Investors in oil companies have learned that drilling oil wells in deep water can be like 'betting the company' on every well, even for oil majors.
Ceres is coordinating an initiative to persuade oil companies to manage the risks in offshore drilling. It seeks better disclosure, better incentives and higher industry standards. And Ceres recognises that the weakest performer matters because a bad accident can easily cause collateral damage to the entire industry.
These are good intentions, but they miss an important ingredient. BP's direct financial losses were huge. The current figure, $40.9 billion, represents almost three times 2009's profit, and is leading to a smaller BP. Insurance would have been insignificant for losses on this scale.
But what brought BP uncomfortably close to its knees was the the scale of the reputational damage, which came close to destroying BP's 'licence to operate'.
But what brought BP uncomfortably close to its knees was the the scale of the reputational damage, which came close to destroying BP's 'licence to operate'.
Oil companies need to get a grip on reputational risk. Reputation is a valuable, strategic asset even though it is not even mentioned in most balance sheets. For a well regarded company, reputational capital represents a large proportion of the share price. As Warren Buffett put it, “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently.”
Failure to identify reputational risks means that the opportunity to manage and reduce risks to this valuable strategic asset is lost. Unfortunately, traditional risk analysis techniques miss large swathes of reputational risk. And by revealing some reputational risks, they lull practitioners into thinking they have found them all. The truth is that many are very hard to find.
So it is no surprise that BP seems to have been unaware of important risks to its once-valuable reputation. Yet looked at with the right analytical approach and experience, it is now predictable whether (and why and how) a serious accident for a large company is likely to mushroom from a crisis into a reputational catastrophe. Timing is of course something else.
Unfortunately these new analytical tools, designed systematically to uncover and assess risks to reputation, were not widely available before the crisis struck.
Better, independent, safety regulation is essential, but it is not enough. Oil companies need to understand their reputations, systematically find and catalogue their reputational risks and fix the foundations. Otherwise the next oil spill to hit global headlines won't just damage the company involved. It could set back the whole industry.
Activist investor groupings such as Ceres, Calpers and Hermes should encourage investee companies to understand their reputations, systematically analyse and understand the risks – and take a proactive approach to making their reputations sustainable.
As Bill Margaritis of FedEx put it, “A good reputation can be a life saver in a crisis and a tail wind when you have an opportunity.” But the best reputation won't save you if it is built on hope and good intentions. You need solid foundations.
As Bill Margaritis of FedEx put it, “A good reputation can be a life saver in a crisis and a tail wind when you have an opportunity.” But the best reputation won't save you if it is built on hope and good intentions. You need solid foundations.
Anthony Fitzsimmons
