Environmental Risk Management at Chevron

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Environmental Risk Management at Chevron Powered By Docstoc
					Environmental Risk Management
         at Chevron

              Professor Doug Cerf
  Donald Bren Graduate School of Environmental
            Science and Management
   Environmental Risk Management (ESM 286)
                  Winter 2008
          Management Decision
• Simulate the environment where a recommendation is
  made to management regarding the implementation of
  DEMA
   – Quantitative environmental risk analysis decision making model
     (DEMA)
   – Should Chevron move to a more systematic system to manage
     environmental risk?
       • From a decision framework to assess risk through a qualitative and
         judgmental evaluation to quantitative system
           – A superior system is where a quantitative analysis informs experienced
             judgment
   – DEMA is used on a test basis in the refinery in Richmond,
     California, and Chevron Overseas Petroleum Inc. (COPI), should it
     be implemented company wide?

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                   The Process
• Teams physically organize in their groups.
• A team (volunteer) states their case
• Other teams should:
   – Support other teams specific statements with
     explanations
   – Debate other teams specific statements with
     explanations
   – Add related considerations to specific topic being
     discussed
• A second/third team should state their case

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Discuss the following to conclude
          the discussion
                Case questions
•   What risks is Chevron management worried about?
•   If you are the CEO at Chevron, are you more worried
    that line managers in the field will spend too much
    money on environmental risk management, or are you
    worried that they won’t spend enough?
•   Is Chevron using the right tools for managing
    environmental business risk? Why do the tools differ
    from those used to manage other types of business risk?
•   Should Chevron make company wide use of quantitative
    risk management tools like DEMA?

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 What risks is Chevron management
           worried about?
• Risk of damage to the natural environment, human health,
  and corporate profitability or all of the above
• Environmental externalities and impact on public goods at
  every stage of their value chain
   – Public good, non rival (one’s consumption does not impact others)
     and non excludable (consumption can not be restricted)
       • A cake is not a public good
   – Their value chain --from raw material extraction to the pump
   – Contingent environmental costs (cleanup costs, example
     superfund, RCRA) from past operations
   – Cleanup in the future related to current operations


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 What risks is Chevron management
           worried about?
• Cost of business interruption
• Loss of goodwill and reputation
   – How sensitive is Chevron to goodwill and reputation?
• Is Chevron concerned about protecting firm value
  or are they concerned about the environment?
   – Are these the same things?
   – How does a firm executive think of environmental risk
     compared to an executive of an environmental NGO?

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                 Specific risks
• Transportation of crude oil and refined products
• Leaking underground tanks at service stations
  contaminate ground water
• Emissions from the tail pipe
   – Smog
   – Particulate matter
   – Greenhouse gasses
• Other businesses
   – Coal mining
   – Chemical manufacture
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   Factors that impact environmental
              business risk
• The probabilities of different adverse events
    – Example: marine oil spill
    – mitigate by investing in double-hulled tankers to reduce the probability of
      a spill
• The total social burden if an event occurs
    – Invest in rapid response cleanup teams to reduce the social burden
• The fraction of those burdens for which the firm is responsible
    – Buy insurance against a spill reducing the fraction of the burden for which
      the firm is responsible in exchange for a premium
• The quality of the information that is available to the firm for each of
  the above items
    – Conduct research on the causes and consequences of spills



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 Tools to manage environmental risk

• Tool 1: Internal command and control regulation
    – Policy 530
• Tool 2: Employee education and training programs to reduce the
  probability and severity of environmental damage
• Tool 3: Corporate wide emergency response programs reduce expected
  losses
• Tool 4: Insure against environmental liability risk with external
  contracts
• Tool 5: Management evaluation and promotion as tool for creating
  incentives
    – Environmental performance does not play a large role in determining
      managers’ bonuses
• Tool 6: Implicit threat of “consequences”


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 If you are the CEO at Chevron, are you more worried that line
    managers in the field will spend too much, or not enough
           money on environmental risk management?
• Tools 1 and 2 lead to increased investment in
  environmental risk management
• Tools 3 and 4 lead to decreased investment in
  environmental risk management because they are partially
  protected from the consequences of an accident
   – Mitigated by the size of the deductible
• Tool 5 may increase investment in environmental risk
  management unless they belie short term profits are a more
  important determinant of bonuses.
• Tool 6 will increase managers investment in risk reduction

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  Should Chevron be more systematic and
 analytical in managing environmental risk?



• Understand true costs of environmental incidents
• Effect of different investments on the probability
  and magnitude of those incidents
• Will this effort make environmental risk
  management more efficient?
• Is this possible given the incomplete information
  available to make these decisions?

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              Possible answers
• Answer #1: Yes because the system will clarify
  the true costs and benefits of different risk
  reduction proposals and enable the company to
  reduce more risk for a smaller outlay.
   – Experience with DEMA at the Richmond refinery and
     internal operations
   – DEMA saved “several millions” at the Richmond
     refinery.
   – Richmond is 5% of Chevron’s total income
   – An attempt at an estimate: Several million is $3 million
     times 20 equals a company wide savings of $60 million

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               Possible answers

• Answer #2: Yes because it forces long-term
  consequences of current behavior
   – Without some analytical system like DEMA long term
     consequences of current practices could be ignored.
      • This would transfer risks to future shareholders
      • In an efficient market with full understanding of risks long
        term consequences should impact current stock price
   – The increased managerial attention from a system
     brings about greater creativity with respect to risk
     management and greater efficiency

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              Possible answers
• Answer #3: No, because although the improved
  analytical capability is valuable, it is outweighed
  by the additional risk of bad publicity that a firm
  creates by generating and using explicit valuations
  of different risk endpoints.
   – Environmental groups, communities where the
     company does business and government regulators will
     not react favorably to company tradeoffs between
     environmental quality or community safety against
     dollar opportunity costs of different risk reduction
     proposals.

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            Possible answers

• Answer #4: No, because the improved
  analytical capability is not very valuable.
  – The conversion factors are bound to be so
    arbitrary that they will not provide any useful
    information.
  – Arbitrary conversion factors will undermine
    line managers and external stakeholders
    confidence in the company’s environmental
    management system as a whole.
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               Possible answers
• Answer #5: No, because DEMA is intended to
  maximize net benefits and this may not be the
  appropriate goal for corporate risk management.
   – DEMA compares projects expected values
   – Does not include intangibles, biases and high level
     experience
   – Example two projects that cost $500,000 with expected
     values of $1 million
      • Project A reduces from 50% to 40% the probability of an event
        that will cost $10 million if it occurs
      • Project B reduces from .01% to 0 the probability of an event
        that will cost $10 Billion if it occurs

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Where on the value chain does Chevron’s
  environmental risk start and stop?

– Environmental risk for the value chain --from
  raw material extraction to the pump
– Does chevron need to manage environmental
  risk past the pump?




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 Connection between environmental
     risk and economic risk?
• Is Chevron’s goal to manage environmental risk or
  are they really managing both short and long term
  economic risk?
• Is management of any type of business risk
  (interest rate risk, foreign exchange risk etc.) a
  subset of management of economic risk?
• Insurance is the hedge for managing
  environmental risk
   – More difficult to manage than financial risk (e.g.
     currency risk) where instruments exist to hedge risk

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