Abstract
Firms that operate in the oil and gas industry experience a number of risks in the supply chain of oil and gas and petrochemical as by-products. These risks are inherently inculcated into the supply chain of oil and gas and related products ranging from the exploration, production, and marketing of oil, gas and related products. Quantitative and qualitative research will be conducted into the effects of these risks has revealed a strong relationship between the concepts of risk management and other risk management strategies on product and service quality. Organizational executives use the concept of risk management (RM) techniques to design tailored RM strategies to integrate the concept into their enterprise risk management frameworks. Typically, that characterizes BP’s risk management approaches including its reputational risk management strategy. Reputational risks in the oil and gas industry are the key driving forces behind the risks that influence the relationship between the RM concept, enterprise risk management, and product and service quality. These risk components typically characterize the exploration, production, refining, and marketing of oil and gas and petrochemical products in the supply chain. A hypothetical analysis of the effects of risk management has been formulated and analyzed on a probabilistic model to reinforce the qualitative research was conducted to crystallize the effect of risk management on product and service quality, culminating in the discussion of findings with a conclusion and recommendations on the way forward.
Introduction
The oil and gas industry is susceptible to a myriad of risks that identifiably influence the operational efficiency of oil and gas firms. That is typically in relation to the product and service quality offered by the firms. Quantitative and qualitative risk management (RM) studies help to crystallize the effects of risk management (RM) on product and service quality. Risk management is a concept that equips oil and gas company executives with appropriate RM techniques to design tailored RM strategies and integrate them into their enterprise risk management frameworks. Reputational risks in the oil and gas industry are the key driving forces behind the risks that influence the relationship between the RM concept, enterprise risk management, and product and service quality. These risk components typically characterize the exploration, production, refining, and marketing of oil and gas and petrochemical products in the supply chain.
This paper critically examines the types of risks which include environmental and financial risks, the theory of risk management and its relationship with reputational risk management (RRM), the concept of reputational risk which emphasizes capital and people which are the most important assets of a company, and the fact which affirms that though people and capital can diminish, they can be recovered, but if reputation diminishes, it is near impossible to recover. BP is a typical case study where the concept of risk management is applied to an organization’s enterprise risk management framework. The research looks into the relationship between different types of risk management strategies and their integration into each other based on different risk management models to crystallize the relationship between these risks and their influence on product and service quality. However, the research concludes with an evaluation of the weaknesses of principles of RM in a practical environment targeting BP and possible solutions to the weaknesses applicable in BP’s risk management environment.
Methodology
In order to study the whole concept of risk management, the aim of the research was identified along with the main objective of the study to guide the research as stated below.
Aim: To examine how risk management can affect the reputation of oil and gas companies and influence the perceptions of their product and service quality.
Objectives: To study risks associated with the oil and gas industry based on the theory of risk management, the concept of risk reputation management, the effect of risk management on product and service quality in the oil and gas industry, reputational risk management, and the relationship between enterprise risk management at British Petroleum (BP) and product and service quality, the weaknesses of RM and possibilities for BP to enhance its reputation.
Background
British Petroleum (BP), as a case study, is a global oil and gas industry whose customers and business activities cover 26 countries which include the USA, Canada, Africa and Russia. The company is divided into 22 group functions, three business segments, and 4 regional areas. The three business segments include oil exploration and production, the development and production of oil and gas, and the refining and transportation of the oil and gas to the market besides marketing of petrochemical products. On the other hand, group functions are concerned with risk management, a topic of interest in this research.
Group functions aim to sustainably achieve and deliver value to BP’s stakeholders by identifying and responding to risks as described in its risk management framework. Typically, there is a myriad of risks that the company encounters within its operational activities. These risks are strongly related to the reputation of the company and affect product and service quality as discussed elsewhere in this document.
Qualitative and Quantitative Research
Notably, the research will be conducted with secondary qualitative and quantitative methods to provide an answer on the effect of risk management on product and service quality in the oil and gas industry focusing on BP’s risk management approaches as a case study. Various authors agree that qualitative research is overtaking quantitative research in more modern times as a research method. That is typical because qualitative research endeavors to seek answers to research questions are based on evidence, are able to crystallize information not anticipated or known before, and produce findings that can be used in the future. In addition to that, qualitative research provides a means of identifying intangible issues where qualitative research findings are appreciated by other players in the oil and gas industry. On the other hand, quantitative research seeks to confirm a specific hypothesis about given research, is more rigid, and is quantifiable in categorizing variations. On the other hand, qualitative research is descriptive, exploratory, and is more flexible, provides explanations for relationships, and is open-ended.
Literature Review
Risks Associated With the Oil and Gas Industry
A number of qualitative research studies have been conducted to identify risks associated with the oil and gas industry and the relationship between risk management and product and service quality in the industry. Research findings indicate that these risks largely influence the reputation of firms that operate in the oil and gas industries, findings are reinforced by the fact that the global economy is largely dependent on oil and gas which is the driving force behind the exploration, production, and marketing of oil and gas. In addition to that, emerging economies such as China and India have demonstrated an insatiable demand for oil as the main source of energy, compelling further demands for oil and gas, hence directly affecting the supply chain activities of oil and gas and the impact on supplier firms’ reputational risks in their risk management strategies (Ball, Power & Gold, 2010).
Ball, Power and Gold (2010) give weight to the observation that aggregate risk management issues related to the coastal and marine ecologies are identifiable issues that are critical in determining the issues related to the oil spills on coastal rigs where oil and gas are extracted occurs. In addition to that, revenue transparency, destructive effects on natural habitats whose effects are permanent, particularly where oil rigs are located, the safety of the population and employees from oil rigs at risk of exploding, and the health of the population living alongside these oil rigs are other risk management issues in the oil and gas industry. The impact on vulnerable people is largely a challenge to risks and uncertainties that determine the reputation of these firms. In addition to that, these issues effects affect the service and product quality offered by these firms and their reputation. On the other hand, consumer behavior of the oil and gas and its products also contribute to the risk management issues that the industry experiences. Casselman (2010)’s arguments are particularly reinforced by the fact that oil and gas are the drivers of global economies in industry and domestic use. In addition to that, mounting evidence from experimental and practical results indicates that climate change due to the effects of burning fossil fuels has accelerated the depletion of the ozone layer, another critical risk management issue. It is important to have an overview of the oil exploration and production process to clearly identify the sources of risks that characterize the oil and gas industry, calling for risk management strategies and their impact on the overall effect on product and service quality (Browne, 1997).
Browne (1997) emphasizes that environmental and social risks, in the supply chain of oil and gas, certainly form major components of risks that characterize the oil and gas industry in the exploration, production, refining, and retailing of the product (Bahree, 2006). All these undertakings are prone to risks that call upon management to address them. However, firms that operate in this industry endeavor to identify types and sources of risks to equip risk management personnel to make informed decisions on appropriate risk management strategies and to reinforce the rationale for adopting specific risk management approaches (Hanna & Newman, 2001).
Bahree (2006) observes that research and other scientific findings indicate that oil and gas are a result of the organic decomposition of organic materials found within the earth’s crust. The exploration and production of the resulting chemical substances split the oil and gas industry into upstream and downstream activities which are specific to each stream (Bento, 2003). These activities are defined by the supply chain which consists of the exploration of oil and gas, the production of these chemicals, refining of the oil and gas, and marketing these products to specific consumers. That also includes petrochemical products from oil and gas as secondary activities. The impacts of risks associated with these processes typically influence the reputation of the firms. That On the other hand, the downstream process includes refining and marketing the oil and gas for consumption. That is particularly characteristic of terrestrial and marine oil exploration and production processes. Every step of the exploration and production process has characteristic risks whose management influences the impact of service and product quality in the sector (Bahree, 2006).
Exploration is typically concerned with identifying the geological locations of sedimentary rocks that are reservoirs of crude oil and gas. During the exploration process, a number of destructive effects on the environment are bound to occur. In the exploration process, management typically identifies risks associated with the process and endeavors to formulate risk management strategies specific to the oil exploration process. Inherent risks are particularly associated with seismic or intrusive surveying. It is important to note, at this point, exploration may traverse national boundaries, introducing a further risk associated with operating in different legal jurisdictions. Therefore, management finds legal risks as another challenge. Typical approaches to managing legal risks also translate to determining service and product quality in the gas and oil industry. Exploration is a typical evaluation approach and criteria for determining identifying strata for oil and gas production. In addition to that, the exploration process evaluates the economic feasibility of engaging in the production of oil by evaluating the potential quantities of oil in the reservoir. Thus, company management is confronted by another risk, the financial risk that executives have to manage to the satisfaction of existing regulations and legal requirements Casselman & Gold, 2010).
It has been established that the production process is bound to come with a myriad of risks that risk managers have to address. The process is characterized by forcing crude oil to the surface where potentially harmful chemicals are used in the extraction process. These chemicals are potential sources of environmental risks that organizational managers find pressed to address (Casselman & Gold, 2010).
The rationale behind managing environmentally associated risks is to positively impact product and service quality by improving, among other elements, the corporate image of the oil-producing firm. Environmental risks are associated with the damage to the marine ecosystem when geological investigations are conducted to identify an oil-rich rock. A large number of gaseous emissions into the atmosphere during the production process, emissions into the sea, and waste emissions from the drilling processes into the sea, oil and gas spills into the environment are other environmental risks that call upon risk managers to keenly evaluate and strategize on their mitigation. In addition to that, risks are associated with uncontrolled blowouts that may occur during the drilling and production processes. The refining, liquefaction, and marketing of oil and gas also come with associated risks that risk managers of firms operating in the oil and gas industry find compelling to address. A discussion of each of the risks associated with the production and marketing of oil and gas and approaches to managing them will crystallize an understanding of their effect on product and services quality in the oil and gas industry Casselman & Gold, 2010).
A number of companies endeavor, at the management level, to design and implement management strategies to effectively address risks that have an overall impact on the product and service quality offered by these companies. It has been realized that management plans that are incorporated into the management systems of these firms come in different levels of phase activity and lifecycle in managing environmental risks has a direct impact on the long terms effect on product and service quality offered by these firms (Casselman & Gold, 2010).
A number of risks have been identified to characterize the oil and gas industry which are typically categorized into environmental and social risks which ultimately influence the nature of the reputation and product and service quality offered in this industry. However, arguments indicate that management strategies for these risks influence the perception of the product and service quality in this industry due to the overall effect of the strategies on the people and the environment in general. Therefore, that calls upon a detailed discussion and analysis of the risks and the management strategies of these risks and their overall impact on the product and service quality as discussed below (Casselman & Gold, 2010).
The practice has demonstrated that in the oil exploration and mining process, particularly when land clearance occurs, risks that lead to the destruction of habitats including loss and destruction of vegetation particularly when land is opened for further exploration occurs. That is particularly true due to the use of explosives in the exploration process. On the other hand, exploration risks are characterized by emissions of gases into the atmosphere, particularly from oil and gas drilling equipment. Typically, the pollutants are composed of sulfur dioxide and other chemicals gases that have an overall adverse effect on the health of the people and the environment in general. Research has shown that hydrogen sulfide gas is one of the components that constitute natural gas and crude oil. These emissions significantly affect the health of human life particularly when the concentration is high. It is therefore important for managers to design strategic approaches to mitigating these risks (Casselman & Gold, 2010).
One approach that has been suggested and proved practical, and has been implemented by various oil and gas firms is to minimize the footprints characteristic of the oil facilities by optimizing the use of water and energy consumption in the oil refineries. Further management approach to minimizing the risks is the continued maintenance of resources, particularly using silencers to reduce noise and other vibrations, as contained in the management plan of the oil facility.
Managers find it important to incorporate emission inventory approaches in managing environmental risks besides employing an air quality monitoring system in the facility. That environmental risk management strategy is reinforced by the use of preference explosives with a bumping effect (Chu, 2004). The strategy is reinforced y the use of the best available technologies to ensure optimal use of resources to minimize the risks and their impact on the environment and the people that are directly affected by them. It has sanguinely been argued that habitat fragmentation is another risk management variable. The direct relationship between the landscapes and the visual impact variable typically influences the fragmentation of habitats as an environmental risk (Casselman & Gold, 2010).
On the other hand, managers agree that the exploratory stage in the oil production cycle constitutes risks due to the oil drilling process, mud due to the drilling process, and cuttings in the production process. These risks are further aggravated by gas venting and flaring risks. In the exploratory drilling stage, other risks identifiable with this stage include natural hazards. These are particularly influenced by typical risk variables such as wells blowing up as has been evident in a number of incidents in oil drilling rigs and water contaminations. A critical evaluation of the management approach in handling these risks includes contingency plans to counter the risks (Casselman & Gold, 2010).
Research has shown that managerial approaches to dealing with the above risks and the implications of the risk management approach indicate that controlled venting of oil and gas optimizes a facility’s mechanical capabilities as a spill prevention mechanism. In addition to the prevention strategy, the risk management strategy calls upon management preparations and preparedness with emergency plans in place to address these issues. It has been observed in the oil and gas industry that pressurized oil and gas are controlled through a management plan that constitutes a spill prevention plan. That emphasizes the use of the best available technology. Technology solutions optimize newly available technologies to minimize environmental pollutants from being discharged into the environment with their destructive effects. That is done by identifying opportunities for minimizing them through effective management planning strategies and best practices. In addition to that, opportunities to reduce the effects of risks on the environment are identified and incorporated into management processes.
Management has strategic approaches to environmental risks by integrating the reuse and recycling of used materials.
Further approaches to managing environmental risks include identifying risks associated with oil and gas spills as an inherent risk in the oil and gas industry. While developing oil and gas, the undesirable occurrence of spills comes as one of the risk elements that management has to address. However, research indicates that oil spills are minimal, though sources of accidents are based on equipment failures, environmental interferences, and at times human errors (Close, 2006).
Analytically, one can note that spills due to accidental discharges are worse off when they occur offshore and in remotely inaccessible areas. Risk management strategies by oil and gas producing firms have a very strong influence on the effects of product and service quality as a result of the above risks. That is particularly reinforced when uncontrolled blowouts occur in oil drilling facilities. Besides blowups being a risk that can adversely affect the environment, it has the potential effect of causing loss of lives and damaging drilling oil rigs. That has the possibility of damaging the oil marine ecosystem and by altering the chemical composition of the water and other chemicals involved in the process.
On the other hand, Jessen (2008) identifies and classifies these other risks into human capital deficits, fiscal terms that have worsened with time, controls on costs, competition for existing reserves, political risks associated with constraints on accessing oil reserves, energy policies that are characterized by uncertainties, and regular shocks due to the demand for oil. In addition to that, Jessen (2008) adds that the concerns about climate changes, shocks due to oil supplies, and the need for energy conservation add to the list of risks and their impact on the reputation of the oil and gas industry. On the other hand, Lewis, Krebs, Cooper, Frois, Moss, Allen, Higbee & Foltz (2005) add that legal risks contribute to influencing the reputation of firms that operate in the oil and gas industry as management is typically influenced by legal risks in making decisions that bear on the reputation of these firms, besides impacting on the overall product and services quality (Jessen, 2008).
It has been argued elsewhere that it is important for oil companies to identify other forms of risks and calling upon management to critically evaluate them and factor them in their risk management strategy. Some of the risks are domestic in nature while other risks are global. These risks include operational risks, reputational risks, and political risks.
Detailed and analytical arguments about these risks and the effect of these risks on product and service quality in the oil and gas industry will afford to crystallize their effect on the reputation of oil and gas firms in this industry. BP identifies and categorizes these risks into three risk management strategies (Jackson, 2006). BP’s management identifies them into risk group plan to include delivery risks, enduring risks and inherent risks. However, a more detailed discussion and analysis of the risks will afford a crystallization of their management in influencing the gradual outcome of product and service quality (Bratvold & Begg, 2009) and (Chazan, 2010).
In the views of Jessen (2008), managers in the oil and gas industry identify the risks associated with the deficit of human capital and the long-term effects on the quality of products and services in the industry. It has been argued in theory and practice that a significant decline in human capital has the potential threat of causing project delays in the industry-leading to the fear that the pace of development in the industry and the world economy may not be able to sustain the exponential growth in the global demand for gas and oil. Thus, adversely impacting the quality of services offered in this industry. In that light, therefore, managers endeavor in their strategies to identify the impact of demeaning human capital. In the light of the management, diminishing capital overly leads to capacity constraints. Jessen (2008) and Chazan (2010).argue that managers in these firms critically identify worsening fiscal terms as being critical in the management of the oil and gas industry. That is particularly due to high prices, political influences, and the nationalism associated with the energy sector. The management of firms operating in developing countries and other oil and gas producing countries face the challenge of operating under the influence of political opportunism, a threat that can potentially impede the quality of products and services offered by firms operating in the oil and gas industry. Typical examples of such countries include Russia and Algeria, among others. In these countries, the product and service quality is largely influenced by the management of risks associated with the political structure, taxation, and other changes in policies (Bratvold & Begg, 2009).
A quantitative approach to the relationship between risk management and product quality has been hypothesized and analyzed as follows. Assume BP claims that it has incurred loss due to loss of reputation due to the oil spill that it experienced recently. Then a hypothesis can be formulated to affirm or reject the assumption as follows (Department of Justice, 2007).
Let the probability of 0.25 be that the company has experienced loss due to a damaged reputation. And suppose a survey of 20 independent respondents provides information whose probability of being correct is 0.25. Analytically, therefore,
H1 (null hypothesis): p = 0.25 (Risk management has a strong effect on product and service quality.
H 2(alternative hypothesis): p >0.25 (Risk management has no impact on product and service quality.
If the null hypothesis is true, then the test value used in the hypothesis will be in the critical region. Therefore,
When p(X>x) <5% on the upper tail of the distribution, the null hypothesis is accepted, and x is the test value. Calculating, using binomial probabilities on a normal distribution, where P (X>7) = 1-P(X<6), then P (X>7)>5% implies that the probabilistic value, 7, is not lying in the critical region. That implies that the null hypothesis is correct, affirming the hypothesis and establishing a strong relationship between risk management and its effect on product and service quality (Department of Justice, 2007).
Theory of Risk Management (RM)
It is important to analytically understand the theory of risk management in relation to the issues of product and service quality in the oil and gas industry. A number of researchers and industry practitioners have defined risk management in different ways. One such definition that borders on risk management in the oil and gas industry states that risk management is “a decision-making process that entails considerations of political, social, economic and engineering information with risk-related information to develop, analyze, and compare regulatory options in order to select the appropriate regulatory response to a potential health hazard” (Thomas & Chazan, 2010). On the other hand, other stakeholders in the industry define risk management as “The monitoring and controlling of various risk factors in an investment portfolio with the aim of minimizing the volatility of investment returns” (Fehle & Tsyplakov, 2003). Yet, another comparative definition of risk management puts it that “Risk management is a structured approach to controlling uncertainties and potential dangers by assessing what the particular uncertainties or dangers are, then developing strategies to minimize or mitigate those uncertainties or dangers” (Jackson, 2006).
Drawing on these definitions, one is bound to argue that risk management in the oil and gas industry entails that management is able to systematically address the risks and uncertainties that characterize the industry in order to minimize the possibility of their occurrence to optimize and sustain the benefits from the business activities in the provision of quality goods and services. It is an integrative approach where company executives integrate both risk and management techniques by modifying the operations of oil companies, evaluating and adjusting their capital structures by using specific financial tools to achieve desirable levels of service and product quality. Company executives understand well the link between risk management and its impact on product and service quality. However, both approaches are tactically integrative in nature. On the other hand, it is important to note that in the cooperative sector, the elements of capital structure and risk management strategies do not affect the accumulated effects on a firm, but the value addition to its activities. Value addition revolves around product and service quality offered by a firm (Fehle & Tsyplakov, 2003).
Risk management adds value to a firm and overly influences the productivity of a firm in terms of product and service quality. Managers of these firms find themselves charged with the responsibility of implementing a risk management program that is characterized by the short terms and long terms objectives of their firms. Particularly, the risk management programs should be based on the short and long terms aims of these firms. Noteworthy, these firms are faced with issues of product and service quality that the risk management process has to address. It is also important for the approach to be integrative of the risks that the industry faces in conducting its oil exploration and production activities. In addition to that, these firms assume corporate responsibilities when conducting their activities since they are solely responsible for the outcome of their activities. That is solely based on the paradigmatic version of the theory of the firm. Here, the oil firm is the principal-agent with the responsibility to preserve the environment as a principal concern (Fehle & Tsyplakov, 2003).
Of specific concern are the management practices that hold firms to the main objective of managing risks inherent in the industry to address the issues that are characteristic of the industry. The theory of risk management reinforce the fact that firm managers, in the risk management process, endeavor to identify hazards inherent in the oil and gas industry, assess the hazards to crystallize the risks in the industry, endeavor to identify and develop critical control measures to minimize the risks, endeavor to develop strategic plans to implement risk controls, and eventually evaluate and supervise the risks inherent in the industry (Fehle & Tsyplakov, 2003).
The theory of risk management (RM) asserts its position in the oil and gas industry by enabling managers in the industry to achieve the sole objective of reducing and if possible inhibiting risks for the safety of people. In this argument, the theory asserts its position as protecting people typically by controlling such risks that may lead to undesirable consequences such as the destruction of the environment and other activities that make the environment uninhabitable. However, the theory, therefore, appears to be stringent in its application. It conflicts with the business pursuits of the oil and gas industry activities. However, the theory seems to equip managerial executives with the techniques of decision making and enhance the management position while reinforcing the idea of understanding approaches to reach decisions on risks. The theory relates practical and theoretical aspects of risk management in decision-making by adopting a number of approaches to risk management in the decision-making process. In that respect, the theory enables managers to critically identify and make informed decisions on ethical issues and the social impact of the risks due to the activities of oil and gas. In addition to that, the risk management theory calls upon managers to devise methods of optimizing benefits to society while ensuring that adverse economic impacts on society are mitigated. The theory guides managers on how to typically achieve protection for individuals and society (Jackson, 2006).
It is important to note that different researchers and theorists view the theory of risk management (RM) differently. Another view of risk management is based on the static and dynamic models. The dynamic risk management approach is based on a framework that is continuous and has an infinite approach to addressing risks that do not fit into the static model. However, the static model was the model used in the last decades by management executives to manage risk (Fehle & Tsyplakov, 2003).
In the dynamic model, a number of issues that include an optimal risk timing approach to risk management entail that a firm initiates a risk management contract in which operational conditions of a firm are continually evaluated against the overall outcome of the impact of the risks. Analytically, therefore, the firm makes dynamic risk management decisions as opposed to the static models that assume that decision-making is a one-time undertaking. It is a one-period model. However, in practice, risk management in the oil, and gas industry is dynamic and not a one-time process decision, enabling researchers to designate risk management in the oil and gas industry to fit into the dynamic model. Typically, the dynamic model calls upon managerial executives to employ short-term methods to strategically hedge long-term operations in risk management (The Economist, 1999). That is basically due to the dynamic nature of risks in the industry. Therefore, the firm reevaluates risks and typically decides to strategically readjust its hedging position in relation to short-term and long-term contracts. It is typically possible, under the theory of RM, to select a maturity risk management strategy that flexibly plays on long-term and short-term risks. Therefore, optimal adjustments of typical risk management instruments are used in the oil and gas industry and are typically influenced by the optimal roll-over strategy. On the other hand, risk management can be statistically modeled to address salient risks in the oil and gas industry (Fehle & Tsyplakov, 2003).
On the other hand, other theorists argue that the game theory is the best fit to be used and explain risk management in the oil and gas industry. The theory is best explained by the cooperative and noncooperative game theories. The central element of the cooperative game theory, in its typical application in risk management in the oil and gas industry, argues that people have a strong tendency to do what they can do. On the other hand, the noncooperative game theory of risk management emphasizes the need for people and organizations to interactively cooperate to achieve their set objectives and goals (Fehle & Tsyplakov, 2003).
Issues of Product and Service Quality
Thomas and Chazan (2010) express the fact that in managing risk, BP has over time taken steps to ensure product and service quality are integrated into its risk management framework by enhancing and improving its operational activities such as reducing emissions into the environment as a critical issue in product and service quality. That is in addition to identifying enduring risks and setting high standards in its corporate citizenship strategy. It has been demonstrated that BP has an integrated internal control mechanism that controls the quality of its services in the oil exploration, production, and marketing procedures as argued by (Bartling, 2006).
Another issue is the supply chain link and associated risks in the exploration of oil and gas, the production, and marketing of the product by BP and the effect of risk management in influencing the perception of the product and service quality in the oil and gas industry with emphasis on BP (BP Sustainability Review, 2008).
According to a number of research findings, it is clear that BP among other oil and gas industries is affected by the concentration of credit risks in this industry. The core activities of oil and gas companies include the exploration, production and selling of oil and gas and associated petrochemical products such as lubricants. It, therefore, is important to note that the risk management of these industry players affects the credit ratings of stakeholders in the industry (Bartling, (2006) and (BP Sustainability Review, 2008).
Legal issues add to the list of issue that influences the quality of products and services that are offered in the oil and gas industry. These issues are basically influenced by the capital-intensive nature of products and services, besides corporate governance and public-private cooperation. On the other hand, typical legal issues also include contracts, labor laws among other regulations. These issues are typically in form of anti-trust laws, political issues, heavy regulations, and expropriation of assets, jurisdictions that traverse national boundaries and relationships between countries. Another issue is related to intellectual property rights, the volatility of the market, environmental issues, and the issue of human rights (BP Sustainability Review, 2008).
The link between RM and company reputation
Bozon (2006) confirms the argument that oil and gas companies like BP endeavor to enhance their performance by establishing a strong and sustainable link between their risk management activities and corporate governance. Typically, reputation is identifiably a critical variable in the economic and environmental performance of firms that operate in the oil and gas industry besides being a measure of their operational and social performance. It is critical to note that risk management activities are dynamically factored into the economic model of these firms besides being critical components in the social, environmental, and operational performance of these organizations (BP Sustainability Review, 2008). Analytically, every firm’s main objective is to generate profits through long terms or short-term investments. The investment portfolios demand that economic activities in the current global environment are variably affected by the environment in which they are conducted. In addition to that, the operational efficiency of these activities directly impacts the society these activities are conducted. Typically, these activities, besides adding economic value to the companies largely affect the attitude of the people affected by their activities (Willigers, Bratvold & Hausken, 2009). These activities are subjected to risk management to ensure that these companies are shielded from the effects of risk. That, therefore, translates to corporate reputation which affects the whole organization and the relationship between risk management and the cooperative image (Hoffman, 2004).
In the BP Sustainability Review (2008), reputation has been identified as an intangible asset that bears a strong value and relationship with the brand name of a company. Oil and gas firms view reputation as an asset that constitutes the aggregate sum of stakeholder experience and attitudes. Reputation is the motivating force behind the cooperation of different entities in conducting business with different partners. Reputation should therefore be critically managed to ensure litigations lead to the improvement of company evaluation (Bozon, 2006).
As discussed elsewhere, the current economic environment fits well into a dynamic risk management (RM) model that critically affects a company’s corporate image translating into a strong relationship between a company’s reputation and its risk management strategy. This argument heavily draws on a logical framework that is based on BP’s socio-cultural orientation in its operating environment, among other companies in the oil and gas industry (Bozon, 2006). It has been noted by a number of researchers that oil and gas industries operate in environments that are populated with people. In their operational activities, these oil and gas companies endeavor to create a framework that incorporates cultural values that are typical of the operating environment. Thus, they critically endeavor to inculcate frameworks that typically reflect strategies in their risk management activities for managing company reputation, reinforcing the strength in the relationship between risk and company reputation (Bozon, 2006).
Reputation, therefore, has an intrinsic value that typically influences any oil and gas company in adding value to the relationship between product and service quality that is typically in relation to the activities of these companies. In theory and practice, risk management is an internal management process. Companies endeavor to set objectives for managing reputation and put in place measures for determining the extent to which risk may inherently influence a company’s reputation (Jessen, 2008).
Notably, risk management and reputation are strongly related variables since reputation shapes the inherent behavior of firms that operate in the oil and gas industry. On the other hand, reputation is a strong indicator of the relationship between companies, their activities, and the operational environment. This argument reinforces the need for companies to set objectives and strategies for identifying risks to their reputation, and to set down remedial measures to counter any damage to their reputation. Therefore, justifiably, a reputational risk management framework is an exceptionally critical risk management tool, affirming the relationship between risk management and company reputation (Fehle & Tsyplakov, 2003).
The relationship between RM and reputation is further asserted in the framework involving organizational management structures in the oil and gas industry. A typical example is BP. In BP’s management framework, risk management is strongly tied to its reputation in its reputation risk management strategy. All the functional management entities in the management hierarchy seek to identify potential circumstances that may deny the company the ability to operate to achieve its objectives through the damaging of its reputation, hence asserting the reputation risk management strategy. That is inculcated into these firms’ cultural orientations. It has been argued further that reputation in risk management is a process that identifies typical attitudes and links between risk management and organizational reputation (Boyles & Melvin, 2005).
It has been argued that reputation and risk management are two correlated components that should be well understood by organizational managers to crystallize their effects on product and service quality besides establishing a clear-cut policy on managing risk. Risk management and organizational reputation enable companies to establish a strong socio-cultural map that constitutes the elements of the financial map of an organization. Risk management enables oil and gas players to set a clear relationship between customers, employees, and stakeholders to ensure these stakeholders establish a strong working relationship between them. In addition to that, industry players endeavor to understand organizational reputation in the context of internal, external, organizational performance, and market assets (Lewis, Krebs, Cooper, Frois, Moss, Allen, Higbee & Foltz, 2005).
Risk to reputation has been identified to originate from a number of elements. In addition to that, these sources for reputational risks assert that ethical behavior, corporate governance, regulatory compliance, and regulatory compliance are among the general sources of reputational risks that organizational managers have to design and implement a reputational management strategy. Thus, the corporate image is improved in the process (Boyles & Melvin, 2005).
Typically, these companies endeavor to implement reputational risk management in their operations since it has been identified to be a basic tool for improving the cooperate image of the designated company. Findings indicate that reputational risk management creates value for shareholders through better capital allocation, enhanced operational efficiency, and better ratings by rating agencies. Typically, findings indicate that risk management and reputation confer on a company the benefit of competitive advantage as products and services are deemed to possess the inherently perceived quality. That practically translates to a better reputation with customers and other stakeholders. In practice, that calls to mind the reason why oil and gas companies get involved in corporate social responsibility (CSR) activities besides operating within the prescribed limits of the law (Fehle & Tsyplakov, 2003).
It is important to note that risk management bears a strong correlation with organizational reputation since organizational benefits due to reputation are strongly related to organizational risk management strategies. One can therefore justifiably argue that firms that operate in the oil and gas industry typically value their corporate reputation as an intangible asset. That is particularly true when considering the organizational leadership and governance, organizational innovation strategies, the business relationship between oil companies and customers, communication approaches used in the oil and gas industry, and the cultural orientation of the oil corporations (Boyles & Melvin, 2005).
Managing corporate reputation as an integrative element in reputational risk management plays a critical role in enhancing organizational productivity while enhancing product and service quality and improving further the transactional quality of their activities. On the other hand, a negative reputation typically downplays the transaction values of a firm and leads to organizational inefficiencies. Risk management overly protects a company and improves its brand image. It is important to argue, based on experience, that reputation is an intangible asset that takes a firm a considerable length of time to build. Therefore, the image of any firm that operates in the oil and gas industry is forged on reputation besides a trust base for image building. That is the case when handling risks that plague the oil and gas industry. A typical example includes the frequent occurrences of oil spills in different parts of the globe in oil and gas exploration and production (Fehle & Tsyplakov, 2003).
When an oil spill occurs, destructive chemicals are released into the environment whose consequent impacts are not desirable. If the operating firm does not come out with a tailored crisis management strategy, the reputation of such a firm may adversely suffer leading to distrust among its stakeholders. That is typical because corporate risk strongly influences investor confidence in holding shares within a company, the regulatory behavior and attitude of governments an oil company operates in, the motivation of organizational employees, and the willingness of the consumer to purchase the product from the designated company. Facts illustrate the fact that the possibility of other supplies cooperating with an oil company whose reputation has been damaged is potentially damaged while the cost of capital is negated and media coverage may negatively portray the image of the oil company to its detriment (Boyles & Melvin, 2005).
The concept of reputation risk
The concept of reputation risk is based on the argument that it takes several years, close to twenty years, to build a reputation and a few minutes to damage and completely destroy that reputation. Reputational risk is defined as “the risk of loss in the value of a firm’s business franchise that extends beyond event-related accounting losses and is reflected in a decline in its share performance metrics.” On the other hand, “Reputation risk is the potential loss that negative publicity regarding an institution’s business practices, whether true or not, will cause a decline in the customer base, costly litigation, or revenue reductions (financial loss)” (Bebbington, Larrinaga & Moneva, 2007). While elsewhere “A corporate reputation is a collective representation of a firm’s past actions and results that describe the firms’ ability to deliver outcomes to multiple stakeholders. It gauges a firms’ relative standing both internally and externally.” (Bebbington, Larrinaga & Moneva, 2007). That is typically linked to crisis events that draw firms to lose market capitalization with the consequent result of losing revenue and higher operational costs. That is the case with the recent high-profile event that gripped BP. The reputational risk of BP was placed at a critical market position when an oil spill in the Gulf of Mexico from its Deepwater Horizon oil rig exploded killing eleven employees before the situation was halted in July. That led to exponential expenditure by BP in terms of claims for damages and other contingency costs that were incurred at the time (Bebbington, Larrinaga & Moneva, 2007).
Bebbington, Larrinaga and Moneva (2007) argue that the concept of reputation risk has driven researchers to argue that reputation, capital, and people are the most important assets of a company and affirm that though people and capital can diminish, they can be recovered, but if reputation diminishes, it is near impossible to recover it. That argument about risk is reinforced by the observations common across industries that customers always related their choice to consume products and services from specific companies due to their reputation. Further still, reputation inspires confidence in insurers who bank on distant promises. On the other hand, it has been demonstrated that reputation is vital in the modern period of global changes (Fehle & Tsyplakov, 2003).
Researchers agree that organizational employees find it more confident to be loyal to a company with a better reputation than one with a bad reputation. That is in agreement with the observation that individuals and stakeholders are always ready to risk investing in companies with a good reputation. It is critical to note that when investors make choices, they critically evaluate the reputation of a company before risking their investment in a company of choice. It is important to note that reputation provides a company with a social license to conduct its operations, as is typical of BP. In addition to that, legal entities find it flexible to lessen legal requirements on a company, as has been with BP before the oil spill that cost it its reputation (Bebbington, Larrinaga & Moneva, 2007) and (Fehle & Tsyplakov, 2003).
It has been agreed that corporate reputation creates trust and serves as a repository of goodwill. That is typically influenced by the drivers of reputation which include long term financial performance, corporate ethical values and human capital, crisis management strategies, corporate governance, and the quality of products and services in the industry, and other external factors such as corporate social responsibility and the activities of pressure groups (Bebbington, Larrinaga & Moneva, 2007).
It is important to consider typical mechanisms for managing reputational risk. Findings indicate that reputational risk can be managed through a number of mechanisms. These include establishing processes that are typical of group issues, integrating into an organization’s internal whistle-blowing mechanisms, ensuring communication mechanisms within the organization incorporate the right information dissemination methods, and incorporating risk calculation mechanisms in calculating economic capital (Bebbington, Larrinaga & Moneva, 2007).
British Petroleum (BP)’s Enterprise Risk Management
In practice, “Enterprise risk management (ERM) includes the methods and processes used by organizations to manage risks and seize opportunities related to the achievement of their objectives.” other researchers and bodies define enterprise risk management as a “process, effected by an entity’s board of directors, management and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives” (Department of Justice, 2007). That is the case with BP. In practice, BP has integral an enterprise risk management strategy in its management and operational management and organizational activities to ensure organizational objectives are achieved in line with the organization’s vision. BP’s risk management framework is aimed at minimizing capital costs by appropriately managing volatility through risk identification and assessment in a 360-degree review of potential risks based on internal controls. That is particularly entrenched in its value chain of activities through an accumulation of information from all stakeholders to ensure the strategy goes beyond insurable risks (Bebbington, Larrinaga & Moneva, 2007).
Once these risks have been identified and assessed, risk quantification and prioritization are conducted based on BP’s needs, operational needs, and previous experience such as the explosion in one of its oil rigs that occurred off the coast of Mexico. That is followed by an appropriate allocation of resources to treat the risks.
Research studies indicate that in BP’s risk management framework, a number of risks have been associated with the principal risks and uncertainties. These include containment risks that are tailored to address the flow of hydrocarbons from the exploded oil rig, litigation and claims risks tailored to address exploration and production of oil and related products, regulatory risks which include stringent regulations due to the oil rig explosions, and group strategy risk that are influenced by the outcome of reputational damage of the BP brand due to the oil rig explosions. These risks adversely affect the ability of the company to access finance on terms acceptable to the company and the group’s credit ratings (Bebbington, Larrinaga & Moneva, 2007).
Measuring Risk management at BP
Both qualitative and quantitative studies illustrate the approach used at BP in its enterprise risk management strategies. However, both qualitative and quantitative studies are based on secondary research. That is typical because primary data and relevant information is available within the repository of BP and has been analyzed in relation to BP’s risk management framework. However, it is important to identify the procedures used by BP to quantify and qualitatively evaluate risks (Bebbington, Larrinaga & Moneva, 2007) and (Department of Justice, 2007).
Boyles and Melvin (2005) note that in modern the age of information technology, various tools have been integrated into BP’s risk management framework to measure the frequency with which BP is subjected to risks. One such approach is where BP has incorporated an advanced database system that helps in data warehousing all mapped risks BP is susceptible to experience. The designated manager categorizes risk before evaluating the frequency with which such risks are likely to occur. It is evident that risks have the potential to cause financial loss. Hence the risk manager ensures that the probability of a specific risk occurring within a given period of time is noted. Noteworthy, risks are classified into medium, low, and high risks (Bebbington, Larrinaga & Moneva, 2007) and (Fehle & Tsyplakov, 2003).
However, low impact low-frequency risks get minimum attention in the allocation of resources. However, high impact risks get immediate attention and such risks are reported to the top management for due immediate attention. In a quantitative approach to managing such risks, risk management specialists endeavor to focus their attention on their management as illustrated in figure 1 below.
The shaded region in the above diagram illustrates the level of risks and the degree of concentration that the risk managers are called upon to evaluate. However, sometimes risk specialists are sometimes met with the challenge of establishing accurate frequencies of the occurrence of these risks to design an appropriate risk management approach. On the other hand, BP realizes that statistical methods for analyzing data on the likely impact of risk are integrated into the management framework of the organization to enhance the risk management approaches.
A quantitative approach to statistical risk management methods to risk management is based on a number of statistical theories. These include the poison density function and Weibull Density Function, among other approaches. The poison density function is used by risk management specialists to identify distribution frequency and probability of the occurrence of an event as illustrated below.
That is typically in relation to risks related to the environment, operational losses, capital market risks, and reputational risks among others. However, other arguments indicate that Weibull Density Function is more practically oriented toward conducting a reliability risk analysis. In that analysis, Weibull answers the question as to where and when such a risk is likely to occur. The stochastic approach is based on the formula illustrated below (Jessen, 2008).
In the above formula, the risk variables are identifiably influenced by the location of the operation defined by γ as the location parameter, η as the scale parameter, and β as the shape parameter. However, when the location parameter is zero, then the formula translates to:
On the other hand, when β = C are constant, then
In these models, it is assumed that the parameter β is already established based on the number of products and services offered by the company. That implies that even limited data sets can be analyzed based on the above formula (Bento, 2003).
Other researchers agree that Weibull’s formula has to be truncated to fit into losses that are large in nature. In their approach to modifying the theory, the Extreme Value Theory (EVT) is used to model the tails of Weibull’s distribution. The modeling fits well into a generalized Pareto distribution as illustrated below.
In the above illustration, expected losses are due to process operational failures such as occurred in the explosion that damaged BP’s reputation while unexpected losses are basically due to the failure of the management or its internal weakness in laying appropriate risk management strategies. On the other hand, exceptional risks are due to issues like fraud or major failures that may adversely impact the reputation and functionality of a company (Boyles & Melvin, 2005).
Findings and Discussion
Findings from the literature review based on qualitative and quantitative studies indicate that the oil and industry are susceptible to risks in the exploration, production, refining, retailing, and legal risks in the supply chain of oil and gas and related products and services.
A quantitative study indicates a strong correlation between risk management and product and service quality, drawing from the statistical hypothesis of the significance test.
A qualitative research study indicates that Managing risks in the supply chain overly impacts the reputation of the firms by improving the attitude of stakeholders hence the credit ratings of the firms. A downgraded credit rating in the long and short terms due to reputational consequences of risk such as the risk related to BP’s oil spill off the coast of Mexico due to an increase in group costs has adverse consequences on product and services quality of oil and gas firms, with BP as a typical example. A downgraded credit rating may demand collateral from the designated oil firm in its business activities, financial obligations, contractual obligations, business risk profiles, funding arrangements for pension trustees, group liquidity, and constrained cash flows. That denies the firm the necessary capital investment and limits access to group financing. On the other hand, when risks are managed effectively, the credit rating of a specific firm is counterproductive and asserts a firm’s financial and risk profile.
Analytically, a number of identifiable issues such as environmental aspects related to the destructive effects of natural habitats, the safety from exploding oil rigs, social issues, and organic discharge of chemicals into the environment is risk management variables that affect the reputation risks of oil and gas firms. These risks strongly relate to human capital deficits, fiscal terms that have worsened with time, controls on costs, and competition risks. Political risks associated with constraints on accessing oil reserves, energy policies that are characterized by uncertainties, and regular shocks due to the demand for oil also influence the final product and service quality offered by oil firms.
Further research indicates that risk management in the oil and gas industry draws heavily on the theory of risk management (RM). The theory arms managerial executives with practical techniques in decision making to enhance the management position when faced with risk management options. The RM theory is critically applied in BP’s enterprise risk management strategy to identify and prioritize risks and design risk management strategies geared to enhance the reputation of the company. Thus a strong relationship between reputational risk and risk However, risk management strongly relates to the issues of product and service quality identifiable by embarking and incorporating technical and engineering standards to ensure reduced emissions, high standards, high-quality control mechanisms, minimization of risks in the risk management in the supply chain, and legal issues.
On the other hand, research has established a strong relationship between reputation risk management and the quality of products and services offered by oil and gas firms. Reputation, being an intangible asset has been identified to influence economic, environmental, and operational performance. In addition to that, these findings indicate a strong relationship between reputational risk management and stakeholder attitudes toward a firm. The concept of reputation risk is an embedded driver in corporate reputation creating trust and serving as a repository of goodwill.
Conclusion and Recommendations
From the foregoing research and discussions, it has been established that oil and gas firms experience a number of risks in the exploration, production, refining, retailing of oil and gas and related petrochemical products besides legal and political risks in the production and supply chain. Risks experienced in the chain, however, are subject to a risk management strategy that include the management of reputational risks and other forms of risk projected to impact product and service quality offered by oil and gas industry firms. In addition to that, reputational risks have been identified to strongly influence the credit rating of oil and gas firms, a concept integrated into the enterprise risk management (ERM) strategy of these firms. BP’s enterprise risk management incorporates the reputational risk management strategies into the risk framework to ensure that reputational risk is appropriately managed through the ERM strategy employing RM techniques. These risk management approaches are strongly correlated elements in determining the quality of products and services offered by BP based on environmental issues such as gas emissions and leaking of oil among the other risks associated with the exploration, production, and marketing of oil, legal risks, corporate governance issues, political regulations, and jurisdictions.
Therefore ERM provides a risk management framework for managing reputational risk based on the RM theory to influence the quality of products and services offered by oil and gas firms. In the above study, however, RM has weaknesses since the elements of capital structure and risk management strategies do not affect the aggregate effects on a firm where optimal risk timing approach to risk management entails that a firm initiates a risk management contract in which operational conditions of a firm are continually evaluated against the overall outcome of the impact of the risks. RM employs different models. The dynamic model calls on managers to continually evaluate risks and the static model assumes that risks are static and makes a one-time decision on RM approaches for the entire life of the existence of the firm. Another weakness inherent in the RM of these firms revolves around its inability to be used to allocate capital and to provide precise projections on the financial allocations for risks. In addition to that, the theory does not provide optimal mathematical measures of confidence even for specified periods of time. In addition to that, RM cannot be modeled after the stochastic volatility of risks experienced in the oil and gas industry and neither does the theory provide enhanced measures of risk beyond that determined by the RM management. In addition to that, the theory does not provide a multivariate approach to handling financial and other reputational impact risks do not provide a measure of the independence of a firm from risk and market behavior, and long terms impact on the quality of products and services offered by oil firms.
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