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What Every CFO Should Learn From BP Oil
Obviously the BP oil spill is a tremendous tragedy. Many mistakes were made, but who is primarily at fault? CEO Tony Hayward is taking most of the heat, but I would argue the CFO should be answering for this catastrophic mistake.
In my book “Profitpreneurship”, I list risk management as one of the responsibilities of a CFO. I define risk management as follows:
“On the surface, this responsibility may appear simple. The majority of organizations feel that managing risk is as simple as purchasing insurance. Although it is critical that all of the proper insurance is in place (workers’ compensation, umbrella, etc.), what about the risks of entering a new market—especially outside the countries where you normally do business? Acquisitions, currency fluctuations, regulatory changes are just a sample of the risks a CFO needs to manage. Managing risk includes running the applicable what-if analysis and determining the cost-vs.-benefit of hedging the applicable risk (if possible).”
One of the reasons the oil spill was not prevented is BP’s lack of a remote-controlled switch called the “acoustic switch.” The acoustic switch functions to turn off a rig’s valve on the seabed if other spill-preventing contraptions fail to close the valve. The use of an acoustic switch on a rig is not yet mandated by U.S. regulators, and the Deepwater Horizon – the rig that caused the largest offshore oil spill in U.S. history when it exploded on April 22nd, 2010 – did not have an acoustic switch as a back-up safety plan. An acoustic switch costs roughly $500,000 (Wall Street Journal).
View how an acoustic switch works:
Did the BP’s finance team make the right decision when they chose not to incur more preventive cost that could have saved BP hundreds of billions of dollars? Let’s analyze the statistics.
Note: the computations below are based on available statistics and numerous assumptions and may be prone to uncertainties and errors.
According to research*, the probability that an oil leak greater than 10,000 bbl would happen during the reservoir’s life time is
0.16 spill ÷ 109 bbl oil handled × 50 million bbl of oil in the reservoir = 0.8%.
*0.16 spill per 109 bbl oil handled represents the average spill rate for an Outer Continental Shelf platform having a spill greater than or equal to 10,000 bbl during the periods of 1964-1992 (citing Anderson and LaBelle’s research “Comparative Occurrence Rates for Offshore Oil Spills”), and there are at least 50 million bbl of oil in the broken well according to BP CEO Tony Howard (AP Report).
To date, BP’s market capitalization has dropped more than $100 billion, and Goldman Sachs predicts that BP could spend up to $70 billion combating the oil spill in “a reasonable worst-case scenario” (msnbc), which brings the tab to a grand total of $170 billion, discounting future changes in BP’s market capitalization.
Therefore, when BP’s finance department decided that they were not going to incur additional preventive cost, they calculated (or at least they should have calculated) the expected cost of that decision. I would use the following method:
Probability of an event × cost as a result of the event
0.8% × $170 billion = $1.36 billion dollars
Using simple risk management methodology, BP should have invested up to $1.36 billion dollars in order to prevent the oil spill from occurring. Whether or not they spent this much in prevention is debatable. However, we do know an acoustic switch would have cost approximately $500,000. And we know they did not have one.
Further Readings:
Wall Street Journal: Leaking Oil Well Lacked Safeguard Device
Christian Science Monitor/Associated Press: BP oil disaster: How much oil is left?
msnbc: BP faces huge tab, has deep pockets
Want more? See Ren’s new book, “Profitpreneurship”, which is available on Amazon.com. “Profitpreneurship” debuted as the #1 Business Plans book on Amazon.com on May 11, 2010! If you would like to purchase a copy of Profitpreneurship, please follow the following link: http://amzn.to/cCCXTJ
Comments (8)
Sterling McKinley
July 2nd, 2010 at 8:10 am
good post…
Randy Pound
July 2nd, 2010 at 8:11 am
Before blaming individuals, it is vital to determine whether the overall process had the technical right to succeed. In this case, the answer is “no.” The process was flawed from the beginning. There was no Potential Problem Analysis done, there was no procedure for capping a catastrophic leak 5,000 feet below the surface, and thus BP could not practice for such a catastrophe.
There was no single individual who failed. Every person at BP who called himself or herself a “professional undersea oil remover” was, in fact, unprofessional. And, I’m sure that BP is not the only company in this state of unprofessionalism.
Rob Stewart
July 2nd, 2010 at 8:13 am
There is not enough of this type of thinking that occurs before a decision like this is made. Unfortunately, most people do not have a preoccupation with failure and asking what if this goes wrong. They take a chance as they have done it before with no consequences indeed they may even have been rewarded for the risk taking. Organisational behavior has got to change. The risk approach you are advocating is a good start.
Cesar E. Martinez
July 2nd, 2010 at 10:33 am
I do not agree. The CFO has financial responsability, not operational responsability.
The decisions taken by BP were operational decisions. The involvement of a CFO should have been advisory and try to have the operational prople think about what the costs could be if everything went wrong. The persons responsible are the CEO and others who made the decisions to cut corners.
In addittion the “mistake” is a predictable consequence of the cavalier, take no prisoners irresponsible approach taken by the oil industry in general. By the attitude, that we make all the decisions and if “accidents” happen we are not respnsible. Look at EXXON and the Valdez disater. Twenty yeras after the disaster the still have not finished the cleanup and paid the minimal damages that they were assigned to.
There should be personal responsability of top management forthese actions.
Greig Fennell
July 6th, 2010 at 8:14 am
Most likely the CFO presented the risk analysis, if presented at all. We do not know what was really debated around the BP’s executive table regarding the use of the acoustic switch. We don’t even know if what Ren developed was even considered by BP’s executives. IF what Ren calculated was presented then most likely there was an executive decision made by the COO and the CEO to not spend the money.
What we do know is that the acoustic switch was not installed and there was not a reliable contingency. RMs can present all the facts and probabilities, but in the final analysis it is the decision-maker who rolls the dice and makes the decision. In the case of BP it was a decision that met with catastrophic consequences.
Cornelius Graves
July 6th, 2010 at 10:09 am
I agree that the BP incident is a catastrophic event, but I would also wonder how this event/process made it’s way to BP annual risk assessment project, if at all. While this might appear as an operational event, I think this is a great example of how operational actions can quickly transform into a financial concern. Just my 2 cents.
S.Mushtaq Hussain Bokhari
February 2nd, 2011 at 4:03 am
It sounds unreasonable to blame CFO for the catastrophy,buyibng or otherwise of “acustic switch” is undoubtedly an operational decision.The fundamental question is whether those responsible for operations ever thought about the risk and considered buying or otherwise of the switch and presented the case with the data for risk assessment and mitigating measures.The cfo is responsible only if he has considered the case and then went against spending $ 500000.Making a risk assessment now after incurring a loss of $ 170 billion is simple because it is a post event.I don’t agree with the assertion that CFO is responsible for this catastrophic event.
S.Mushtaq Hussain Bokhari
February 3rd, 2011 at 8:58 am
It sounds unreasonable to blame CFO for the catastrophy,buyibng or otherwise of “acustic switch” is undoubtedly an operational decision.The fundamental question is whether those responsible for operations ever thought about the risk and considered buying or otherwise of the switch and presented the case with the data for risk assessment and mitigating measures.The cfo is responsible only if he has considered the case and then went against spending $ 500000.Making a risk assessment now after incurring a loss of $ 170 billion is simple because it is a post event.I don’t agree with the assertion that CFO is responsible for this catastrophic event.
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