More on the BP disaster

Just posted this comment to the Economist, after reading the latest article on the BP disaster and the mounting costs. The article is here; here is my posted comment:

Watching this tragedy unfold day by day is as painful as watching a train wreck. As the time passes and we look for root causes we peel back layer after layer of the onion to discover:

— a corporation whose behaviour seems to put profit ahead of safety and prudence;
— a specific regulatory institution that seems highly compromised;
— an entrenched attitude throughout government that generally buys into the notions of “deregulation” and “industry self-regulation”;
— government policy that is driven by the political realities of short-term requirements (immediate economic growth, getting re-elected, etc.) over long term sustainable growth and societal welfare;
— a citizenry that is “outraged” by the incident and seeks some kind of retribution however doesn’t want to own up to their own culpability in the overall play that is being acted out;
— lots of “after the fact” mud-raking (no pun intended) by most of the central players to nominate a villain, assign blame, and promise “never again”.

Not surprisingly, I believe this is exactly the same list of statements you could make about the recent economic meltdown, the Exxon Valdez incident, the Union Carbide tradegy in Bhopal, and any number of other corporate disasters.

I write “not surprisingly” as I think this is exactly the way we have designed the modern corporation to operate. Placed in a regulatory environment of “we generally want to trust you — please try to do the right thing” the corporation has every incentive to seek to minimize costs in search of profits, and to constantly lobby to externalize as much of their actual cost and risk base as possible. The same corporation will use every legal tool at their disposal to limit their overall liability and seek to reduce any fines or costs that are imposed on them.

It is instructional to note that after 19 years of ongoing legal activities the fines imposed on Exxon after the Valdez incident have been reduced from $2.5B to around $500M. It cost Exxon about $188M in legal fees to achieve this outcome — which from a business perspective is money well spent.

After the economic meltdown, we went after the banks. Now, we’re going after BP. The thing I think we are missing is that the common feature across all these disasters is the role, power, and incentives of the modern corporation to operate the way it does. And hand in hand with this is an analysis of the regulatory environment necessary to balance our society’s desire for ongoing “growth” with the risk posture we are willing to take on in pursuit of that “growth”.

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4 thoughts on “More on the BP disaster

  1. I think there are also “personal” considerations here — since we elect sloppy gov’t, and patronize sloppy companies. I think our toxic world is highly democratic. If we don’t approve the toxicity, why patronize the corporations? Particularly a corporation like BP with it’s safety record: When BP finally figured out that it was better for business to improve safety — it pursued the lowest rate of safety improvement it could, to keep itself off the public radar.

    I think the Economist article was a pretty shallow assessment… There will be many “unforeseen consequences” — of course we can’t see them yet, but we shouldn’t ignore them either… how many seasons will the fisheries have to stay closed? what will the consequences of using dispersants be? What about social problems: drug abuse, violent crime, and family violence could all increase as a result of the economic upheaval — paying people for their lost business does not restore their lives.

    Obama wanted $20b escrow — today I read that BP is raising $50b in order to bolster investor confidence — I don’t think 50b is anywhere near what a final accounting will show. If Valdez is any indication — we might still be adding the numbers in the next century. (New science continues to measure cost of the Valdez — 2 decades later. In this accident, there could be 10 Valdez’s spilled already — and another one every week — for weeks more, maybe months).

    To detox business we need to make investors responsible for their “unforeseen” consequences. Perhaps all profits should go into escrow, and only be allowed into the greedy hands of the investors after it’s shown that “unforeseen consequences” are being paid for. As investors, we are greedy — we want to take out more than we put in. But the ‘unforeseen consequence escrow account’ is probably too much to ask… I don’t know what would have the highest death toll, the economic chaos that would ensue as investors retreated en masse in fear of their own liability, or a disaster like we face now with BP every 20 or 30 years?

    I fear that those that want to dump the unforeseen consequences on their grand children vastly outnumber those that don’t… onward ho — we have an entire planet to destroy — and it’s a big planet!

    1. Thanks for the comment, Peter. I like the concept of an “unforeseen consequence” fund, however I would argue that in fact these consequences were not unseen, just not accounted for upfront. We must be honest enough with ourselves to realize that if when we are pushing the limits of human engineering and driving new innovations (whether drilling a mile under the ocean surface, or introducing new unproven financial derivative products) we are driving up our risk posture and we should attempt to account for that upfront and have that risk built into the economic incentives that drive the business.

      Here is a question: If BP had been required to put aside a $10B fund in escrow BEFORE being allowed to drill in the gulf in case anything happened, and they knew they could only retrieve those funds once the rig was successfully decommissioned at the end of its useful life, would the company have acted any differently in their upfront planning and execution of the drilling of this well?

      My gut tells me that if they KNEW they were on the hook for some real (non-trivial) amount of money — as part of the cost of doing business — they would have proceeded with somewhat more caution as they would have had a clear economic incentive to manage risks more intelligently. While possibly a simplistic way of thinking, I truly believe that businesses are fully capable of effective risk management when they have a clear economic incentive to manage risk.

  2. I think I heard that BP has about a 100 wells in some stage of development or production at this moment… in some ways — that 10b seems like a drop in the bucket — and, I think it would be to the guys working on the rig… some of whom probably have little allegiance to BP, the company.

    My take on this is that everybody knew the rig cost 1/2 a million per day to operate — and there were probably huge bonus incentives to get the job done on schedule and ahead of schedule. Somewhere else I’ve read about the hydraulics problem on the blowout preventer: BP was not responsible for that piece of equipment — but a repair required an operational shutdown that could last days… I’m imagining two project managers arguing about who’s going to pay rent while the blow out preventer is being repaired and the bonuses are being burned. I’ve had a couple of arguments like that myself on high visibility projects… when you know the fire is getting close — you get to a point where you just don’t want to be the one that’s burned. And those guys on the drilling rigs — they’ve been playing with fire all their life.

    These kind of working conditions, which are driven by quarterly earnings reports, also need to change — perhaps somewhere along the management chain — a manager could call a timeout — draw money from the unforeseen consequences fund to pay rent and protect bonuses — and greed could become less of a factor in making critical safety decisions.

    1. The challenge today is our business environment is that there is every economic incentive to cut corners, hope for the best, etc. (eg: the rig costs 1/2m per day so lets not waste time – push, push, push!), but the economic cost of a failure is very fuzzy and who bears it is not explicit. The idea of a fund in escrow before drilling is to put a tangible “price of failure” into the equation such that business managers can make intelligent risk trade-offs.

      I think your imagined scenario of project mgrs from different companies (BP, Halliburton, Transocean) arguing about who is going to suck up the cost of “being prudent” is very real — in this case I imagine the BP guy just said something like “screw you — you work for me so do it now!!” . Let’s pretend our $10b escrow fund was a joint liability fund that all major subcontracting companies were required to participate in. Now each subcontractor knows they have “skin in the game” and has a strong financial incentive to put down their tools and raise the issue to their own management if they believe that the risk profile warrants it. And since they are the experts at the associated tasks (since it is being outsourced to them) arguably they are in the best position to understand the specific technical risk.

      In terms of how big the “unforeseen consequences fund” (UCF?) is should be based on perceived technical risk, historical company track record, worst case scenario probability, etc. I’m not sure if it would be $10b for BP for all wells in the gulf, or $10b per 10 wells, or whatever, but I’m happy to let others figure that out!!

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