Analysis Of Bps Operational Risk Management Management Essay

British Petroleum PLC (BP), one of the world’s largest oil and gas companies, is headquartered in London, United Kingdom. It provides its customers with fuel for transportation, energy for heat and light, retail services for gasoline and petrochemical products for everyday items (About BP, 2011). The Company’s operations primarily include the exploration and production of gas and crude oil, as well as the marketing and trading of natural gas, power, and natural gas liquids. At present, BP employs over 80,000 people and operates in more than 100 countries. It produces approximately 3.8 million barrels of oil per day and has 22,400 service stations worldwide (BP, PLc Swot Analysis, 2010).

In 2010, the Company incurred incredible losses from the Deepwater Horizon Oil Spill Incident in the Gulf of Mexico due to lack of oversight and control of operational risks (McDonald, BP Oil Disaster Breaks Records, Puts Spotlight On Risk Management Failure, 2010). The Incident has caused disastrous biological environment, 13 people’s deaths and 17 others’ injuries (McDonald, BP Oil Disaster Breaks Records, Puts Spotlight On Risk Management Failure, 2010). Immediately after the Incident, the Company’s risk management practices were investigated. The scrutiny ultimately led to the dismissal of its CEO, Tony Hayward (McDonald, BP Oil Disaster Breaks Records, Puts Spotlight On Risk Management Failure, 2010).

In this report, we will explore how BP unsuccessfully managed its operational risks prior to the Incident, and the strategic steps that have been taken in order to mitigate the losses and prevent a similar crisis from happening again.

Reasons that Led to BP’s Exposure to the Incident

According to McDonald, the Incident was mainly attributable to the poor operational risk management of the corporate executives who placed a low priority on the safety issues (McDonald, BP Oil Disaster Breaks Records, Puts Spotlight On Risk Management Failure, 2010). McDonald also mentioned that Hayward appeared to know nothing about the front-line operations in the Company (McDonald, BP Oil Disaster Breaks Records, Puts Spotlight On Risk Management Failure, 2010).

Furthermore, BP’s history of oil spill incidents demonstrated its poor operational risk management in the past years. These previous tragic incidents included the U.S. refinery explosion in 2005 and the Prudhoe Bay oil spills in 2006 and 2007 (Fineberg, 2007). Since the Company continued to ignore the safety issues and risk management even after these incidents, a more serious Incident in the Gulf of Mexico has occurred.

Finally, BP failed to inspect the oil rig on a monthly basis as prescribed in the government regulation (Strickler, 2010). A government inspection report revealed that BP’s Deepwater Horizon oil rig had missed 16 inspections in total since January 2005(Strickler, 2010).

Financial Losses and Reputational Damage following the Incident

Following the Incident, BP was required to reduce planned capital expenditures and increase asset disposals in order to provide additional liquidity (BP p.l.c, 2010). Moreover, a total pre-tax charge of $40.9 billion was recognized during 2010 (BP p.l.c, 2010). However, BP is still uncertain about the total amount that will ultimately be paid. The Company is currently being charged in a number of lawsuits that could lead to substantial costs (BP p.l.c, 2010). These costs may include the amount of pending and future claims, the potential expenses of implementing remedies sought in the various proceedings, and the amount of fines ultimately levied on BP (BP p.l.c, 2010).

As seen in Appendix A, Moody’s Investors Services and Standard & Poor’s have downgraded BP’s credit ratings immediately after the Incident. Although there have been slight improvements ever since, the current credit ratings are still lower than they were immediately before the Incident. The lower credit ratings prompted a large number of investors, who were holding BP’s US Industrial Revenue/Municipal bonds, to exercise their option to tender the bonds for repayment (BP p.l.c, 2010). This caused BP a total repayment of $2.5 billion (BP p.l.c, 2010). The lower credit ratings could also limit the Company’s access to new financing.

In addition, the Incident has led to a significant drop in BP’s share price. On June 25 of 2010, the share price went down to the lowest point of $27. 02, as compared to $60.48 on April 23 of 2010, the day of the Incident (BP plc (ADR) (Public, NYSE:BP) ).

Along with the financial losses, the Incident has damaged BP’s reputation, which may have a long-term impact on the Company’s ability to build business relationships with new counterparties and access new opportunities (BP p.l.c, 2010). Moreover, the current counterparties, concerned about the additional financial and business risks following this Incident, may require the Company to provide collateral or other forms of financial security for its obligations (BP p.l.c, 2010).

Risk and Liquidity Management

After the Incident, BP has taken preventative measures to mitigate future unexpected events related to poorly-managed operational risks (McDonald, All Road Lead to CEO, 2010). On September 29 of 2010, the new CEO, Bob Dudley, announced a plan to establish a new safety division with “sweeping powers” to oversee and monitor the Company’s operations around the world (BP Creates New Safety and Risk Division, 2010). The new division has been given the authority to intervene in all aspects of BP’s technical activities. The division’s experts will be embedded in BP’s operating units, including exploration projects and refineries. These experts have the responsibility to ensure that all operations are carried out in compliance with government regulations and auditing standards (BP, 2010). In order to further reinforce this new practice, Dudley has requested the head of the safety division to report directly to him so that all information regarding the Company’s current operational risk status can be conveyed in a timely manner (McDonald, All Road Lead to CEO, 2010).

BP has also reinforced its accountability of risk management by restructuring its exploration and production segment from a single business into three separate functions-exploration, development and production (BP, 2010). This makes it easier for BP to monitor each function separately.

To increase available liquidity, BP cancelled the ordinary share dividends in the first three quarters of 2010, secured additional bank lines totaling $12 million and announced its intention to sell up to $30 billion of assets (BP p.l.c, 2010).

Conclusion

Prior to the Incident, BP’s executives overlooked the necessity of operational risk management. This made the Company vulnerable to operational risks. Even after the two oil spills between 2005 and 2007, BP still did not take effective measures to improve its risk management practices. Fortunately, the problem has finally been recognized by Dudley, who has initiated constructive plans to enforce operational risk management across all divisions in the Company.

Appendix

Appendix A: A comparison of BP’s Credit Ratings before and after the Incident

Before

Immediate After

Current

Moody’s Investors Service

Aa1 (stable outlook)

A2 (negative watch)

A2 (stable outlook)

Standards &Poor’s

AA (stable outlook)

A (negative watch)

A (negative outlook)

Source: BP p.l.c. (2010, December 31). Annual Report and Form 20-F 2010. Retrieved March 20, 2011, from BP Global: http://www.bp.com/assets/bp_internet/globalbp/globalbp_uk_english/set_branch/STAGING/common_assets/downloads/pdf/BP_Annual_Report_and_Form_20F.pdf