Oil Spill Stains Risk Management's Reputation

The BP oil spill disaster in the Gulf is obviously the result of a failure of both technology and regulation. However, the biggest culprit is a catastrophic failure of risk management.

The job of a risk manager is to hope for the best, but be prepared for the worst. That means putting emergency response systems in place to cope with a worst-case scenario. 

It's hard to imagine a scenario any worse than the one we are witnessing in the Gulf. An offshore oil rig explodes, killing 11 workers. The rig collapses into the ocean. Oil continues to gush from a deep sea well, threatening the Gulf coast, the Florida Keys and perhaps even the Eastern seaboard.

One makeshift solution after another is implemented, with BP officials offering no guarantees of success--essentially keeping their fingers crossed. The situation remains out of control, and the damage could be substantial--environmentally, economically and even politically.

Where was the risk management department in this mess? Where were the fail-safe systems? Why did it feel as if BP was making up its response as it went along the past few weeks?

Most importantly, how can we make sure something like this never happens again?

Some might simply say that catastrophes like this don't happen very often at all. Indeed, the lack of frequency, combined with the immense severity potential for such exposures is why oil companies generally self-insure such liabilities in the first place. It would just be too expensive to transfer such risks, given the premium an insurer would have to charge to cover a major loss.

But that's just the insurance side of the equation. Since oil companies literally pump money out of the ground, they can always count on their substantial cash flow to bail them out of any major exposure, including this one.

However, the risk management coin has two sides. One is insurance to pay claims and damage control costs, but the other is loss prevention. That's where BP really let everyone down.

BP officials defended the company's risk management preparation in a May 10 "Wall Street Journal" article (http://online.wsj.com/article/SB10001424052748704307804575234621987007784.html), essentially arguing that this scenario goes well beyond "worst case," into the realm of unforseeable.

"You have here an unprecedented event. Never before have you seen a blowout at such depth and never before has a blowout preventer failed in this way," according to a BP spokesman, Andrew Gowers. "The unthinkable has become thinkable, and the whole industry will be asking searching questions of itself."

However, the Journal went on to report that "BP's plan, as submitted to the Mineral Management Service, placed exceedingly low probabilities on oil reaching land in the event of a major spill. Even in the case of the worst spill, BP said, there was only a 3 percent chance that oil would come ashore after a month in any part of the Gulf other than Plaquemines, La., which juts into the Gulf south of New Orleans."

This is a stretch. Could it be that just like the company figured it didn't need to transfer the risk due to the unliklihood of such an event, it also held off on potentially expensive risk management measures because it was so unlikely, in BP's view, that this scenario could take place?

I am not throwing risk managers under the bus here. It's quite possible the BP risk manager wanted a more reliable loss prevention system in place, but was overruled by cost considerations, or less risk-averse senior executives. Getting to the bottom of how BP handled risk management internally is a job for federal investigators to uncover.

In the meantime, we're obviously not going to rid our country of its oil addiction anytime soon. Nuclear power, even if it is enthusiastically accepted (and that is far from certain), will take years to make a significant impact. Wind power is minuscule compared to our energy requirements. And it's unlikely Americans will accept the kinds of behavior-altering tax regimes to lower our consumption to any significant degree.

That means we're going to need to keep drilling for oil--often in environmentally dicey places. President Barack Obama recognized that with his statement prior to the BP fiasco that he was open to more off-shore drilling.

But it's clear that if we're going to keep sticking straws into the Earth deep under the ocean to suck out more oil, we need to be better prepared to react if something--especially the worst possible thing--happens. There needs to be more vigilant, arm's length regulation to make sure oil companies are better prepared, and that starts with more accountable risk management, of the enterprise-wide variety.

If we're going to play with fire, we had better be prepared to put out the flames before they consume us all.

(NU Risk Management Editor Caroline McDonald also addresses the loss control implications of the BP spill in her blog at http://noriskzone.com/.)