Avoiding Deep Water.

We have all by now heard of B.P.’s saga with its Macondo well in the Caribbean. The event has focused minds not only on operational procedures, though also issues concerning insurance, contractual arrangements and above all else, a company’s public profile. There are valuable lessons to be learnt from such an incident, particularly with relation to a company’s operational procedures.

Background.

B.P.’s Macondo well failed due in large part to a faulty blow out preventer. Between the time when the incident occurred and the time when the well was finally capped, some 4.9 million barrels of oil were discharged into the Caribbean. The resultant pollution caused extensive damage to wildlife and also involved a major clean up operation along the Gulf coast of the southern U.S.A.. B.P. came under such close scrutiny by the U.S. authorities, that the company had to make a sacrificial lamb of its’ chief executive Tony Hayward. Though the latter’s handling of the crisis came in for criticism, he took all the actions which any company could take in such circumstances. He effectively became the ‘fall guy’.

The Legacy.

B.P.’s corporate image was very badly dented and it had to divest itself of assets, in order to pay for the estimated $20 billion clean up costs and compensation payments. Further assets may be required to be sold in due course, in order to meet the costs arising from the incident. This will ultimately only become known when all the resultant legal actions have been settled, which may take many years. This will have long term effects on the future strategy of the company and the oil industry. Its’ image and previously strong financial position will take many years to rebuild.

Relevant issues to all companies.

Whilst one may not immediately appreciate it, there are issues which this catastrophe raises, which are pertinent to almost all companies. They can be subdivided into the points which follow this introduction. Many are resolvable, should a company take suitably preventative action.

Loss of reputation.

At one point during the unfolding events, it was questioned as to whether B.P. could survive and as to whether it would fall victim to a predatory bid. It was also questioned as to whether the company would lose substantive market share going forward, due to customers boycotting their products. It is important to appreciate that the American political system and media apportioned blame on B.P., without having properly assessed the root causes of the loss. Though B.P. had ultimate responsibility for the site, the day to day operation was left with subcontractors. It was the latter’s staff, who were in control and directing operations at the time of the incident. Any company, given such a situation, needs to fully appreciate the potential harm which can be done to a company’s reputation, as a result of such incidents. A tight reign needs to be kept on contractors at all times, ensuring that they meet various strict operating guidelines. This may have been B.P.’s failure. Whilst it has to be appreciated that no company is able to prevent such style of catastrophic losses from occurring, there are ways and means of lessening their effect. The most important effective defence a company possess, is a “disaster recovery” plan, which can be put into effect as soon as such an incident occurs. This would involve preset strategies for handling the media and if necessary, governments. It would also involve having equipment and personnel available to fly into any potential ‘disaster zone’ at a moments notice, with the aim of limiting any damage at a very early stage.

Contractual indemnities.

B.P. whilst being lead co-venturer on the Macondo well site, had no active part in the well’s operation;. This was subcontracted to various American companies. B.P. had various contractual indemnities built in to their contracts and fully expected them to function, should there be a loss. In the circumstances, the subcontractors, particularly Transocean, declined to indemnify B.P.. This left the company with little option other than to try and legally enforce the terms of the contracts upon them. The key issue is to whether the indemnities are sufficient to make a serious impact on B.P.’s losses. Whilst one may argue as to the point of their existence should it be difficult to enforce them, they are nonetheless a valuable tool in attempting to limit any company’s financial exposure. It is imperative that any company studies the so called fine print of any contract prior to signing contractual documentation. Subcontractors, by signing a contract as presented to them without fully reviewing the legal niceties of its’ terms can lose rights of defence which might otherwise be available to them, or head contractors being unable to recover losses suffered as a result of a breach. In drawing up any contract, a company, must make sure that its rights are adequately protected. It must also ensure that any drafted contract will not have its terms over ruled by the law governing the operational territory. The key point in the latter regards, would relate to allowed financial compensation limits. Often companies review contracts in detail, in order to ensure that any contained clauses do not open them up to potential exposures, without availing themselves of added clauses which may act to provide added protection to them.

Operational procedures.

It is essential for any company carrying out any work, to make sure that it has not only a safe working environment for its / any subcontractor’s employees, though also has strict guidelines in place to ensure that operational procedures leave little or no room for potential errors to creep into the system. One way in which a company can act to restrict its’ liability, is to create a separate subsidiary company with its own legal identity. This not only acts to keep the glare of adverse publicity from the front door, though also limits liability to the extent of the assets of the subsidiary company. Whilst a holding company might become involved in legal actions and the like, the chances of potentially large pay outs are substantially reduced when such structures are in place.

Replacement parts / operator issues.

Often companies operating systems do not plan for the unforeseen. One such possibility is that a contractor defaults. This could in the worst situation, leave the operator with no ability to complete an assignment and meet contractual deadlines. Another would be as a result of spare parts not being available at the required time. This is particularly important where a key component fails with the result that the production process comes to a standstill. In B.P.’s case, the failure related to the lack of a suitable spare blow out preventer being available at short notice. This would have allowed the well to have been capped at an early stage and avoided much of the oil leakage. Whilst one may be able to easily ascertain internal lead times for replacement parts, this becomes much more difficult when relying on external sources. Should parts be complex in nature, it only acts to increase the lead times involved. Any well organised company should have a back up supply of key components which are easily accessible in the case of an emergency. Companies increasingly rely on external contractors for the supply of key components. When entering into agreements with third party suppliers, it is essential that a company has some ability to exert some management control over the company, or conversely have alternative suppliers, who can supply key components at a moments notice. This is particularly the case with modern day “just in time” manufacturing techniques. Failure to have access to key components can have a devastating effect. An issue might arise when the equipment involved has a very high value and as such a company may not either possess or desire to expend its reserves on keeping a spare part on semi-permanent standby. One has to question the cost benefit analysis of retaining replacement parts as against the risk of a serious incident occurring. In the majority of cases, it is not a risk worth taking.

Limiting operational risk.

Any company operating at the edge to the so called technological boundaries, must not operate beyond it’s ability to rectify any potential problem. It also can not operate in such an environment, whereby it can not meet the financial cost of failing either to complete the contract or rectifying a major problem. A company must have the financial resources available, in order to be able to meet the cost of rectifying problems. Many people considered B.P.’s problem with its’ Macondo well, was the depth of the water in which it was drilling. Realistically, the only problem which the company faced was the potential cost of rectifying a problem with the well. In B.P.’s case, this was the cost of the clean up costs, which became so enormous, that it was in danger of ‘bringing down’ the company.

Insurance considerations.

B.P. chose some years ago to self insure almost all of its risk. Even should the company have decided upon purchasing high levels of insurance cover to protect itself when the so called once in fifty year loss occurred, the cost would have been uneconomic. This must not act to detract from the fact that higher levels of insurance purchases for many companies, is almost a good housekeeping procedure. The cost of purchasing reasonable levels of higher limit insurance may in many cases not be prohibitively expensive. Though company directors may question the financial benefit of such insurance purchases, the value would only ever be realised, when a major catastrophe struck. Though the style of loss may well only be a one in fifty year scenario, they are sufficient to bring a company to its’ proverbial knees with the result that its’ future viability is threatened.

Disaster Recovery Planning.

Whilst some companies have regular disaster drills, imitating circumstances whereby a major catastrophe has hit the company, this practice is not common place. Those companies with disaster recovery plans have well laid procedures to put into place, as and when a disaster strikes. These plans often go into great detail and provide clear roles for individuals within the company’s structure. Such planning does not need to be costly and though it might incur management time. This must be a ‘cost’ well worth incurring. Those companies without disaster recovery plans, live with the ever present fear that when a catastrophe does strike, not only are they not prepared for such an eventuality, though the company effectively disintegrates at its’ onset.

Management Supervision.

The U.S.A. official report into the incident noted that though there was an operational inspection process, the appointed survey company had failed to inspect the rig and therefore confirm its ability to operate safely. This was compounded by the fact that there was a dual supervision process involving both B.P. and Transocean. As a result, neither company co-ordinated their management sufficiently, in order to ensure that the warning signs of an impending disaster were heeded. It is clear that for such a disaster to be avoided, there needs to be more central control and decision making.

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Conclusion.

There are many lessons for all companies to learnt from the Macondo well loss. Whilst some companies are aware of the operational risks which they face, many others are not! Companies all too often do not have structures in place to handle the impact of a serious loss. Whist the corporate body often provides specific company directors with responsibility for key areas of the company’s operations, risk is frequently swept under the proverbial carpet in the hope that it does not raise its ugly head. Risk is endemic throughout company structures though rarely spotted until the company suffers a loss. Even then, when losses are of low value, people take little note of them. Only when a company suffers a catastrophe, do people stand up and take notice. Companies must be aware of the potential risk which the major loss scenario represents and assemble suitable plans / a team of individuals, which can deal with such a situation. They must also check on a regular basis that the levels of insurance purchase meet the company’s requirements and are adequate when considering the sector in which the company operates. Having rehearsals for such eventualities can only act in a company’s best interests. The alternative is either a catastrophic loss of reputation from which the company will not survive, or such huge financial losses, that it forces the company either to find a purchaser for its assets or conversely declares itself bankrupt.

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