06.23.10

Operations Abstracted : Company Crashed

Posted in News Commentary at 8:16 pm by steve

“What the hell did we do to deserve this?” - Tony Hayward CEO of BP after the Deepwater Horizon spill.

“Who cares, it’s done, end of story, will probably be fine” - unidentified BP employee in an e-mail before the Deepwater Horizon spill (Economist 19JUN2010 p65.) writing about the use of six centralizers rather than the 21 recommended by the drilling company.

On April 20th Deepwater Horizon burped, blew up, and started spewing oil at what is now estimated to be 60,000 barrels per day. In one hundred twenty days, that’s just short of 2 million barrels of oil. And at $100 / barrel, that amounts to about $200 million in lost product alone. Add to that the cleanup cost which could reach nearly $ 100 billion and the accident begins to look like a rather costly error.

For some brief period of time there was some question about whether this was simply a case of bad fortune. But within days of the accident it became clear that BP systematically cut corners over the whole life of the project. The quotation above suggests that BP employees knew that their work was shoddy; but hoped for the best.

A similar situation held for the piping. Virtually all major oil companies use double walled pipe, but BP chose to use cheaper single walled one, even though the decision violated their own standard

There were problems with the blowout preventer leaking hydraulic fluid and failing tests. Tests of the cement job were unsatisfactory.

It is common practice to circulate drilling mud before removing it in order to remove any gas that it has absorbed precisely to prevent blowouts. BP skipped this step. Similarly, there were serious questions about the quality of the cement job, due in part to the decision not to circulate and degas the drilling mud.

Arguments between the drilling company, Transocean and BP broke out on the rig days before the accident about how to remove the drilling mud. Transocean employees argued that BP’s method took unnecessary and potentially dangerous risks, to which BP’s Mr. Harrell said - referring to the faulty blowout protector - “I guess that’s what we have those pinchers for.” But on the day of the accident, the guy running to push the activation button didn’t get there in time. So we’ll never know whether it would have worked.

The stories about this accident demonstrate a theme. The theme is that BP considered being on time and under budget much more important than it considered safety. And that’s a culture of the company that goes back at least four years. It was in May of 2007 when John Browne resigned after the Prudhoe Bay oil spill and the Texas City refinery explosion that killed 15 employees. One explanation was a pattern of “willful and egregious” (Economist)breaches of safety procedures. Another explanation was that BP had systematically fired its most experienced and most technically savvy employees and had promoted its movers and shakers - the guys who did best at cutting corners. See also, the kind of guy’s who would write “… end of story, will probably be fine.”

Soon after Tony Hayward took the reigns from John Browne he decided to reorient the company. The goal was to improve shareholder value (at least in the short term). He eliminated the alternative energy operations, rendering the newly minted “Beyond Petroleum” slogan to mean nothing, literally. Nothing lay beyond petroleum for BP.

In May 2009, almost a year before the Gulf coast oil spill, Hayward gave a lecture at the Stanford Business school in which he outlined the many problems that he faced when he came to BP. A major issue, he noted, was that “We had too many people that [sic] were working to save the world. We had sort of lost track of the fact that our primary purpose in life is to create value for our shareholders…our primary purpose in life was not to save the world.”

BP’s “Beyond Petroleum” rebranding was, admittedly, the work of Hayward’s predecessor, Lord Browne, and Hayward was focused on developing the company’s core competencies. Then again, with only 6% of BP’s capital expenditure going into renewable energy sources, it’s not as if the company’s radical change ever extended much beyond its PR campaign.

See full article from DailyFinance: http://srph.it/9D107T

The question of how to treat alternative energy is an old one in oil companies: “Are we a primary energy company, or are we just an oil company?” Every oil company has people who believe passionately in one version or the other. One argument is that oil production and refining is a core competency, and that other forms of energy require other technologies and other forms of marketing and are, therefore, distractions. But if you are going to use the argument that you will focus on oil because that is your core competency, you really ought to be good at it.

If Tony Hayward came to Washington and said, “Sorry, we put our best people on alternative energy precisely because we want to end the dependency on oil,” then the appropriate response would be “Well you need to be better at doing oil, don’t you?” And that could be the end of the discussion. But if you have sacked all your best oil engineers because they cost too much, and if you have cut corners in every conceivable measure in the drilling operation - taking exceptions to industry standards and practices at every step, and if you have killed all the alternative energy programs, then it looks like the only concern you have is the bottom line - safety be damned. And after a huge accident such as Deepwater Horizon, it looks like you have been penny wise and dollar foolish.

It’s not behavior that helps the customer. It’s not behavior that helps the public. And ultimately, it’s not behavior that helps the shareholder. BP lost half it’s market capitalization as a result of the accident. And they suspended their dividends - which will make a lot of Brits, Her Majesty included, very upset.

But the failure to behave in a way consistent with generating long term value is not unique to the top levels of BP. It affects other companies.

People at the highest levels of any corporation at times need to abstract the operations of their companies in various ways in order to avoid getting bogged down in details. So operations of all sorts are viewed as black boxes. It’s both necessary and appropriate to do, sometimes.

But one of the great temptations is to view all operations as black boxes that work pretty much regardless of what you do to them, carefully ignoring all the details regarding what is required to make them work. The second half of the problem is to view the profits that operations produce as simply the difference between the cost of inputs and the revenue from sales. If you put these views together without any other information, the only logical step in maximizing profits is to increase sales and to cut costs.

One cuts costs fastest by cutting people. And one cuts the most expensive people first. Sometimes much can be gained by cutting corners in raw materials or processes. Or by cutting out safety redundancies in projects. But in this frame of thinking, because the operation is abstracted at the highest levels and is assumed to work regardless of conditions or constraints, then cutting costs on people or on materials, or on projects, or on quality assurance processes by definition cannot affect the outcome of operations. Operations keep on working, regardless. In this view of the unconditionally functional black box, there can be no straw that breaks the camel’s back.

What happened to BP resembles this in many ways. They kept cutting costs on pipe maintenance until oil leaked at Prudhoe Bay. They kept cutting operating costs at the Texas City refinery until it blew up. They kept cutting costs in drilling until they had produced the most costly oil leak in the history of the US. It demonstrates a serious problem in corporate culture, a problem that goes all the way to the top of the company.

Interestingly, what is happening at BP resembles what has recently been going on at Johnson and Johnson. In a Business Week interview, six or eight years ago soon after he became chairman of the board, Bill Weldon presaged his primary approach to managing the company. The days of 30% per year revenue growth were gone for good, he announced. So the company would have to cut costs.

Wave after wave of hiring freezes and job cuts followed. The first several cuts evidently produced no problems that were serious. But over the last year a significant portion of the products produced by J&J’s consumer pharmaceuticals company within J&J has been removed from the marketplace for quality defects. And the FDA is contemplating filing criminal charges against J&J employees. It’s a black eye for the most visible part of J&J’s business, and it will change for a decade or two how people judge J&J’s commitment to the quality of its products.

In all the details, BP’s Deepwater Horizon accident and J&J’s consumer products recalls are different. But in at least one way they are the same. They arose from a rather profound failure of one or more of the people at the top of the corporation to acknowledge the crucial importance of operations - a failure to acknowledge that cutting costs might start by cutting fat, but it eventually slices away muscle and bone and essential organs until, eventually, the body collapses or bleeds to death.

Treating operations as a black box that always functions, regardless of how it is treated, can produce serious problems. The further the CEO gets from operations, the more likely is the failure. Hubris, and the arts of networking and persuasion are crucial tools for CEOs. Many times CEOs succeed in getting their way because nearly all the constraints they face are political; it is, therefore, tempting for them to believe that the only political constraints exist. And to behave accordingly

But in the end, the real world does constrain our actions. It’s why we have standards and tests and procedures inside companies and in governmental agencies. It’s why companies and governmental agencies hire, train, and retain good people. It’s why CEO’s need to listen carefully and provide the resources for people to do their jobs properly. It’s why sprawling corporations have compliance and process excellence departments that report to the highest levels of the corporation, not to managers of individual business units. And it’s why CEO’s need to be quick to fire people who cut corners in order bolster profits.

Eventually, treating operations as a little black box that just keeps on cranking out profits - no matter what you do to it - will be the beginning of the end for your company.

06.14.10

Resource Wars

Posted in News Commentary, Politics at 4:15 pm by steve

Any science fiction or futurist writer worth his weight in muddy water would tell you that one of the more realistic plots for how civilization grinds to a a bloody end involves protracted resource wars between major players. There is a sense in which both of the first two World Wars can be viewed as resource wars. Japan sought access to cheap resources throughout Asia. Germany sought access to cheap resources throughout the mideast. And British fought to keep access to cheap resources in Africa, India, and the Far East. Ultimately, it is about who is to control resources that virtually every war is fought.

When Dubya invaded Iraq and the rest of the world declared that the whole thing was a charade, an elaborate grab for oil resources, most Americans were skeptical. But now that we see what has happened since, it seems like a most plausible explanation. The control of oil is, indeed, the most economically salient outcome of the invasion.

Iraq has the second largest proven reserves of oil in the whole world, surpassed only by the stated reserves of Saudi Arabia. And since Saudi Arabia keeps their stated reserves constant regardless how much oil they withdraw, nobody completely believes those statements. Which means that Iraq may hold more oil than any nation in the world. Regardless of rank, there are 112 billion barrels of proven reserves and almost twice that much in speculative reserves. At $100 per barrel, the value of the oil exceeds $10 trillion.

The US has spent in excess of $1 trillion on the war in Iraq. It has spent more than half a billion dollars on building the embassy alone. These acts suggest a seriousness of purpose. More telling are the permanent bases it intends to occupy indefinitely outside of populous areas, and the fact that they are located not far from the oil fields they are designed to protect. There can be no question that one [presumed] outcome of the invasion is the political stabilization of the area and improved access to the oil found there. Even the negotiations with Iraqis over the pricing of oil sought major pricing concessions that would have brought significant excess profits to the oil majors who operated there. So there simply can be no question about whether oil was a major motivating factor. The only question is whether it was the only motivating factor.

(I have never heard it argued before, but I think it is worth arguing that the US was willing to move out of South Vietnam at the point where it was decided that synthetic rubbers could do the job once done by natural latex rubbers and therefore Vietnam was no longer a source of an essential strategic resource. Without any rubber, the US’ major industry at the time - the auto industry - would fail. With rubber it would thrive.)

There never was any question about whether the war in Iraq was about terrorism. The Saddam regime was hostile to al Qaida and to radical Wahibbists in general. It was a regime interested in commerce with the west and with the Orient. And it was strongly motivated by sanctions.

Similarly, there never was much question about whether the war in Iraq was about weapons of mass destruction. Iraq had quite visibly dismantled its WMD programs. And there never was much evidence to the contrary. Furthermore, WMD is never the real reason one nation invades another. At least until the statehood of Israel it was assumed that a nation had the right to defend itself against aggressors with what armaments it could assemble.

What of the role of neocons? Neocons had grabbed the reigns of public opinion in the US and controlled most of the high-powered policy decision-making in Washington. Richly financed by the arms industry who sorely needed real action in order to justify continued lavish defense department expenditures exceeding half a trillion dollars per year, Neocons manufactured rationalizations for the war in Iraq. There can be some doubt, however, whether their arguments were purely mercenary or whether they were calculated to serve the interests of some other group.

They had, after all, advocated a US led occupation of Iraq and Iran some years before 2001, suggesting that war with Iraq and Iran had nothing to do with terrorism, in their minds. The level of preparedness for the invasions and for the bodies of law that followed the putative trigger to the invasion is remarkable, suggesting almost prescience on their part. Or perhaps when one prepares to invade nations to extract their resources, a considerable amount of the right kind of theater makes the job politically possible.

The fact that there exists something in excess of $10 trillion of proven oil reserves in Iraq, the fact that there might be two or three times that quantity there, the fact that political instability threatened access to those reserves, and the fact that an occupying force provides powerful incentive to create political stability within Iraq ought to be sufficient to suggest rather forcefully that the primary motivating force for the invasion was access to oil.

The invasion of Afghanistan has always made a little less sense. Afghanistan was the source of opium valued recently at more than $50 billion per year, and the Taliban had shut down the trade in the year prior to the invasion. After the invasion, the trade bourgeoned. So if one were to imagine, hypothetically, that the parties who benefitted most from this revenue stream also were officials instrumental in making the decision to invade Afghanistan, then the invasion would begin to make sense as a means of restoring the opium trade and the revenue that flowed from it. But it was easy to wonder if that was all. In comparison to the bountiful resources captured in Iraq, Afghanistan hardly seems worthwhile. At least until today.

A story in today’s New York Times sets Afghanistan’s mineral wealth in excess of $1 trillion, pronouncing its bounty huge in comparison even to the rich trade in opiates. Bear in mind that it will take twenty years at least to develop and extract its mineral wealth and $50 billion for 20 years is $1 trillion; therefore, if the mineral resources dwarf the opiate trade we are talking more of three or five or ten trillion dollars worth of resources.

This story begins to bring us closer to understanding the real reason for the invasion. The article suggests that this is new information. It also suggests that the information was known by the Soviets during their occupation of Afghanistan in the 1980’s but was unknown and ignored by the US until some time in the last coupla years. That’s a little hard to believe.

Perhaps it is true that before the survey spoken of in the article, the quantity and quality of Afghanistan’s mineral wealth was less certain; but there can be little question that it was completely unknown. Satellite reconnaissance could have scoured the rocky terrain of the country using special spectrographic techniques that would reveal the concentration of every valuable mineral known to man over almost every square foot of the nation. And this could have been done, probably, in the ‘nineties. So a very good estimate of the mineral wealth there could have been known to high level officials a decade ago, maybe two. The specialists who reported back recently could have merely been doing verification work, not exploration work.

So if we consider the total mineral wealth of Afghanistan and Iraq to be a minimum of $20 trillion and possibly as much as $30 trillion or more, and if we consider that the people who profit most from this mineral wealth will be using other people’s money to secure access to it, then the invasions of both countries would seem like a great deal for them.

The hypothetical question is: if there were to exist a great pot of money that was between $20 trillion and $30 trillion in size; and if that pot of money is known to only to a small group of military-industrialists, and if that group needed a good story to provide political cover to use military force to grab the loot, what do you suppose they might do?

If you stood a chance of getting $10 million for a pivotal part in selling half-truths and outright lies to the American public in support of a goal of access to $10 trillion worth of minerals, what would you do? What do you think your next door neighbor would do?

I mean, after all: those resources are unavailable until the region is politically stable. So the invasion physically improves the lives of all who benefit from the commercial successes of industry and trade as practiced in Europe, North America, and Asia. Doesn’t the end justify the means?

Of course it is impossible to prove just by examining events how people were individually motivated, but there can be no question that the wars in Afghanistan and Iraq gave western nations access to tens of trillions of dollars worth of strategic mineral resources that might have been unavailable otherwise. There can be little question that access to resources figured prominently in the decision to go to war. And that no war could be publicly justified on these terms, so there had to be another reason for public consumption.

The resource wars have begun.

06.05.10

Obama and Slippery Slope Reasoning

Posted in Energy - NonRenewable, Politics at 9:37 pm by steve

Who’s Bad?
From all the press about Obama and the oil well, you’d think that the President himself descended a mile beneath the Gulf and chewed through the steel pipeline with his own teeth. Had he actually done this, then I think one could argue that the oil spill in the Gulf was at least partly his own fault. But he didn’t. And it isn’t.

So why are political opponents trying to tar and feather Obama for the Gulf Coast oil spill? Let’s look at some possible reasons:

1) It happened on his watch. In 1883 Krakatoa erupted, sending 21 cubic kilometers of earth into the atmosphere. Chester Arthur was President of the US at the time. Despite this disaster, historians judge Arthur on his achievement in passing the Civil Service Reform Act. Lots of things happen on a President’s watch that are not his fault. Katrina itself was not Dubya’s fault. The disaster itself was not the problem. The lack of response was not even the problem. The problem was a rather wretched and deep denial that there was a problem. It was Dubya’s insistence that everything was under control when, in fact, almost nothing was being done. It was denial of a problem when there was a very real problem and denial of services by a federal agency whose reason for existence was to provide those services.

There is no such agency for oil spills. And there was no denial of the problem.

2) Obama advocated for offshore drilling. According to a book review in a recent issue of the Economist, a recent executive of Royal Dutch Shell argues that the reason for the spill is that US policy has forbidden drilling in easy places offshore; therefore oil companies must drill in difficult places. Had oil drilling along the eastern seaboard been allowed - as Obama advocated days before the disaster - BP would not have been drilling where it did in the Gulf. It’s a self-serving argument. It’s not clear that the depth of the well contributed at all to the problem. In fact, it is possible that a deeper well might have made control of the high pressure gas a little easier. So while agreeing with this executive would help our argument, we find it difficult to agree.

Still, it is one thing to advocate for offshore drilling in a responsible way. It is another to chant “Drill, baby, drill” like some mantra by a crazed sex addict. One is an act of reason; the other an act of mischievous passion.

Curiously, it is the people who yelled loudest “Drill, baby, Drill” who are most shrill in their criticism of Obama on this issue. So if we were to give them credit for possessing a shred of sanity, it is impossible that they would be arguing “We ought to drill offshore, but Obama is insane for advocating it.”

3) Katrina and Oil are both disasters to hit the Louisiana coast. Bush got blamed for Katrina; therefore Obama must get blamed for Oil.
In other words, it’s a habit of the mind. Habits of the mind are frequently quite illogical; and they frequently produce ideas that are completely false. But their effects can be quite persistent. So we need to look at this a little more closely.

Katrina is not Deepwater

What do these two events have in common.
1) They affected the Gulf Coast.
2) People were hurt.
3) The effect was big.
4) Someone was president at the time.
5) Both stories got a lot of attention from a bored press.

What is different about these two events:
1) Katrina was a natural disaster. The oil leak is a man-made one.

2) There were several days’ warning in advance of Katrina, none for the oil disaster. So the federal agency charged with preparing for natural disasters, FEMA, could have been doing something to make sure that it was ready to help if help were needed. No such agency exists for oil spills. Even if we were to assume it might be a good idea to cobble together such an agency (and it’s not) it would take years of political wrangling to get it operational.

3) The problem in New Orleans was the failure of a safety system for which the federal government had direct responsibility. The problem with the oil well was the failure of a company to adhere to the highest standard of safety processes. A Wall Street Journal investigation discussed in The Week clearly establishes nearly half a dozen distinct points at which BP departed from industry best practices, sometimes with stark criticism from their contractors. Even procedures required by the US government permit may have been ignored.

4) It is reasonable to make governmental entities responsible in helping to minimize damage during hurricanes and other natural disasters, it is reasonable to expect the government to be responsive when natural disasters strike. Agencies are charged with the task and their work is funded. It is not reasonable, however, to make governmental entities responsible for minimizing damage caused by man-made disasters, especially when those disasters are caused by profit-maximizing activities of companies that externalize the cost of failures. To do so tempts the most egregious abuses. Both the mortgage system bubble and the blown well in the Gulf are examples. Governments ought to step in not to save the institutions themselves, but to save American taxpayers from ruinous results. Sometimes, as in the case of TARP the one has required the other.

5) Bush attempted to use the Katrina disaster for grandstanding purposes; Obama has attempted to use the oil disaster as an opportunity to tighten up what little control the federal government has over the permitting process.

6) Bush supporters have, since Reagan uttered the incantation “Government is the Problem”, argued that less government oversight is unconditionally better. Such reasoning increased the probability of damage from events such as Katrina. Such reasoning increased the probability of an oil spill disaster such as the one in the Gulf. Such reasoning led to the deregulation of the banking industry that led to the need for the TARP program.

In short, it was the idea that “government is the problem” that underlay the real problem in both cases. That Obama opponents don’t immediately see this and capitulate on this dangerous mythology is testimony to the idea that hubris and deception too often trump reason and interest in the common good in US politics.

7) Katrina and events like it are inevitable. They are conditions of nature that arise regardless of how we behave. The question is in how to deal with them. The Bush Administration dealt with them by not showing up for a while. While we would like to believe that spills from offshore oil wells are avoidable - this is the first one in about forty years - they are likely to occur so long those who drill wells are not held to the highest standards and held accountable when they fail to adhere to those standards. In this respect, Obama has been showing up.

What ought to be baffling to most sane people is the idea that government has no place in regulating the behavior of oil companies; but that it is fully responsible for cleaning up their messes. What kind of a world does that create? A little more care in drilling probably would have averted this particular disaster. And that extra care might have cost a few millions of dollars. But instead, we have a spill that could cost billions in lost product and tens of billions to clean up. Limits on liability externalize that cost, shifting it to taxpayers. If oil companies had to pay more, they would have less incentive to cut corners, and the cost of oil production for them and for us could be a little lower, once the cost of big disasters is properly accounted for as a cost of production.

Oil Must Flow
Americans are totally dependent on oil. It is a dangerous addiction. And it is an addiction impossible to cure before the oil runs out. Until that time, even if we could spill enough oil into the oceans to kill every kind of marine life found there, we will be drilling for oil in the oceans. There is no other choice. To do otherwise means giving up most of the conveniences that we enjoy: things like food and water, good jobs, internet connectivity, and so on. Cheap energy got us all this stuff. And when cheap energy is gone, so will be the stuff. My grandparents lived without the aid of fossil fuel and theirs was a hard life filled with privation. I am not prepared to live it. Neither, I think, is the greenest of the radical greens.

So the oil must flow. What responsibility does Obama have? He has the responsibility to use the event to fix problems inside the federal government’s permitting office. He has a responsibility to use this event to frame America’s oil dependency as a problem. He has the responsibility to push for laws that hold oil companies liable for larger fines when they have some measure of culpability in oil spills.

Moral Hazard
Obama, however, has absolutely no responsibility to protect anyone from the fallout. While it is reasonable to see the government play a role in responses to natural disasters, it is less reasonable that the government should play a role in cleaning up disasters caused by failures of large corporations. TARP, for instance, was not about saving bankers from the consequences of their own bad decisions, it was about saving the American public from those consequences. The American government does not have the expertise to clean up oil spills. Nor is there any reason it should. If oil spills are to be a regular part of American life, then oil companies must be responsible for doing it themselves, or for funding third party efforts to do it.

It might be tempting to say that because no single entity has as many resources to clean up disasters as the federal government, that it ought to be the responsible party. In the case of natural disasters, it makes sense. But in the case of disasters caused by institutions that are acting irresponsibly in order to increase profits as is the case for banks and for oil companies, this line of thinking invites the very kind of excesses that cause disasters.

This is one slippery slope we cannot afford to slide down.