Davis.howard

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 &

SpillHyd

roca

rbon

s

(BP, 2010, Deepwater Horizon Accident Investigation Report)

Risk Systemicity

Case Study Analysis Definitions

Background of BP Risk Culture

Post Accident Consequences

Analysis of Strategic Risk

Lessons Learned

Application to NASA

Definitions

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 plansP

roba

bili

ty

Impact

Compl

exity

of

Mitig

atio

n

Low HighLo

w

High

Low

High

(Davis, 2010)

Aggressive M&A Strategy8

Mergers 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

Acquisitions Burmah Castrol in 2000

Objective: Become a global mega-corporation

Aral in 2002 Objective: Cleaner fuels and ultramodern service stations

BP Process Safety & Risk Deficiencies14

2005 explosion at the Texas City refinery

Oil spill in Alaska from corroded pipes

Illegal manipulation of propane gas market

BP Trending Towards ChangeTony Hayward, CEO

following Browne, had less risky orientation14 Implemented an Operating

Management System7 Desire to achieve safe,

reliable, and compliant operations8

Focus on process safety8 (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 world8

2008 – Thunder Horse established as the largest single producing field in the Gulf8

2009 – Tiber discovery is the deepest oil and gas well ever drilled14

BP’s shares rose by 4% in a single day

Expected to drive global growth(BP, 2010)

Challenges of Deep Water Production8 High pressures and temperatures Heavier crudes 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-engineering8

Floating rather than fixed production structures Subsea equipment development

(BP, 2010)

New approaches to monitoring and maintenance

Improvements in information and sensing

Greater distances between wells and the host production facility

Macondo Well14 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

(Swenson, 2010)

New BP Strategy through 20208

(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 Oversight17 BOEMRE* responsible for offshore drill

permits11 Provide oil spill risk analysis (OSRA) model for

companies to determine their ability to handle accidents11,15

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 Plan25 Based on shallow water technology model Expired experts 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 Gulf6 Regulatory and response structure of government was based

on decades of success6 The oil and gas industry rejected proposals (2001-2003) to

strengthen government regulations on blowout preventers6 Insurance analysts do not know how to deal with

environmental, social, and governance (ESG) risks with large oil drilling disasters10

(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 low3

$40B clean-up for BP plus strategic change of direction

BP’s partner in the well, Anadarko, planned to sue BP for gross negligence3,11

Increases in insurance premiums and lengthy times to obtain drilling permits13

Unknown long-term environmental effects

Analysis of Strategic Risk

Strategic Risk

Decisions

Statistical Decision Theory

Prospect Theory Agency Theory

Multiple Reference Point TheoryBowman’s Paradox Theory

Leading Decision Theories

Agency Theory21 Principals hire agents to manage business – decision making is

delegated to the agents

Multiple Reference Points Theory21 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 Paradox19,21 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 Theory29

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 Theory20,27 Use existing data to quantify the value of prospects

as a function of their probabilities for opportunity and loss

π1

π2

π3

π4

π5

Boost Efficiency and Reduce Costs ($ Mil)

0 5 10 15-5-10-15 20 25

π1: Expand deep water drillingπ2: Diversify into unrelated marketπ3: Expand global presence π4: Expand related marketsπ5: Develop commercial technology

Tornado Diagram

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


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


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

Lessons LearnedMulti-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 Learned9

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 drilling4 Require oil companies to

provide more information when applying for permits to drill offshore11

Strengthen inspections4 Reorganize BOEMRE to

avoid conflicts of interest4

(Wade, 2010)

Lessons Learned - GenericFrom 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 risk1, 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

Portfolio Risk Review Board

Sensitivity Analysis

New Technology

Budget

StrategicGoals

Application to NASANew & Discontinued Strategic Goals (2011 –

2015)22 New Goals

Space Technology: $4.9B Construction & Environmental Compliance and

Restoration: $1.9B Exploration R&D: $13.9B

Discontinued Goals Institutional Investments: $294M (2009) Congressionally Directed Items: $67M (2009)


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

Questions?

(www.nola.com, 2010)

Questions?

(Riedel, 2010)

Questions?

(Riedel, 2010)

References1. Ackerman, F., Eden, C., Williams, T., & Howick, S. (2007). Systemic risk assessment: A

case study. The Journal of the Operational Research Society, 58(1), 39-51.

2. ADVFN. (2010). www.advfn.com

3. Anonymous. (2010, June 26). Business: court tester; BP and the oil spill. The Economist, 395(8688), 66.

4. Bureau of Ocean Energy Management Regulation & Enforcement. (2010, October 29). http:/www/boemre.gov/ooc/press/2010/press1029a.htm.

5. Boeing. (2007). Risk management plan. Retrieved from a secure Boeing Intranet.

6. Bolstad, E. (2010, July 20). BP's oil spill caused by fed's "dangerous culture of permissiveness”. McClatchy Newspapers.

7. British Petroleum. (2010). 2009 annual report. http://www.bp.com/extendedsectiongenericarticle.do?categoryId=9021605&contentId=7040949.

8. British Petroleum. (2010). http://www.bp.com/bodycopyarticle.do?categoryId=1&contentId=7052055.

9. British Petroleum. (2010). Deepwater Horizon Accident Report. http://www.bp.com/sectiongenericarticle.do?categoryId=9034902&contentId=7064891.

10. Carter, D. (2010). Managers learn from the BP catastrophe. Pensions & Investments, 38(13), 2-3.

References11. Casselman, B. (2010, June 18). Anadarko blames BP for rig disaster. Wall Street

Journal (Online). Retrieved July 12, 2010, from ProQuest database. 12. Chaffin, J. (2010, June 30). BP executives to face public grillings. FT.com. Retrieved

July 11, 2010, from ProQuest database.13. Colter, A. B. (2010, June 25). Gulf oil spill may spur M&A; Smaller producers and oil-

servicing companies will need to partner with other firms to shoulder higher costs. The Investment Dealers Digest, 76(24), 21.

14. Crooks, E. (2010, July 3). BP - anatomy of a disaster - part 1; cover story. Financial Times, p. 16. Retrieved July 11, 2010, from ProQuest database.

15. Crovitz, L. G. (2010, June 28). Drilling for better information; The financial crisis and BP share a common attribute: regulatory failure. Wall Street Journal (Online). Retrieved July 11, 2010, from ProQuest database.

16. Davis, H. P. (2010). Risk management plan. Unpublished manuscript, Capella University.

17. Department of Interior. (2010). http://www.doi.gov/doi/deepwaterhorizon/index.cfm18. Herbert, G. (Photographer), & Webb, T. (Author). (2010, April 27). Whistleblower

accuses BP over rig documents. http://www.guardian.co.uk/business/2010/apr/27/bp-whistleblower-atlantis-rig

19. Massachusetts Institute of Technology. (1980, March). A risk/return paradox for strategic management (WP 1107-80). Cambridge, MA: Bowman, E. H.

20. Mazumder, A. (2003, November). Statistical decision theory: Concepts, methods and applications. Retrieved from http://www.probability.ca/jeff/ftpdir/anjali0.pdf.

References21. Mukherji, A., Desai, A. B., & Wright, P. (2008). A contingent relationship between risk

and return: Toward a behavioral model of decision making. Journal of Behavioral & Applied Management, 9(3), 240-257.

22. National Aeronautics and Space Administration. (2010). www.nasa.gov.23. Oliver, J. (2008). A 3-D risk assessment model. Journal of Validation Technology,

14(5), 70-76.24. PMI. (2008). The standard for portfolio management. (2nd ed.). Newtown Square, PA:

PMI.25. Power, S., Kell, J., & Hughes, S. (2010, June 16). The Gulf oil spill: BP, oil industry

take fire at hearing --- scientists raise estimate of leak to up to 60,000 barrels a day, raising fresh questions about containment plans. Wall Street Journal (Online). Retrieved July 12, 2010, from ProQuest database.

26. Riedel, C. (2010, June 3). Photo gallery: Ripple effects of the BP oil spill. http://www.katu.com/news/photos/95866799.html

27. Ruefli, T. W., Collins, J. M., & Lacugna, J. R. (1999). Risk measures in strategic management research: Auld Lang Syne? Strategic Management Journal, 20(2), 167.

28. Swenson, D. (2010, April 30). What's going on beneath the sea? A graphic explanation of the fight to shut off the oil leak. http://www.nola.com/news/gulf-oil-spill/index.ssf/2010/04/whats_going_on_beneath_the_sea.html

29. Van De Kuilen, G. (2009). Subjective probability weighting and the discovered preference hypothesis. Theory & Decision, 67, 1-22.

30. Wade, J. (2010, June 9). Charting the BP oil spill in infographic form. http://www.riskmanagementmonitor.com/charting-the-bp-oil-spill-in-infographic-form/

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