Environmental Risk Management at Chevron

1
Environmental Risk Management at Chevron

• Professor Doug Cerf
• Donald Bren Graduate School of Environmental
  Science and Management
• Environmental Risk Management (ESM 286)
• Winter 2008

2
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?

3
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

4
Discuss the following to conclude the discussion
5
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 wont
  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?

6
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 (ones 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

7
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?

8
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

9
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

10
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

11
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

12
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?

13
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 Chevrons total income
• An attempt at an estimate Several million is 3
  million times 20 equals a company wide savings of
  60 million

14
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

15
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.

16
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 companys environmental management system as
  a whole.

17
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

18
Where on the value chain does Chevrons
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?

19
Connection between environmental risk and
economic risk?

• Is Chevrons 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