How BP flunked its risk tests

By James Ledbetter
Sunday, June 13, 2010

The continued gushing of oil into the Gulf of Mexico raises widespread questions about how badly prepared BP was from an environmental perspective. But what about from a corporate perspective? Multinational giants like BP spend large amounts of money to map out scenarios and, presumably, prepare for them. Why didn't BP's risk models account for a crisis of this proportion, and doesn't that represent a colossal management failure?

We asked Ian Bremmer to explain. He heads the Eurasia Group, a firm that specializes in measuring risk (BP is not a Eurasia Group client), and wrote "The End of the Free Market: Who Wins the War Between States and Corporations?"

TBM: How does a huge, experienced multinational company find itself in a situation like this?

Bremmer: First of all, we've found in a number of cases, whether it's BP or financial firms, you get the best and the brightest, the smartest and the most highly compensated people in these positions in the private sector. The folks left to do the regulation and the oversight are poorly paid, not as up-to-speed, and the most talented can't be kept there. And they often get run circles around, despite the fact that they are the guys who are supposed to understand externalities and look after the public weal. I think we found, in terms of the [collateralized-debt obligation] crisis, as well as with BP's utter lack of preparedness . . . two manifestations of exactly the same thing.

The second thing I would say is that . . . unregulated private sector actors have a problem. They are thinking about maximizing profits short-term, at the risk of maximizing profits long-term. Especially in the context of an economic downturn, there's a massive amount of pressure to make your numbers this quarter. Not just for BP, but for every subcontractor that was in that chain. In that environment, you are as weak as your weakest, most financially pressured, most short-term-in-orientation link.

TBM: This is precisely the parallel that I see to the financial market meltdown. We've had meltdowns before, and we've had oil spills before, yet they don't seem to take that into account. How is it that a company like BP doesn't build this worst-case scenario into its risk assessment? Or is it the case that it is in their risk assessment and this is how it plays out?

Bremmer: No, I think it isn't. If you look at the responses from [BP chief executive Tony] Hayward and the BP brass in the days and weeks afterward, they clearly thought that this was much more benign. They're talking about how big the ocean is, how limited the damage is going to be. That implies that their worst-case scenarios absolutely did not take into consideration how dangerous a long-term spill from the bottom of the ocean could be.

TBM: The New York Times reported that BP had presented to regulators a worst-case scenario of spilling 250,000 barrels a day. They weren't required by regulators to have a plan for that, and they clearly didn't.

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