How Energy Companies Reduce Risk
Risk is always a double-edged sword; the greater the exposure, the greater the risk — but also the greater the opportunity for profits. Some prefer conservative operations, expecting continual, long-term profits to grow the organization. Others choose to embrace the risk, believing that their ability to avoid it better than others will lead to a short-term windfall and a quickly expanding presence in the marketplace.
Where a company falls on that sliding scale depends on its risk appetite. (Unfortunately,too many companies never clearly define exactly what their risk appetite is … but that’s a whole other story for another post.)
Energy companies often embrace risk.
In the video below, faculty from Harvard Business School discuss this fact and professor Forest L. Reinhardt sums up the general attitude that those in the sector have towards risk. “The fundamental question for energy leaders is what risks they confront and how they can most cheaply reduce the exposures that they don’t want while getting compensated for bearing exposures that they want to retain.”
Of course, in energy, an industry whose risks are often — literally — volatile, failures of risk management stand out gravely when they occur. Lives can be the collateral damage. There has been a rash of high-profile catastrophes related to the energy sector of late: Gulf oil spill, Massey mine collapse, the Chilean mine rescue and the San Bruno explosion, to name just those that made major headlines. The contentious safety and environmental debates over deepwater oil drilling (and the equipment used), hydrofracking for natural gas and extracting crude from tar sands have opened other worm cans.
Meanwhile, energy companies are among the most profitable in the world. Three of the top four companies on this year’s Fortune 500 list, for example, make their money off of energy. (Exxon is second after Walmart, followed by Chevron and ConocoPhillips.) Seven others whose operations focus on petroleum or pipelines appear in the top 100. (#24. Valero. #29. Marathon Oil. #68. Sunoco. #74. Hess. #80. Enterprise Products Partners. #99. Plains All American Pipeline.)
Does the recent wave of disasters represent unlucky streak that will inevitably happen from time to time in any industry that faces such extreme risks? Or are perhaps too many companies within the energy realm being too cavalier with their risk appetite?
I’m not qualified to answer that question. And any company is of course entitled to shower its shareholders with wealth if they can make it while obeying relevant laws and regulations. But it seems as though, even in a sector as competitive as this, companies could re-invest a larger percentage of the profits into loss prevention without significantly hurting their quarterly results.