) and major projects. The Production division is accountable for safe and compliant operations, including upstream production assets, midstream transportation and processing activities, and the development of our resource base. Divisional activities are integrated on a regional basis by a regional president reporting to the Production division.

Refining and Marketing’s activities include the supply and trading, refining, manufacturing, marketing and transportation of crude oil, petroleum and petrochemicals products and related services. The segment comprises a number of strategic performance units (SPUs), which are organized along either geographic or activity-related lines. Each SPU is of a scale that allows for a close focus on performance delivery, starting with safety, and includes the appropriate management of operating and financial parameters.

Our group functions and regions support the work of our segments and businesses. The key objectives of the functions are to establish and monitor fit-for-purpose functional standards across the group; to act as centres of deep functional expertise; to access significant leverage with third-party suppliers; and to establish and maintain capabilities among the functional staff employed within our operating businesses. In addition, the head of each region provides the required cross-segment integration and co-ordination of group activities in a particular geographic area and represents BP to external parties.

In June 2010, following the Gulf of Mexico incident, we established the Gulf Coast Restoration Organization (GCRO) and subsequently equipped it with dedicated resources and capabilities to manage all aspects of our response to the accident. This organization reports directly to the group chief executive and is overseen by a specific new board committee.

Among the changes we have made following the Gulf of Mexico incident, we have redefined and strengthened the scope and accountabilities of the group function for safety and operations, creating an enhanced, independent Safety and Operational Risk (S&OR) function, to oversee and audit the company’s operations around the world. The function has its own expert staff embedded in BP’s operating units, including exploration projects

We have well-established operations in Europe, the US, Canada, Russia, South America, Australasia, Asia and parts of Africa. Currently, around 68% of the group’s fixed assets are invested in Organization for Economic Co-operation and Development (OECD) countries, with around 42% of our fixed assets located in the US and around 20% in Europe.

Our Exploration and Production segment included upstream and midstream activities in 29 countries in 2010 including Angola, Azerbaijan, Canada, Egypt, Norway, Russia,Trinidad &Tobago (Trinidad), the UK, the US and other locations within Asia, Australasia, South America, North Africa and the Middle East. Our Exploration and Production segment also includes gas marketing and trading activities, primarily in Canada, Europe and the US. In Russia, we have an important associate through our 50% shareholding in TNK-BP, a major oil company with exploration assets, refineries and other downstream infrastructure.

In Refining and Marketing, we market our products in more than 70 countries, with a particularly strong presence in Europe and North America, and also manufacture and market our products across Australasia, in China and other parts of Asia, Africa and Central and South America. In the US, we own or have a share in five refineries and market fuel primarily under the ARCO and BP brands. See Refining and Marketing (Our strategy) on page 55 for further information on forthcoming portfolio changes in the US. In Europe, we own or have a share in seven refineries and we market extensively across the region, primarily under the Aral and BP fuel brands. Our long-established supply and trading activity is responsible for delivering value across the crude and oil products supply chain. Our petrochemicals business maintains a manufacturing position globally, with an emphasis on growth in Asia. Our lubricants business blends and markets lubricants globally, primarily under the Castrol brand, and is a growing business through market growth and the development of new products. We continue to seek opportunities to broaden our activities in growth markets such as China and India.

Global oil consumption rebounded sharply, reflecting a recovery in the global economy and several one-time factors, rising by roughly 2.8 million b/d for the year (3.3%)^c, the largest annual increase since 2004. Growth was broadly-based, with the largest (volumetric) increases seen in China and the US. The relative stability in crude oil prices for much of the year reflected the stability of OPEC crude oil supply, as OPEC members sustained the production cuts implemented in late 2008 throughout 2010, with crude production averaging roughly 2 million b/d below the 2008 level. Commercial oil inventories in the OECD remained high for much of the year before falling as the global supply-balance began to tighten – and prices began to rise – later in the year.

The rebound in oil prices in 2010 followed a decline in 2009 – the first since 2001. Global oil consumption in 2009 reflected the economic slowdown, falling by roughly 1.2 million b/d for the year (1.7%)^d, the largest annual decline since 1982. The biggest reductions were early in the year, with OECD countries accounting for the entire global decline. Crude oil prices rose sharply in the second quarter in response to sustained OPEC production cuts and emerging signs of stabilization in the world economy, despite very high commercial oil inventories in the OECD. OPEC members cut crude oil production by roughly 2.5 million b/d^e in 2009.

We expect oil price movements in 2011 to continue to be driven by the pace of global economic growth and its resulting implications for oil consumption, and by OPEC production decisions.

Margins in the Far East improved the most but continued to struggle – averaging $1.63 per barrel in Singapore as new refining capacity continued to be added in the region. Margins also rose in both the North West Europe and the Mediterranean but European margins overall remained well below 2008 levels. Margins in the US were relatively unchanged, up slightly on the West and Gulf coasts but down in the Midwest.

Refining margins fell sharply in 2009 as demand for oil products collapsed in the wake of the global economic recession and as new refining capacity came onstream. The premium for light products above fuel oils reduced as demand for transport fuels fell along with the reduction in economic activity, compressing margins even for fully upgraded refineries.

Looking ahead, refiners are likely to continue to operate with excess capacity globally, although near-term supply-demand fundamentals appear broadly in balance. From 2011, we will be reporting a new refining indicator margin, replacing the GIM, which we call the refining marker margin (RMM). This adopts a basis that we believe is more closely related to the approach used by many of our competitors. (See Refining and Marketing on page 55 for further information on RMM.)

In contrast, we believe that in many countries natural gas has the potential to provide the most significant reductions in carbon emissions from power generation in the shortest time and at the lowest cost. These reductions can be achieved using technology available today. Combined-cycle turbines, fuelled by natural gas, produce around half the CO₂ emissions of coal-fired power, and are cheaper and quicker to build. It is estimated that there are reserves of natural gas in place equivalent to 63 years’ consumption at current rates^b and they are rising as new skills and technology unlock new unconventional gas resources. For these reasons, gas is looking to be an increasingly attractive resource in meeting the growing demand for energy, playing a greater role as a key part of the energy future.

At the same time, alternative energies also have the potential to make a substantial contribution to the transition to a lower-carbon economy, but this will require investment, innovation and time. Currently, biofuels, wind, solar, and other modern forms of renewable energy account for less than 2% of total global consumption^a. Assuming continuing policy support and favourable technology trends, these forms of energy are likely to meet around 6% of total energy demand in 2030^a.

If industry and the market are to meet the world’s growing demand for energy in a sustainable way, governments will be required to set a stable and enduring framework. As part of this, governments will need to provide secure access for exploration and development of fossil fuel resources, define mutual benefits for resource owners and development partners, and establish and maintain an appropriate legal and regulatory environment, including a mechanism for recognizing the cost of carbon.

For a discussion of production, see Exploration and Production on page 43.

In Refining and Marketing we made disposals totalling $1.8 billion, which included our French retail fuels and convenience business to Delek Europe, the fuels marketing business in Botswana to Puma Energy, certain non-strategic pipelines and terminals in the US, our interests in ethylene and polyethylene production in Malaysia to Petronas and our interest in a futures exchange.

There were no significant acquisitions in 2009. Disposal proceeds in 2009 were $2.7 billion, principally from the sale of our interests in BP West Java Limited, Kazakhstan Pipeline Ventures LLC and LukArco, and the sale of our ground fuels marketing business in Greece and retail churn in the US, Europe and Australasia. Further proceeds from the sale of LukArco are receivable in 2011. See Financial statements – Note 5 on page 164.

In 2008, we completed an asset exchange with Husky Energy Inc., and asset purchases from Chesapeake Energy Corporation as described on page 23.

Moreover, the Gulf of Mexico oil spill has damaged BP’s reputation, which may have a long-term impact on the group’s ability to access new opportunities, both in the US and elsewhere. Adverse public, political and industry sentiment towards BP, and towards oil and gas drilling activities generally, could damage or impair our existing commercial relationships with counterparties, partners and host governments and could impair our access to new investment opportunities, exploration properties, operatorships or other essential commercial arrangements with potential partners and host governments, particularly in the US. In addition, responding to the Incident has placed, and will continue to place, a significant burden on our cash flow over the next several years, which could also impede our ability to invest in new opportunities and deliver long-term growth.

More stringent regulation of the oil and gas industry generally, and of BP’s activities specifically, arising from the Incident, could increase this risk.

Refining profitability can be volatile, with both periodic over-supply and supply tightness in various regional markets, coupled with fluctuations in demand. Sectors of the petrochemicals industry are also subject to fluctuations in supply and demand, with a consequent effect on prices and profitability.

BP’s clean-up costs and potential liabilities resulting from pending and future claims, lawsuits and enforcement actions relating to the Gulf of Mexico oil spill, together with the potential cost of implementing remedies sought in the various proceedings, cannot be fully estimated at this time but they have had, and could continue to have, a material adverse impact on the group’s business, competitive position, financial performance, cash flows, prospects, liquidity, shareholder returns and/or implementation of its strategic agenda, particularly in the US. Furthermore, we have recognized a total charge of $40.9 billion during 2010 and further potential liabilities may continue to have a material adverse effect on the group’s results of operations and financial condition. See Financial statements – Note 2 on page 158 and Legal proceedings on pages 130-131. More stringent regulation of the oil and gas industry arising from the Incident, and of BP’s activities specifically, could increase this risk.

Crude oil prices are generally set in US dollars, while sales of refined products may be in a variety of currencies. Fluctuations in exchange rates can therefore give rise to foreign exchange exposures, with a consequent impact on underlying costs and revenues.

For more information on financial instruments and financial risk factors see Financial statements – Note 27 on page 185.

BP and certain of its subsidiaries have also been named as defendants in numerous lawsuits in the US arising out of the Incident, including actions for personal injury and wrongful death, purported class actions for commercial or economic injury, actions for breach of contract, violations of statutes, property and other environmental damage, securities law claims and various other claims. See Legal proceedings on page 130.

BP is subject to a number of investigations related to the Incident by numerous federal and State agencies. See Legal proceedings on page 130. The types of enforcement action pursued and the nature of the remedies sought will depend on the discretion of the prosecutors and regulatory authorities and their assessment of BP’s culpability following their investigations. Such enforcement actions could include criminal proceedings against BP and/or employees of the group. In addition to fines and penalties, such enforcement actions could result in the suspension of operating licences and debarment from government contracts. Debarment of BP Exploration & Production Inc. would prevent it from bidding on or entering into new federal contracts or other federal transactions, and from obtaining new orders or extensions to existing federal contracts, including federal procurement contracts or leases. Dependent on the circumstances, debarment or suspension may also be sought against affiliated entities of BP Exploration & Production Inc.

Although BP believes that costs arising out of the spill are recoverable from its partners and other parties responsible under OPA 90, such recovery is not certain and BP has recognized all of the costs incurred in its financial statements (see Financial statements – Note 2 on page 158, Note 37 on page 199 and Note 44 on page 218, under ‘Contingent assets relating to the Gulf of Mexico oil spill’).

Any finding of gross negligence for purposes of penalties sought against the group under the Clean Water Act would also have a material adverse impact on the group’s reputation, would affect our ability to recover costs relating to the Incident from our partners and other parties responsible under OPA 90 and could affect the fines and penalties payable by the group with respect to the Incident under enforcement actions outside the Clean Water Act context.

The Gulf of Mexico oil spill has damaged BP’s reputation. This, combined with other recent events in the US (including the 2005 explosion at the Texas City refinery and the 2006 pipeline leaks in Alaska), may lead to an increase in the number of citations and/or the level of fines imposed in relation to the Gulf of Mexico oil spill and any future alleged breaches of safety or environmental regulations.

Following the Gulf of Mexico oil spill, Moody’s Investors Service, Standard and Poor’s and Fitch Ratings downgraded the group’s long-term credit ratings. Since that time, the group’s credit ratings have improved somewhat but are still lower than they were immediately before the Gulf of Mexico oil spill. The impact that a significant operational incident can have on the group’s credit ratings, taken together with the reputational consequences of any such incident, the ratings and assessments published by analysts and investors’ concerns about the group’s costs arising from any such incident, ongoing contingencies, liquidity, financial performance and volatile credit spreads, could increase the group’s financing costs and limit the group’s access to financing. The group’s ability to engage in its trading activities could also be impacted due to counterparty concerns about the group’s financial and business risk profile in such circumstances. Such counterparties could require that the group provide collateral or other forms of financial security for its obligations, particularly if the group’s credit ratings are downgraded. Certain counterparties for the group’s non-trading businesses could also require that the group provide collateral for certain of its contractual obligations, particularly if the group’s credit ratings were downgraded below investment grade or where a counterparty had concerns about the group’s financial and business risk profile following a significant operational incident. In addition, BP may be unable to make a drawdown under certain of its committed borrowing facilities in the event we are aware that there are pending or threatened legal, arbitration or administrative proceedings which, if determined adversely, might reasonably be expected to have a material adverse effect on our ability to meet the payment obligations under any of these facilities. Credit rating downgrades could trigger a requirement for the company to review its funding arrangements with the BP pension trustees. Extended constraints on the group’s ability to obtain financing and to engage in its trading activities on acceptable terms (or at all) would put pressure on the group’s liquidity. In addition, this could occur at a time when cash flows from our business operations would be constrained following a significant operational incident, and the group could be required to reduce planned capital expenditures and/or increase asset disposals in order to provide additional liquidity, as the group did following the Gulf of Mexico oil spill.

Our systems of control

The board is responsible for the direction and oversight of BP. The board has set an overall goal for BP, which is to maximize long-term shareholder value through the allocation of its resources to activities in the oil, natural gas, petrochemicals and energy businesses. The board delegates authority for achieving this goal to the group chief executive (GCE).

The board maintains five permanent committees that are composed entirely of non-executives. The board and its committees monitor, among other things, the identification and management of the group’s risks – both financial and non-financial. During the year, the board’s committees engage with executive management, the general auditor and other monitoring and assurance providers (such as the group head of safety and operational risks, the group compliance and ethics officer and the external auditor) on a regular basis as part of their oversight of the group’s risks. Significant incidents that occur and management’s response to them are considered by the appropriate committee and reported to the board. In July the board established a new committee of non-executives, the Gulf of Mexico committee, to monitor the response of the company to the Gulf of Mexico incident through oversight of the new GCRO. The committee engages with GCRO management on a regular basis to monitor the response to the incident and management of the risks arising. (See Board performance report on pages 90-105.)

The company maintains a comprehensive system of internal control. This comprises the holistic set of management systems, organizational structures, processes, standards and behaviours that are employed to conduct our business and deliver returns for shareholders. The system is designed to meet the expectations of internal control of the Corporate Governance Code in the UK and of COSO (Committee of Sponsoring Organizations of the Treadway Commission) in the US. It addresses risks and how we should respond to them as well as the overall control environment. Each component of the system has been designed to respond to a particular type or collection of risks. Material risks are described in the Risk factors section (see pages 27-32).

Key elements of our system of internal control are: the control environment; the management of risk and operational performance (including in relation to financial reporting); and the management of people and individual performance. Controls include the BP code of conduct, our operating management system (OMS), our leadership framework and our principles for delegation of authority, which are designed to make sure employees understand what is expected of them.

As part of the control system, the GCE’s senior team – known as the executive team – is supported by sub-committees that are responsible for and monitor specific group risks. These include the group operations risk committee (GORC), the group financial risk committee (GFRC), the resource commitments meeting (RCM), the group people committee (GPC), and the group’s disclosure committee (GDC), which reviews the disclosure controls and procedures over reporting.

Operations and investments are conducted and reported in accordance with, and associated risks are thereby managed through, relevant standards and processes. These range from OMS which is the structured set of processes designed to deliver safe, responsible and reliable operating activity, to group standards, which set out processes for major areas such as fraud and misconduct reporting, through to detailed administrative instructions. The GCE conducts regular performance reviews with the segments and key functions to monitor performance and the management of risk and to intervene if necessary. People management is based on performance objectives, through which individuals are accountable for specific activities within agreed boundaries.

Following the Gulf of Mexico oil spill, the company established the GCRO in June to manage the company’s response activities, including managing clean-up and restoration costs, claims management and litigation. Lessons learned from the incident and the recommendations of BP’s internal investigation are being embedded into all areas of the system of internal control and in particular in OMS.

Initially BP mobilized a fleet of 30 vessels and over a million feet of protective boom. Thereafter the scale of activity grew rapidly, and at its peak included more than 6,500 vessels, more than 13 million feet of boom and almost 48,000 personnel.

BP also formed an investigation team charged with gathering the facts surrounding the accident, analysing available information to identify possible causes and making recommendations that would help prevent similar accidents in the future. The team concluded that no single action or inaction caused this accident. Rather, a complex and interlinked series of mechanical failures, human judgments, engineering design, operational implementation and team interfaces came together to allow the accident. Multiple companies, work teams and circumstances were involved over time. See Internal investigation and report on page 37 for further information on the investigation and its findings.

The only outstanding work associated with the Macondo site is the seabed and seismic surveys of the area. In consideration of, and subject to, the weather conditions, it is anticipated that the seabed and seismic surveys will take place at the end of first quarter of 2011.

Extensive surface skimming activities took place, ranging from large-scale offshore skimmers to inland and shallow water equipment. The UAC also leveraged its Vessels of Opportunity (VoO) programme to assist with this and to support the fish and wildlife, Shoreline Clean-up Assessment Team (SCAT), and Rapid Assessment Team.

Controlled in situ burning of oil on the surface of the water was conducted where concentrations of oil with suitable characteristics could be identified. Approximately 400 controlled burns were performed, which in total removed an estimated 265,450 barrels of oil according to the UAC.

Chemical dispersants were deployed under the close supervision of the UAC. Dispersants are mixtures of solvents, surfactants and other additives that break up the surface tension of an oil slick or sheen and make oil more soluble in water. On the surface, dispersants help break oil down into microscopic droplets that can be dispersed through the seawater and more easily degraded by oil-eating bacteria. Subsea application of dispersants was used to break the oil into small particles that disperse throughout the water column, forming a more dilute oil-and-water solution that degrades more easily.

BP worked closely with state and local officials, seeking to prevent shoreline oiling. The effort involved significant deployment of boom. BP worked closely with experts from the US Coast Guard, the US Fish & Wildlife Service, the National Oceanic and Atmospheric Administration (NOAA), the National Park Service, as well as state agencies to identify the most sensitive wildlife habitats and prioritize appropriate spill countermeasures. These measures included booming wildlife refuges and using methods to deter wildlife from entering oiled areas. BP also established animal treatment facilities, with significant capacity to treat birds, mammals and turtles.

In line with BP’s previous commitment to donate its share of the revenue (net of royalties and transportation costs) from the sale of recovered oil to the National Fish and Wildlife Foundation (NFWF), total donations to date have amounted to $22 million.

In support of the settlement of claims BP established the Deepwater Horizon Oil Spill Trust (Trust), and committed $20 billion to the Trust over a period of three-and-a-half years. While funds are building, BP has secured its commitments to the Trust by granting, conveying, and/or assigning to the Trust first priority perfected security interests in production payments pertaining to certain Gulf of Mexico oil and natural gas production. During 2010, BP made payments to the Trust totalling $5 billion and is committed to making additional payments of $1.25 billion, in one or more instalments, during and prior to the end of each calendar quarter commencing with the first calendar quarter of 2011 and continuing until the last calendar quarter of 2013. The trust fund is available to satisfy legitimate individual and business claims administered by the GCCF, state and local government claims resolved by BP, final judgments and settlements, state and local response costs, and natural resource damages and related costs. Fines and penalties will be paid separately and not from the Trust. Payments from the Trust are made as costs are finally determined or claims are adjudicated, whether by the GCCF, or by a court, or as agreed by BP. The GCCF evaluates all individual and business OPA 90 claims, excluding all government claims. The establishment of this Trust does not represent a cap or floor on BP’s liabilities, and BP does not admit to a liability of any amount in the Trust. The Trust agreement provides for the term of the Trust to continue until 30 April 2016, subject to the right of the Individual Trustees to extend or expedite this expiry date under certain circumstances. Any amounts left in the Trust once all legitimate claims have been resolved and paid will revert to BP. See Financial statements – Note 2 on page 158, Note 37 on page 199 and Note 44 on page 218 for further information on the Trust and on contingent liabilities arising from the incident. See Proceedings and investigations relating to the Gulf of Mexico oil spill on pages 130-131 for information on legal proceedings.

On 17 February 2011, the Commission’s Chief Counsel published a separate report on his investigation about the causes of the incident. The Chief Counsel’s investigation concluded that the blowout resulted from a series of engineering and management mistakes by the companies involved in the incident, including BP, Halliburton and Transocean.

Financial consequences

Costs incurred during the year mainly related to oil spill response activities, which included the drilling of relief wells and other subsea interventions, surface response activities including numerous vessels, and shoreline response involving deployment of boom and beach cleaning activities.

Under US law BP is required to compensate individuals, businesses, government entities and others who have been impacted by the oil spill. Individual and business claims are administered by the GCCF, which is separate from BP. BP has established a trust fund of $20 billion to be funded over the period to the fourth quarter of 2013, which is available to satisfy legitimate individual and business claims administered by the GCCF, state and local government claims resolved by BP, final judgments and settlements, state and local response costs, and natural resource damages and related costs arising as a consequence of the Gulf of Mexico oil spill. In 2010, BP contributed $5 billion to the fund, and further quarterly contributions of $1.25 billion are to be made during the period 2011 to 2013. The income statement charge for 2010 includes $20 billion in relation to the trust fund, adjusted to take account of the time value of money. The establishment of the trust fund does not represent a cap or floor on BP’s liabilities and BP does not admit to a liability of this amount.

BP has provided for all liabilities that can be estimated reliably at this time, including fines and penalties under the Clean Water Act (CWA). The total amounts that will ultimately be paid by BP in relation to all obligations relating to the incident are subject to significant uncertainty.

BP considers that it is not possible to estimate reliably any obligation in relation to natural resource damages claims under the OPA 90, litigation and fines and penalties except for those in relation to the CWA. These items are therefore contingent liabilities.

BP holds a 65% interest in the Macondo well, with the remaining 35% held by two joint venture partners. While BP believes and will assert that it has a contractual right to recover the partners’ shares of the costs incurred, no recovery amounts have been recognized in the financial statements.

For a full understanding of the impacts and uncertainties relating to the Gulf of Mexico oil spill refer to Financial statements – Note 2 on page 158, Note 37 on page 199 and Note 44 on page 218. See also Risk factors on page 27 and Proceedings and investigations relating to the Gulf of Mexico oil spill on pages 130-131.

Upstream operations in Argentina, Bolivia, Chile, Abu Dhabi, Venezuela and Russia, as well as some of our operations in Angola, Canada and Indonesia, are conducted through equity-accounted entities.

Dated Brent for the year averaged $79.50 per barrel, 29% above 2009’s average of $61.67 per barrel. Prices fluctuated in a relatively narrow band of $70-$80 per barrel for most of the year before rising in the fourth quarter. Prices exceeded $90 per barrel in December, the highest level since October 2008.

In 2011, we expect oil price movements to continue to be driven by the pace of global economic growth and its resulting implications for oil consumption, and by OPEC production decisions.

Natural gas prices strengthened in 2010, but were volatile. The average US Henry Hub First of Month Index rose to $4.39/mmBtu, a 10% increase from the depressed prices in 2009.

Gas consumption recovered across the world along with the economy. In the US, a cold start to 2010 followed by a hot summer and low temperatures towards the end of the year also contributed to demand strength. Yet domestic production growth – of shale gas in particular – continued apace and limited price rises. Henry Hub gas prices stayed below coal parity in US power generation from the summer, leading to the displacement of coal by gas. The differentials of production area prices to Henry Hub prices continued to narrow as pipeline bottlenecks were reduced.

In Europe, spot gas prices at the UK National Balancing Point increased by 38% to an average of 42.45 pence per therm for 2010. Yet plentiful global LNG supply kept spot gas prices below oil-indexed contract levels for most of the year, causing competition with contract pipeline supplies and marginal European gas production. UK spot gas prices only attained contract price levels from the end of November as cold weather caused rapid inventory draw-downs.

In 2011, we expect gas markets to continue to be driven by the economy, weather, domestic production trends and continued significant growth of global LNG supply.

We are increasing investment in Exploration, a key source of value creation at the front end of the value chain, and we are evolving the nature of our relationships, particularly with National Oil Companies. We will also continue to actively manage our portfolio, with a focus on value growth.

In 2010, the number of reported Loss of Primary Containment (LOPC) incidents in Exploration and Production was 194, down from 321 in 2009. Excluding the impact of the Gulf of Mexico incident, the number of reported oil spills equal to or larger than 1 barrel during 2010 was 116, up from 112 in 2009. This is the first year since 1999 that the number of reported spills has increased.

Since the start of 2011, we have been awarded four blocks in the Ceduna Basin, offshore South Australia and, subject to partner and government approval, we have signed a new agreement with the China National Offshore Oil Corporation (CNOOC) to explore Block 43/11 in the South China Sea. We have also announced a strategic global alliance with Rosneft, which includes an agreement to explore and develop three licence blocks in Russia’s South Kara Sea. See Legal proceedings on page 133 for information on an interim injunction, granted by the English High Court on 1 February 2011 and effective until 11 March 2011, restraining BP from taking any further steps in relation to the Rosneft transactions pending the outcome of arbitration proceedings.

On 21 February 2011, Reliance Industries Limited and BP announced their intention to form an upstream joint venture in which BP will take a 30% stake in 23 oil and gas production-sharing contracts that Reliance operates in India, and a 50:50 joint venture for the sourcing and marketing of gas in India. See page 43 for further information.

In November 2010, we announced the Hodoa gas discovery in the deepwater West Nile Delta area of Egypt.

Three major projects came onstream in 2010. Production commenced at the In Salah Gas compression project in Algeria, the Great White field in the Gulf of Mexico, and the Noel field in Canada. In 2010 we took final investment decisions on 15 projects.

Production was lower than last year, largely due to the impact of events in the Gulf of Mexico. After adjusting for the effect of entitlement changes in our PSAs and the effect of acquisitions and disposals, underlying production was 2% lower than 2009. In December 2010, we sustained production from the Rumaila field in Iraq at 10% above the initial production rate in 2009 to achieve the Improved Production Target, which is the first significant milestone in the rehabilitation of Rumaila. In 2010, full-year production growth in TNK-BP was 2.5%.

Sales and other operating revenues for 2010 were $66 billion, compared with $58 billion in 2009 and $86 billion in 2008. The increase in 2010 primarily reflected higher oil and gas realizations, partly offset by lower production. The decrease in 2009 primarily reflected lower oil and gas realizations.

Exploration

Our exploration and appraisal costs, excluding lease acquisitions, in 2010 were $2,706 million, compared with $2,805 million in 2009 and $2,290 million in 2008. These costs included exploration and appraisal drilling expenditures, which were capitalized within intangible fixed assets, and geological and geophysical exploration costs, which were charged to income as incurred. Approximately 80% of 2010 exploration and appraisal costs were directed towards appraisal activity. In 2010, we participated in 479 gross (95.5 net) exploration and appraisal wells in 10 countries. The principal areas of exploration and appraisal activity were Egypt, the deepwater Gulf of Mexico, Libya, the North Sea, Oman and onshore US.

Total exploration expense in 2010 of $843 million (2009 $1,116 million and 2008 $882 million) included the write-off of expenses related to unsuccessful drilling activities in the deepwater Gulf of Mexico ($161 million), the North Sea ($42 million), Libya ($26 million), Angola ($24 million) and others ($4 million). It also included $157 million related to decommissioning of idle infrastructure, as required by the Bureau of Ocean Energy Management Regulation and Enforcement’s Notice of Lessees 2010 G05 issued in October 2010.

Reserves booking from new discoveries will depend on the results of ongoing technical and commercial evaluations, including appraisal drilling.

The proved reserves replacement ratio is the extent to which production is replaced by proved reserves additions. This ratio is expressed in oil equivalent terms and includes changes resulting from revisions to previous estimates, improved recovery and extensions and discoveries. For 2010 the proved reserves replacement ratio excluding acquisitions and disposals was 106% (129% in 2009 and 121% in 2008) for subsidiaries and equity-accounted entities, 74% for subsidiaries alone and 166% for equity-accounted entities alone.

In 2010, net additions to the group’s proved reserves (excluding production and sales and purchases of reserves-in-place) amounted to 1,503mmboe (686mmboe for subsidiaries and 818mmboe for equity-accounted entities), principally through improved recovery from, and extensions to, existing fields and discoveries of new fields. Of our subsidiary reserves additions through improved recovery from, and extensions to, existing fields and discoveries of new fields, approximately 67% were associated with new projects and were proved undeveloped reserves additions. The remaining additions are in existing developments where they represent a mixture of proved developed and proved undeveloped reserves. Volumes added in 2010 principally relied on the application of conventional technologies. The principal reserves additions in our subsidiaries were in the US (Arkoma, Hawkville, Kuparuk, Mars, Prudhoe Bay,Thunder Horse,Tubular Bells), the UK (Kinnoull, Loyal, Machar, Schiehallion), Egypt (West Nile Delta),Trinidad (Immortelle) and Iraq (Rumaila). The principal reserves additions in our equity-accounted entities were in Argentina (Cerro Dragon), Bolivia (Margarita), Canada (Sunrise) and in Russia (Samotlor, Sorochinsko-Nikolskoye, Talinskoye, Uvat).

The following discussion reviews operations in our Exploration and Production business by continent and country, and lists associated significant events that occurred in 2010. Where relevant, BP’s percentage working interest in oil and gas assets is shown in brackets. Working interest is the cost-bearing ownership share of an oil or gas lease. Consequently the percentages disclosed for certain agreements do not necessarily reflect the percentage interests in reserves and production.

United Kingdom

Libya

Australia

Oil and natural gas transportation

BP’s onshore US crude oil and product pipelines and related transportation assets are included under Refining and Marketing (see page 55).

Assets and significant events in 2010 included:

The range of contracts that the group enters into is described in Certain definitions – commodity trading contracts, on page 82.