Diversification Risk of Emerging Technology: Case Study of British Petroleum H. Patrick Davis NASA PM Challenge Long Beach, CA February 9-10, 2011
“ On the evening of April 20, 2010, a well control event allowed hydrocarbons to escape from the Macondo Well on to Transocean’s Deepwater Horizon, resulting in explosions and fire on the rig. Eleven people lost their lives, and 17 others were injured. The fire, which was fed by hydrocarbons from the well, continued for 36 hours until the rig sank. Hydrocarbons continued to flow from the reservoir through the wellbore and the blowout preventer for 87 days, causing a spill of national significance” (BP, 2010, Deepwater Horizon Accident Investigation Report). (Herbert, 2010)
Hydrocarbon Containment Well Control Response Well Monitoring Pressure Integrity Testing Mechanical Barriers Annulus Cement Explosions Fire and Gas System BOP Emergency Operation Well integrity was not established Hydrocarbons entered the well and well control was lost Hydrocarbons ignited Blow out preventer did not seal well Fire & Spill Hydrocarbons (BP, 2010, Deepwater Horizon Accident Investigation Report) Risk Systemicity
Case Study Analysis
Background of BP Risk Culture
Post Accident Consequences
Analysis of Strategic Risk
Application to NASA
Portfolio/Strategic Risk Management – uncertainty among events that if certain conditions occur, there will be positive or negative effects to at least one strategic business objective. 24
Structural: Risks associated with the composition of the portfolio.
Component: Risks of the individual projects/programs within the portfolio.
Overall: Risks that account for the interactions between projects/programs.
Portfolio – entire set of programs and/or projects; entire corporation
Complexity of Mitigation – level of difficulty with implementing risk mitigation plans
Aggressive M&A Strategy 8
Amoco in 1998
Objective: Become the largest oil producer in the UK and US and the largest gas producer in the US
ARCO in 1999
Objective: Expand gas business, invest in new technology, gain excellent position in the deep water of Gulf of Mexico
Burmah Castrol in 2000
Objective: Become a global mega-corporation
Aral in 2002
Objective: Cleaner fuels and ultramodern service stations
BP Process Safety & Risk Deficiencies 14
2005 explosion at the Texas City refinery
Oil spill in Alaska from corroded pipes
Illegal manipulation of propane gas market
BP Trending Towards Change
Tony Hayward, CEO following Browne, had less risky orientation 14
Implemented an Operating Management System 7
Desire to achieve safe, reliable, and compliant operations 8
Focus on process safety 8
(BP, 2010, 2009 Annual Report)
New BP Risk Ideology? 7
“ Risk is fundamental to what we do”
“ We operate at the frontiers of the energy industry where attitude to risk is key…”
“ The board will strive to set high expectations of how risk is managed and remain vigilant on oversight” (statements from the board chairman)
BP Deep Water Production
2007 – Longest single riser tower system in the world 8
2008 – Thunder Horse established as the largest single producing field in the Gulf 8
2009 – Tiber discovery is the deepest oil and gas well ever drilled 14
BP’s shares rose by 4% in a single day
Expected to drive global growth
Challenges of Deep Water Production 8
High pressures and temperatures
Low energy reservoirs result in low production rates
Maintenance and monitoring pose financial and practical challenges
80% of future exploration and production in Gulf will be beneath salt which increases the risk of unsuccessful drilling
Model of a hydrocarbon field in the Gulf of Mexico showing large salt deposits obscuring a hydrocarbon reservoir (BP, 2010) Model of a hydrocarbon field in the Gulf of Mexico showing large salt deposits obscuring a hydrocarbon reservoir (BP, 2010)
BP Production System Required Re-engineering 8
Floating rather than fixed production structures
Subsea equipment development
New approaches to monitoring and maintenance
Improvements in information and sensing
Greater distances between wells and the host production facility
Macondo Well 14
Considered simpler than Tiber (BP’s deepest well)
Macondo was susceptible to gas escapes in the well bore that could cause an explosion – BP Engineer
In its well permit, BP said it could handle a leak of 250,000 barrels of oil per day
New BP Strategy through 2020 8 (Pre-Accident)
Add 42 major projects between 2010 and 2015 totaling 1 million bpd
Boost efficiency and reduce costs
Improve annual pre-tax profit by more than $3B over the next 2-3 yrs
Annual oil and gas output increase by 1-2% a year to 2015
Centralize project management in E&P
Competitive leadership in cash costs, capital efficiency, and margin quality
Focus on deep-water production
Dept. of Interior Oversight 17
BOEMRE* responsible for offshore drill permits 11
Provide oil spill risk analysis (OSRA) model for companies to determine their ability to handle accidents 11,15
Model was scheduled to be updated in 2000
2004 risk model still required companies to base risks on surface spills
Oil company response plans are “prescribed by regulation, including the models that are used to project different scenarios for oil spills” - Exxon CEO Rex Tillerson
* BOEMRE – Bureau of Ocean Energy Management Regulation & Enforcement
Outdated BP Risk Plan 25
Based on shallow water technology model
Protection of non-existent walruses in the Gulf
External Contributory Factors to Accident
Government financial incentives encouraged BP to drill deeper in riskier waters in the Gulf 6
Regulatory and response structure of government was based on decades of success 6
The oil and gas industry rejected proposals (2001-2003) to strengthen government regulations on blowout preventers 6
Insurance analysts do not know how to deal with environmental, social, and governance (ESG) risks with large oil drilling disasters 10
(Riedel, 2010) "ESG and SRI (research) agencies were not capable of properly recognizing the environmental risks of BP” – Christoph Butz, sustainability expert at Pictet Asset Management (Carter, 2010).
Post Accident Consequences
BP’s stock fell to a 13 year low 3
$40B clean-up for BP plus strategic change of direction
BP’s partner in the well, Anadarko, planned to sue BP for gross negligence 3,11
Increases in insurance premiums and lengthy times to obtain drilling permits 13
Unknown long-term environmental effects
Analysis of Strategic Risk Strategic Risk Decisions Statistical Decision Theory Prospect Theory Agency Theory Multiple Reference Point Theory Bowman’s Paradox Theory
Leading Decision Theories
Agency Theory 21
Principals hire agents to manage business – decision making is delegated to the agents
Multiple Reference Points Theory 21
Describes a company’s risk inclination based on how close it is to meeting its strategic industry, survival, and success targets
Slack, aspirations, and performance
Bowman’s Paradox 19,21
Higher profit companies tend to have lower risk (i.e., variance in ROE) – defies the concept that greater risk brings greater returns
High risk pursuits
Leading Decision Theories
Prospect Theory 29
A prospect is a probability distribution over a range of finite outcomes for loss and gain
Each outcome ( π) has a subjective decision weight
π = w(probability of gain) − w(probability of loss)
Performance above the company’s target results in selection of lower risk outcomes (i.e., higher π, but lower $ value)
Performance below the target results in selection of higher risk outcomes (i.e., lower π, but higher $ value)
Statistical Decision Theory 20,27
Use existing data to quantify the value of prospects as a function of their probabilities for opportunity and loss
π 1 π 2 π 3 π 4 π 5 Boost Efficiency and Reduce Costs ($ Mil) 0 5 10 15 -5 -10 -15 20 25 Tornado Diagram π 1: Expand deep water drilling π 2: Diversify into unrelated market π 3: Expand global presence π4 : Expand related markets π5 : Develop commercial technology
Strategic Risk Factors L&C Mitigation Systemicity Performance Score 2 large mergers and 2 acquisitions in a 5 year span High Medium Structural Above 36 Safety and risk decisions appear consistent with the industry culture yet inconsistent with BP’s overall portfolio objectives Medium Medium Overall Meets 24 The BP BOD brought in a CEO with a risk posture consistent with the company’s direction yet they appear to have not fully invested in the proper oversight of emerging technology risks Medium High Structural Meets 24
Strategic Risk Factors L&C Mitigation Systemicity Performance Score 3 consecutive years of increased risk activities with deep water projects High High Structural Above 54 A large percentage of their future prospects are high risk – beneath salt drilling in the Gulf High High Structural Meets 36 Complete re-engineering of their production system for deep water drilling High High Component Above 27 Wells susceptible to explosive gas escapes yet BP rejects increased monitoring by DOI High Medium Overall Below 18
Strategic Risk Factors L&C Mitigation Systemicity Performance Score 42 major projects plus additional $3B annual profit planned for the next 5 years simultaneous with major improvements Medium Medium Overall Above 36 BP was overconfident in the DOI risk model High High Overall Meets 54 No incentive from government, insurers, or industry to reassess risk posture Medium Low Overall Meets 12
Multi-Industry Agreement on Change
"If we learn nothing from this spill, we should learn that the price of this pace of offshore oil and gas development and risk-taking in deeper and deeper and more difficult to access places is very high” - Bill Reilly, co-chair of the presidential commission to investigate the oil spill (Chaffin, 2010).
"One of the extraordinary things about this spill is that the technology necessary to go down that far is breathtakingly sophisticated. It is really very impressive," Mr. Reilly said. "What amazes me is it looks as though the surface response capability is about as primitive as it was in Prince William Sound in 1989. It just hasn't kept pace“ (Chaffin, 2010).
"The parallels between the oil spill and the recent financial crisis are all too painful: the promise of innovation, unfathomable complexity, and lack of transparency" – Kenneth Rogoff, Harvard economist (Crovitz, 2010)
“ The BP oil spill has laid bare fundamental shortcomings in the oil and gas industry's ability to prevent and stop catastrophic blowouts” - Ken Salazar, Dept of Interior Secretary (Casselman, 2010)
BP Internal Lessons Learned 9
Improvement to Drilling and Well Operations Practice & Operating Management System
Procedures and engineering technical practices
Capabilities and competencies for deepwater drilling
Closure and verification of audit findings
Process safety performance management
Improvement to Contractor and Service Provider Oversight and Assurance
Oversight of cementing services
Clear and consistent well control practices
Rig process safety
BOP design and assurance
New Practices from DOI
Increased safety rules for offshore drilling 4
Require oil companies to provide more information when applying for permits to drill offshore 11
Strengthen inspections 4
Reorganize BOEMRE to avoid conflicts of interest 4
Lessons Learned - Generic
From Prospect and Statistical Decision Theories
We must augment external regulations with internal risk analysis to determine proper mitigations for predicted risks and their consequences
Quantify assessment of risk to the portfolio considering the systemicity of risk 1 , performance, and complexity of mitigation in addition to likelihood and consequence
Lessons Learned - Generic
From Agency, MRP, and Bowman’s Paradox Theories
A Portfolio Governance body (e.g., Board of Directors) should be involved in shaping the strategic risk culture - risk averse vs. risk seeking
Triggers can be implemented to help remind us to update risk/contingency plans as technology changes or the environment surrounding the technology changes
New & Discontinued Strategic Goals (2011 – 2015) 22
Space Technology: $4.9B
Construction & Environmental Compliance and Restoration: $1.9B
Exploration R&D: $13.9B
Institutional Investments: $294M (2009)
Congressionally Directed Items: $67M (2009)
Strategic Risk Factors L&C Mitigation Systemicity Performance Score Technology readiness depends on cooperation from other NASA programs and multiple national and international partners. Medium Medium Structural Meets 16 New technologies are needed in multiple areas where technology growth with cost reductions has been challenging. High High Structural Meets 36 The same skills needed in these areas will be needed to address multiple technology R&D and may not be available to support NASA schedule. Low Medium Overall Above 18
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