Thinking Ahead: BP’s Risk Management Challenge

Environmentalists, oceanographers, and commercial fishermen were deeply worried this past week about an ominous side effect of BP’s chemical dispersal strategy to manage its catastrophic oil spill. Apparently, although the chemicals are helpfully dispersing the crude oil over a wide geographic area so that it can be more easily devoured by microbial bacteria, they inadvertently pose a threat to coral reefs and other undersea life.

Furthermore, although concentrated masses of bacteria are indeed digesting the crude oil, they are also draining the Gulf waters of the oxygen that is required to support undersea life. And the oil spill itself is apparently spreading eastward, where it threatens to enter the Loop and Gulf Stream Currents on a path around Florida and up the eastern coastline of the United States.

Fingers of blame are now being pointed among BP and its subcontractors Transcean and Halliburton. But is BP truly negligent for failing to implement an effective system of enterprise risk management?

A Simple Model

Enterprise risk management, as defined by accountants, engineers, and actuaries, relies on a fundamentally simple model of analysis and action. Competent risk managers must begin by defining and listing potential catastrophes before they occur and inflict any damage. Then they must prioritize each catastrophic scenario on the basis of: (a) its probability of occurrence and (b) its potential damage level. Finally, they must take action to implement preventive internal control systems that reduce intolerably high probabilities of occurrence, as well as crisis response systems that reduce unacceptably high potential damage levels.

But what should energy firms do with production sites that are so risky that such systems cannot possibly reduce probabilities of occurrence and potential damage levels to tolerable standards? In that case, the only rational plan of action is to simply walk away from the energy fields. In fact, this is why the United States has decided against relying more heavily on its estimated 100 to 250 year domestic supply of coal to serve its energy needs; it has determined that the environmental damage that would be generated by such a strategy simply cannot be managed in a prudent manner.

In the case of the Gulf oil spill, though, where did BP go wrong? Did it fail to implement any control systems at all, which would indicate that it managed its operations in a grossly negligent manner? Or, as Kentucky Senatorial candidate Rand Paul speculated last week, did BP take reasonable actions to manage this risk and simply fell victim to random chance?

Accidents Happen

Last week,  Rand Paul tersely declared that “accidents happen” and then vigorously defended BP’s business practices. And Paul’s perspective is indeed worthy of consideration; BP has been known, for instance, to stage global simulation exercises that require its managers in training to address critical challenges and make difficult decisions in virtual reality settings.

BP has also installed anti-spill switches on its at-risk equipment in the Gulf of Mexico, although the blowout preventer switch on the damaged field that caused the current spill failed to respond to activation commands. BP has also attempted to activate this switch with technologically advanced remote control submarines, although these efforts did not prove successful.

Nevertheless, BP has indeed performed the requisite analyses to identify and implement these risk management activities. Its manager training sessions, in fact, represent valuable primary crisis response capabilities, and its switch technologies likewise represent primary preventive control activities. But if this is true, then why hasn’t BP been able to control and contain the catastrophic Gulf spill, one that now threatens the entire Eastern coastline of the United States?

Thinking Ahead

The most successful Masters of the game of Chess share a specific critical skill: they are capable of thinking many moves ahead at any given time during a match. In fact, one reason why IBM’s Deep Blue computer program can now defeat the world’s finest Chess Masters is because software algorithms can assess and compare multiple potential future scenarios far more quickly than human minds.

BP, though, may have only planned its risk management strategy a mere two moves beyond its initial catastrophic spill. What should it do if crude oil begins to pour into the Gulf? Activate the preventer switch on the defective equipment. And what if the switch itself fails to halt the spill of oil into the sea? Disperse the spill with chemicals and allow bacteria to do nature’s work.

But what if the monstrous size of the spill itself, as well as the intense toxicity of the dispersal chemicals, threaten the entire environmental eco-system of the Gulf and the Western Altantic? That scenario requires a tertiary level of analysis, one that obviously has not been completed in advance by BP’s management team. And that’s why BP’s current array of ad hoc tertiary responses, ranging from the Top Hat to the Junk Shot, has exposed the firm to such withering attacks from so many different sources.