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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
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
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)
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
Questions?
(www.nola.com, 2010)
Questions?
(Riedel, 2010)
Questions?
(Riedel, 2010)
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