* BP needs further cuts to support dividend, U.S. bank says
* M&A needed to offset production decline
* BAML cuts rating on BP shares to underperform from neutral
By Ron Bousso
LONDON, Sept 4 (Reuters) - BP will need to buy oil and gas fields to offset falling production, which could lead it to issue equity to raise funds, Bank of America Merrill Lynch (BAML) said on Friday, cutting its rating on the oil major's shares to underperform from neutral.
As oil prices are expected to recover only slowly over the next two years, the British oil and gas company will have to sell more assets, cut spending by an additional $5 billion and increase borrowing to maintain dividends, the U.S. bank said.
With lower in-house growth, BP will need to acquire companies or assets. All this could result in BP issuing shares to raise funds, it said.
"We warn of increasing M&A (merger and acquisition) risk: BP is in our view likely to replace organic with inorganic investment opportunities -- including the risk of value destruction as well as further dilution from at least partially equity-funded M&A," BAML said.
"Should project sanctioning see further delays as we face persistently low oil prices, we believe the temptation to engage in more M&A and external reserve replacement will only grow," it added in the report published on Friday.
BP declined to comment.
Barclays last month rated BP's shares "overweight", noting progress in cost saving. "We continue to see BP as having a differentiated opportunity to reduce costs relative to the wider peer group and anticipate further progress throughout the rest of 2015 and into 2016," Barclays said.
Like most peers, BP has slashed spending in the face of an extended period of low oil prices.
It has also sold more than $50 billion of assets over the past year to boost its balance sheet and to finance the costs and fines of the deadly 2010 Gulf of Mexico oil spill.
BP, for years the subject of speculation that it could be an acquisition target, is expected to maintain its dividend payout through increased borrowing, BAML said.
Assuming benchmark Brent crude oil prices recover to $70 a barrel by 2017, BP will still need $4 billion in additional cash savings to cover dividends, BAML said.
"Given the industry's patchy track record on creating value from M&A, we believe investors will be rewarded for patience. In other words, we believe it pays to stand on the sidelines and evaluate any M&A proposition after it is announced," BAML said.
It cut its price target for BP shares to 330 pence from 420 pence. At 1352 GMT, the stock was trading around 338 pence. (Editing by Mark Potter)