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. Printed on recycled paper-actually better, not printed at all

3. Printed on recycled paper-actually better, not printed at all 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. Printed on recycled paper-actually better, not printed at all 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?

6. Printed on recycled paper-actually better, not printed at all 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

7. Printed on recycled paper-actually better, not printed at all 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. Printed on recycled paper-actually better, not printed at all 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. Printed on recycled paper-actually better, not printed at all 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. Printed on recycled paper-actually better, not printed at all 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. Printed on recycled paper-actually better, not printed at all 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. Printed on recycled paper-actually better, not printed at all 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. Printed on recycled paper-actually better, not printed at all 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

14. Printed on recycled paper-actually better, not printed at all 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. Printed on recycled paper-actually better, not printed at all 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. Printed on recycled paper-actually better, not printed at all 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.

17. Printed on recycled paper-actually better, not printed at all 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. Printed on recycled paper-actually better, not printed at all 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?

19. Printed on recycled paper-actually better, not printed at all 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