Drilling for Answers

What can the BP oil spill disaster teach finance executives about risk?

It has been nearly a month since the Deepwater Horizon oil rig exploded off the coast of Louisiana, killing 11 people and opening a well that continues to release thousands of barrels of crude oil into the Gulf of Mexico. As BP, the majority owner of the well, desperately tries to stop the leak, executives both inside and outside the oil industry can only watch and wonder: Could something like this happen to my company? How can I make sure it never does?

The disaster offers risk management lessons even for companies operating far from the high-stakes world of offshore oil drilling, say experts. “There are a handful of characteristics of this situation that are pretty common across the major disasters I’ve studied over the years,” says Mark Abkowitz, a professor of civil and environmental engineering at Vanderbilt University and author of the book Operational Risk Management: A Case Study Approach to Effective Planning and Response (John Wiley, 2008). “The recipe for disaster seems to be pretty clear.”

One ingredient is aggressive corporate cultures that discount risk, says Abkowitz. Companies with such cultures tend to forgo scenario planning that could identify “relatively foreseeable risks,” he says. And when a project promises to generate a major return on investment, “there’s a tendency to satisfy any safety analysis by pointing to your prior record and your ability to marshal an emergency response,” he says.

Indeed, it seems that as BP began exploring deeper waters in recent years, its drilling technology and reach outpaced its ability to clean up any potential spill. At a news conference last week, BP chief executive Tony Hayward admitted as much, saying, “This is the first time the industry has had to confront this issue in this water depth, and there is a lot of real-time learning going on.”

Another ingredient of the disaster recipe is complex systems. The Deepwater Horizon operation was clearly a complicated one, with three different companies — BP; Transocean, which owned the rig itself; and Halliburton, the drilling operations contractor whose employees worked on the rig — involved in a highly sophisticated engineering project thousands of feet under the sea.

“Because of the complexity, it’s very important to have constant and open communication between the business partners,” says Abkowitz. Instead, however, large projects with multiple parties often end up in silos, with each participant executing its assigned tasks. “You get the blueprint, you know what you’re responsible for, and you go ahead and work on those things,” he says. “You may come up against some unforeseen challenges and decide to deal with them a certain way without thinking through how your actions affect other people’s actions.” For example, if a drill depth was deeper than originally specified and a contractor on a rig was unaware of this change, the original design for a cap for the well might not have been adequate for the altered conditions.

Michael Roberto, a professor of management at Bryant University in Rhode Island, points out a third ingredient: psychological factors that cause people to ignore warning signs. “When red flags appear, there is a powerful human tendency to discount the risk, particularly if we’re not sure we have a solution,” says Roberto, whose latest book is Know What You Don’t Know: How Great Leaders Prevent Problems Before They Happen (Wharton School Publishing, 2009). “People don’t want to grapple with the horror of not having a solution.” Instead, they convince themselves that the risks are smaller than they are. In the case of the Deepwater Horizon, the results of tests performed on the rig on the afternoon before the explosion should have given BP’s managers pause, but the operation moved ahead.

Roberto says that CFOs can play a critical role in helping their companies avoid the kind of financial and reputational fiasco BP is now facing. That’s because a finance chief typically has a more independent view of the business than most other executives do, he says. “The people who are running the operations are embedded in whatever they are doing,” he says. “The CFO can be that objective second set of eyes.”

Finance can lead the creation of a rigorous risk management process that identifies “all the hazards that can threaten the enterprise,” says Abkowitz. “You can have a low-probability event that can have such dramatic consequences that you can’t ignore it. The question is, are you prepared to recognize those events?”

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