ERM as an Effective Form of Risk Management and Value Creation in the Oil and Gas Industry - Dissertation Example

?ERM AS AN EFFECTIVE FORM OF RISK MANAGEMENT AND VALUE CREATION IN THE OIL AND GAS INDUSTRY 4.0 Data and Findings The entire aim of the study has been to critically assess the risk management policies that are in place at BP Oil and how these risk management principles have been used over the years in overcoming, managing and preventing major risk events that have hit the company. Specific emphasis has been given to how BP Oil conducted its risk management policies during the Gulf of Mexico oil spill. This section of the research work presents a comparative case study between BP Oil and Tullow Oil Ghana, in understanding how Tullow Oil Ghana can learn from the risk management policies that have been used by BP Oil so far. In effect, the major strengths and weaknesses that have been associated with BP Oil’s risk management policies shall be outlined and compared to risk management practices at Tullow Oil Ghana. This comparison will be done so that in later chapters, particularly the discussion chapter, the researcher will draw inferences on how Tullow Oil Ghana can learn from the strengths and weaknesses of risk management policies from BP Oil perspective. In relation to the general aim of the study, particular attention shall be paid to how BP Oil have both benefited and failed to benefit from the use of Enterprise Risk Management practices at different times of risk situations that the company faced. In order to follow the qualitative philosophies of the research, the researcher is going to dwell on the analysis of secondary data instead of the use of primary data. This will be done because of the impact that secondary data has on qualitative data, making it more subjective, but backed by empirical evidence from related literature (PSA, 2007). 4.1 Analysis of Secondary Data on Risk Management Practices at BP 4.11 Risk Management Options at BP As far as risk management practices are concerned, there are a number of options that can be found throughout of existing data for oil and gas companies, of which BP Oil is one. Generally, BP Oil has been identified to have used three major risk management practices at different times of its operations. These options have been avoidance, knowledge and research, and controlling. Avoidance has been used in very high risk situations to ensure that there exist alternative approaches that do not bear any risks at all (Vinnem et al, 2007). The effectiveness of avoidance has however been found to be vested in a risk management environment where risk managers can be proactive enough to identify alternative options (Bly, 2011). Knowledge and research has been pointed out in some existing research data as not being an independent risk management option but an effective tool for equipping the functionality of other risk management options. At BP Oil therefore, knowledge and research is not used in dealing with initial risks but is used as mop up risk management option to consolidate the efficacy of other options on practice. Commonly, research and knowledge is used in relation to the final risk management option at BP, which is controlling. Controlling has been found to be the commonest risk management option at BP for day to day risk situations (PSA, 2007). It has been found to involve the creations of a risk reduction plan made up of parallel development programmes (Vinnem et al, 2007). From the graph above, it can be observed that BP Oil chooses different risk management options depending on the level of risk that the company is presented with at any point in time. Where there is high risk, the company employs the use of avoidance; where there is medium risk, the company employs the use of controlling; and where there is low risk, the company employs the use of knowledge and research (K & R). 4.12 Risk management failures in the Gulf of Mexico Oil Spill In several sectors of risk management application, BP Oil was sharply criticised in the academic and professional cycles for some levels of inefficiencies that accompanied the handling of the Gulf of Mexico Oil Spill. As far as the critiques were concerned, the companied failed in its risk management practices in handling the Gulf of Mexico Oil Spill (Bly, 2011). Three of the major factors leading up to the risk management failures in the Gulf of Mexico Spill have been elaborated as follows. In the first place, a failure to observe crucial indicators of risk has been cited in numerous secondary sources. Chowdhry and Goyal (2000) has stated for example that as part of the company’s risk management program, the company failed to give detailed attention to details in terms of risk indicators. The second factor that has been pointed in secondary sources has to do with insufficient well control response in its deep water operations. As far as this point is concerned, Al-Tamimi and Al-Mazrooei (2007) has been a very loud critic, condemning the company for not placing risk priorities where risk priorities should be. This is because even though the Gulf of Mexico and other related drilling sites form a very large economic base for BP, the company does not have any dedicated well control response that can give prioritised control and response to risks that are detected at their early stages. The third factor touches on inadequate emergency response training for its team of risk staff (Humphrey, 2001). It has been explained that if such emergency bridge response was in place and well trained, they would have had a risk avoidance approach at the very moment the disaster broke out (Hissam and Daniel, 2009). 4.13 Impact of Risk Management failures on BP In the event of failures in the successful implementation of risk management principles such as the one that was experienced by BP in the Gulf of Mexico Oil Spill disaster, secondary literature suggests that there are several ways that a company becomes impacted negatively. In the case of BP, the following are how most works of literature quantified the impact that was suffered by BP. A very interesting trend that the graph above shows is that the impact that BP suffered as a result of its failure in the implementation of effective risk management were numerous and affected several aspects of their business orientation. This is because there were impacts on the corporate entity of BP, as much as there were impacts on the economic entity of the company. Another trend is that even though different ratings and rankings were apportioned for the different impacts, each of them had a significant value implying that risking with risk management practices could have very detrimental effects on the company’s fortunes and so it is always important to have robust risk management principles that give out the best of results. On the whole, 35% of secondary data reviewed pointed out that the worse consequence that BP suffered was a universal dent on their corporate image. 30% of literature pointed to reduced competitive advantage for the company, whiles 20% said there was a fall in share price within the period of the disaster. 15% said the worse effect suffered by the company was a lost in its market capitalisation within the period of the disaster (Boynton and Zmud, 2004). From the graph below, key financial components of the company that were sourced from its 2009 and 2010 annual reports are exhibited. Generally, it would be observed that most of these key financial indicators recorded reduced values in 2010 as against 2009 because of the impact that the oil spill hard on the reputation of BP Oil. Source: BP Annual Accounts 2010 The table in the graph is tabulated as follows: Indicator 2010 2009 Operation income 7,423,582 5,622,751 Profit for the year 1,425,537 1,634,376 Allocated dividend 750,000 1,200,000 Stocks 230,163 249,428 Total current asset 1,576,599 1,297,990 Intercompany debt 11,861,359 7,900,000 4.14 Improving risk management at BP through Enterprise Risks Management It has been said that the core mandate of improving risk management at BP Oil and for that matter a key strategy to have made the management of the Gulf of Mexico Oil Spill better was for the company to have employed a more proactive approach towards risk management. This is where the idea of enterprise risk management (ERM) becomes advocated by several reviewers in their works of secondary research. Generally, three factors have been cited as conditions that make the use of enterprise risk management an ideal risk management framework for BP Oil. The first of these is the fact that enterprise risk management uses a risk-based approach that gives premium to internal control (Carey, 2001). By internal control, reference is being made to an approach to risk management where the company gives premium to strategic factors that brings risk identification closer to them on an organisational structural level. The second fact is that enterprise risk management employs the use of strategic planning in the risk management agenda. In effect, companies are given the opportunity of fusing risk management to their larger organisational planning principles (Al-Tamimi and Al-Mazrooei, 2007)). Last but not least, as part of its risk-based approach to dealing with risk, enterprise risk management incorporate key provisions within the Sarbanes-Oxley Act in its application. Secondary data available suggests that inculcating the section 404 of the Sarbanes-Oxley Act of 2002 makes risk management effective because of its endorsement for control framework for undertaking internal control assessments (Chen and So, 2002). In sum, enterprise risk management is a multi-variant approach to risk management that allows for creative manipulation of the risk management system to suit prevailing situations. 4.2 Secondary Data and Findings on Risk Management Practices of Tullow Oil Ghana In order to achieve the comparative case analysis between BP Oil and Tullow Oil Ghana, the researcher extended the data and analysis to each Tullow Oil Ghana also. But as the experimental company, the company used only thematic aspects of the data and analysis that took place for BP for Tullow Oil. The presentation of data and analysis are thus given as follows. 4.21 Presence of Risk Culture at Tullow Oil Ghana Various works of literature were searched about the presence of a risk culture at Tullow Oil Ghana. Specifically, the Tullow Oil Ghana website and other official secondary documents of the company were used. Through secondary data collection, it was realised that there is a risk culture in place at Tullow Oil Ghana. Most of the independent practices and events that come together to form the risk culture of the company were however found to be based on local Ghanaian and for that matter African business principles (Mayer, Davis and Schoorman, 1995). From the Ghanaian perspective, most of the key risk culture principles of companies are incorporated into the collective corporate culture of the company. From the figure below, it will be realised that in order to achieve a risk culture, Ghanaian companies including Tullow Oil Ghana go through five major stages to bring about an enhanced corporate culture. Each of these stages is structured in such a way that it relates or links preceding and proceeding stages to create a corporate culture mesh. Risk Culture Diagram for Tullow Oil Ghana (Clark, 2011) It must be stressed that in its adaptation of risk management practices, Tullow Oil Ghana goes through such similar cycle to bring about the mitigation of most risks that it is faced with (Ifinedo, 2008). Clearly, there is the absence of the enterprise risk management (ERM) at Tullow Oil Ghana, even though the parent company may be using enterprise risk management practices. 4.22 Regulatory pressure to instil risk management in Tullow Oil Ghana This line of data sought to visualise Tullow Oil Ghana from a larger Ghanaian business environmental perspective where the influence of the Ghanaian business code was tested in relation to risk management at Tullow Oil. In most cases, companies undertake various forms of risk management practices as part of their individual business functional principles. However, if the working business environment in which they operate also have regulations and statutes that enforce the presence of such risk management principles, it makes it easier mandatory for the companies to add some high levels of commitment to risk management (Cronbach, 1951)). It is for this reason that risk management regulations from the larger Ghanaian perspective are being analysed. Through available secondary data, it has been found that Ghana has a national petroleum regulation that comes under the Ghana petroleum authority regulatory bill (Ghana Laws, 2011). The bill is controlled by the Ghana Petroleum Authority which is responsible for the evaluation and monitoring of oil companies operating in the country (Cohen, Manion, Morrison, 2007). As part of its mandate and backed by the National Petroleum Bill, the National Petroleum Authority ensures that all oil drilling companies in the country have a risk management policy that is revised from time to time to correspond to present needs of the country in terms of exploration and production safety (DeLoach, 2004). It has actually been stressed that this petroleum authority regulatory bill serves as a regulatory pressure that instils risk management in Tullow Oil Ghana (Breiman et al, 2009). 4.23 Benefits of ERM to Tullow Oil Ghana This aspect of the data and analysis section of the research seeks to clearly outline the main benefits that Tullow Oil Ghana will derive from using enterprise risk management (ERM). The findings here were made from the review of secondary data on enterprise risk management and in relation to what other companies have experienced before. The chart below outlines some of the major benefits that were sampled from secondary sources as part of what Tullow Oil Ghana stands to benefit from if the company follow the use of enterprises risk management. 4.24 Limitations that Tullow could face with ERM The researcher was very proactive with the collection of secondary data on some of the limitations that come with the use and implementation of enterprise risk management. The essence of this line of data collection was that the researcher observed how challenging it could be for Tullow Oil Ghana if the company was not informed about some of these limitations. Clearly, having the requisite knowledge on the limitations of enterprise risk management will draw the attention of the company on major issue to look out for while implementing the program. From the secondary data collective, five major limitations were outlined by various researchers. The first of these had to do with the fact that it is not all instances that enterprise risk management becomes applicable to all organizations and for all forms of risk (DeLoach, 2004). When applied in the wrong instance therefore, expected results will not be produced. The second limitation was that enterprise risk management is too much rooted in compliance, requiring that various aspects of regular organizational systems and structures be sacrificed for its implementation. To this effect, there is the tendency that companies may over rely on enterprise risk management to the downgrading of other sectors of their business operations. What is more, the limitation of implementation drawbacks was outlined by various researches, as well as the limitation that enterprise risk management affects external accountability. 5.0 Discussion This section of the research work seeks to test the empirical nature of the data collected and analysed in the previous chapter. This is done by comparing the key data that were collected in the previous chapter with the literature review that was performed earlier. The need for such discussion chapter that ensures that the data collection and data analysis are empirical is that the use of qualitative research methods makes data analysis very subjective, based on the discretional judgment of the researcher (Erden, 2003). Therefore if the findings and analysis are not compared with literature, the reliability of the entire research may be affected in the long run. It must be stressed that the reliability of the research will be achieved if the findings of the research can be replicated when the research work is repeated in a different setting with almost all variables of the current research remaining intact (Fill and Mullins, 2010). Using the subjective views of the researcher alone in the analysis would however defeat this course. The discussion will also be conducted in a manner that ensures that the research objectives are achieved by answering the research questions that were posed in the first chapter of the study. In effect, the thematic areas that will be discussed under this chapter will be structured in a way that conforms to the research questions that were asked in the first chapter of the study. By the close of the chapter, the success of the discussion shall be tested by the ascertaining how meaningful it has contributed to the overall literature. 5.1 Application of Risk Management Options Under the data and findings, it was found that BP Oil utilises three major risk management options. These risk management options are controlling, avoidance, and knowledge and research. Depending on the prevailing level of risk, the company applied one form of the risk management options or the other. Generally though, avoidance was found to be used in cases where there was high risk, controlling for medium risk, and knowledge and research for low risk situations. Under the literature review, a number of revelations were made on risk management options and how each of these can be used by various oil and gas companies. It was outlined that available risk management options continue to change in conformity to the forces of the evolution of enterprise risk management (Erden, 2003). That is, there are two major forces that control risk management options namely internal and external forces. Because under each of the forces, a different situation and need for risk management dynamism may results, the options available for risk management also keep on changing. With reference to the findings on how BP applies each of the three risk management options and the two forces of risk management identified as internal and external forces, it can be deduced that the company does not have any robust application to the two forces. Rather, the company measures all risks only from an internal force perspective without paying attention to the external forces and thus external effects. It is not surprising therefore that, most unpredictable disasters such as the one that occurred with the Gulf of Mexico Oil Spill could not be easily identified with the risk management options available to the company. 5.2 Causes of Risk management Failures In the data and findings section, BP Oil was identified to have made three major risk management mistakes, leading up to the Gulf of Mexico Oil Spill. These were failure to observe crucial indicators of risk, insufficient well control, and inadequate emergency response training. Interestingly, the literature review touches on all these causes of the risk management failures in one way or the other and make further scrutiny as to how BP Oil did not stand a chance on succeeding on its risk management practices with those causes still lingering around. In the first place, it was identified in literature that one of the key agenda that any risk management option should carry is the need to identify risks even before the risks show up (McAllister, 1995). Meanwhile, in the absence of an indicator pointing to the direction where the risk could be coming from, it is virtually impossible to detect the risk (Ifinedo, 2008). It is for this reason that when BP Oil failed to observe crucial indicators of risk, it company failed in its over risk management of the oil spill. The second issue raised under the literature review that points to the failure of risk management at BP has to do with access to control in risk management. It has been stressed by Hunter (2002) that the only reason that risk management is implemented is to gain control over all aspects of business operation. This is because once the business operation takes the better side of control; it results in a situation where things get out of control including the outburst of possible risks. BP was therefore mandated not to leave any issues of well control unaccounted for. Finally, the literature review outlined the importance of staff and employee training in the management of risk. BP would have therefore being put in a very good position of managing its risk if emergency response training had gone for its response team on a regular and periodic basis. 5.3 Impact of Risk Management Failures Under the data and findings, the researcher identified through secondary data collection, four major areas of the business and organisational operations of BP Oil that the company suffered most in terms of effects of the Gulf of Mexico Oil Spill. These four were tinted corporate image or reputation, loss of market capitalisation, reduced competitive advantage, and fall in share price. In relation to the literature review however, not all the facts made in the findings could be agreed with to the letter, though there are a number of the findings that is supported by the literature. For instance, the fact that the effects are not only on the market outcome of the company but also involves some aspects of organisation image and reputation was highly supported by the literature review (Paresh and Octo, 2005). Generally, the literature review also supported the fact that the market capitalisation, competitive advantage and share price of the company could all be affected. However, the rankings or scorings that came out of the findings were not supported in an exact manner. For instance whiles defining corporate reputation and finding the link between enterprise risk management and corporate reputation, it was stressed that corporate reputation has a direct linkage with the creation of competitive advantage for companies. In effect, if the highest ranking impact that BP suffered was a tinted corporate reputation, then it was expected that there was not going to be a separate parameter for measuring the impact of reduced competitive advantage as it is embedded in the reduced corporate reputation. The findings however saw a separate rating for these two parameters of impact of risk management failures. 5.4 Improving risk management with Enterprise Risks Management As part of the data collection and findings, it was established that using enterprise risk management holds a lot of prospects for BP Oil in achieving success with its risk management of the Gulf of Mexico spill and other risk related events. Rightly placed by the literature review, enterprise risk management continues to be a new paradigm that has set a yardstick for the improvement of risk-based corporate operations (Anderson and Terp, 2006). What is advantageous is that with time, enterprise risk management continues to be based with periodic academic and professional reviews that make it more and more effective in the handling of modern data risk issues that face companies and businesses. It will rightly be advocated therefore that BP has a lot to offer other companies such as Tullow Oil Ghana when it comes to the application of enterprise risk management. Subject to the causes of failure with the Gulf of Mexico Oil Spill, there is much evidence that if BP had not forfeited the use of enterprise risk management, things would have been done in a more proactive manner. The lesson for Tullow Oil Ghana to learn therefore is for the company not to repeat the mistake of BP by foregoing the use of enterprise risk management. Comparatively, Tullow Oil Ghana would be said to be a new company operating in a less competitive oil and gas market (Brymman and Bell, 2007). For the company to grow and develop into global standards therefore, it must have a strategic plan that waved around the need to creating competitive global advantage for itself. Meanwhile, the secret to gaining such competitive advantage has just been found to be through the improvement of risk management, which in turn gets improved with undertaken using enterprise risk management. 5.5 Impact of Risk Culture on ERM Even though enterprise risk management has been identified to be a very important tool for improving risk management and general risk-based business operations, the findings revealed that there are very important composite factors that must be used in relation to enterprise risk management for it to be very effective. According to the findings, having a strong risk culture can help in improving enterprise risk management. In relation to the literature review, it can be established that the reason that this is so is risk culture sets out a very fertile premise within such enterprise risk management functions. In the analysis of Tullow Oil Ghana, it was found out that the company lacks a well defined risk culture because the company operates a risk culture system that is tied to the collective corporate culture practice by the company. Clearly, this is not a situation that makes the assessment and monitoring of risk culture within the organisation very effective. For the monitoring and evaluation of the impact of a company’s risk culture to be very proactive, Anderson and Terp (2006) has suggested that companies must operate a risk cultural system that is independent from the corporate culture. As Tullow Oil Ghana is being admonished to take up the use of enterprise risk management to improve the fortunes of risk management therefore, it is being directly suggested that much of the rate of success that the company can enjoy depends on the risk culture that it uses. The time should therefore be now that Tullow Oil Ghana followed the path of some major corporate institutions that have used independent risk culture principles from corporate culture principles and experienced the benefits of this system on their enterprise risk management. 5.6 Effect of State Regulatory Policy on Enterprise Risk Management As part of the realisations that the implementation and use of enterprise risk management would need certain key reinforcing mechanisms to make them effective, the data and findings revealed that having a regulatory policy is one of the most important mechanisms to achievement effectiveness. Interestingly, there is enough evidence within the literature review to support the role that state regulatory policies play in enterprise risk management. In the first place, under the limitations of enterprise risk management, Power (2009) stressed that a refusal to embed risk management with internal control systems within business processes makes the operation of enterprise risk management a very difficult concept. What this means is that the grounded philosophies of business operations help by any company must be made to take a centre stage when implementing enterprise risk management. Meanwhile, the internal control systems that most companies operate on are those that are directed rooted into the larger external parameters of their businesses. That is, most of these companies set internal control systems based on the dictates of external influences to business processes including key business operations regulations. For Tullow Oil Ghana therefore, the clearest indication that this situation gives is that the company must embrace the state regulatory policies in Ghana, controlled by the Ghana Petroleum Authority as a necessary evil that is needed for the company to make progress with its enterprise risk management implementation agenda. Often times, companies see such state regulatory policies as antagonistic principles to suppress the inherent functioning of companies (Paresh and Octo, 2005). Instead of thinking like this, the company must embrace the policy as a means for strengthening its internal control systems and thus its enterprise risk management. 5.7 Benefits of Enterprise Risk Management Under the data and findings, five major benefits of enterprise risk management were pointed out as improved risk data, enhance focus towards risk data, regulation and compliance to audit matters, prompt communication of risks and cost-effective risk monitoring. In a much related fashion, the literature review pointed to three major benefits of enterprise risk management, which are assistance to companies in making better-informed decisions, creation of greater management consensus through improved risk reporting, and improvement in business performance. Clearly, even though these two groups of benefits do not have the same wording, they all point to the same direction. For instance the creation of greater management consensus through improved risk reporting cannot take place in a business environment that lacks a well improved risk data that is enhanced towards a common focus (Angus, 2011). Even more, there cannot be improved business performance if regulation and compliance to audit matters are not followed (Angus, 2011). In the nutshell, several benefits awaits Tullow Oil Ghana if the company learns from the mistakes of BP Oil and decides to implement and effectively use enterprise risk management as an effective form of risk management for value creation in the new oil and gas industry in which it finds itself in Ghana. 5.8 Overcoming the Limitations with ERM In consonance with the data collection performed on the limitations of enterprise risk management, it can be said that Tullow Oil Ghana has a number of principles to follow and use in order to ensure that the implementation becomes a success. One of the very first things to do is that in order to ensure that limitations with implementation drawbacks are overcome, the company must invest so much into training and development for personnel. This is because much of the implementation processes will take place using the expertise of these personnel and so they must be well vest in how to effectively apply them to avoid any problems. Another area of principle has to be the institutionalization of enterprise risk management into the company as a separate entity rather than fusing it with existing entities and departments. This is in line with the limitation that enterprise risk management takes so much strain on the company, resulting in a possible neglect for other sectors of business operations. Because of the demand on the use and implementation of enterprise risk management, fusing it up with other components of business operations might result in a situation where the focus on the integrated operations will be taken away. Finally, the company must embark on comprehensive research and development to ensure that factors that could possibly bring about external accountability problems are eradicated. REFERENCE LIST Al-Tamimi, H.and Al-Mazrooei, F.M. (2007) “Banks’ risk management: a comparison study of UAE national and foreign banks”. The Journal of Risk Finance, Vol. 8(4) pp. 394-409 Anderson, K. and Terp, A. 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