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 Management Decision
‡ Simulate the environment where a recommendation is
made to management regarding the implementation of
DEMA
± Quantitative environmental risk analysis decision making model
(DEMA)
± 
  




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 #
‡ From a decision framework to assess risk through a qualitative and
judgmental evaluation to quantitative system
± A superior system is where a quantitative analysis informs experienced
judgment
± DEMA is used on a test basis in the refinery in Richmond,
California, and Chevron Overseas Petroleum Inc. (COPI), should it
be implemented company wide?

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 ïhe Process
‡ ïeams physically organize in their groups.
‡ A team (volunteer) states their case
‡ Other teams should:
± Support other teams specific statements with
explanations
± Debate other teams specific statements with
explanations
± Add related considerations to specific topic being
discussed
‡ A second/third team should state their case

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Discuss the following to conclude
the discussion
 Case questions
‡ What risks is Chevron management worried about?
‡ If you are the CEO at Chevron, are you more worried
that line managers in the field will spend too much
money on environmental risk management, or are you
worried that they won¶t spend enough?
‡ Is Chevron using the right tools for managing
environmental business risk? Why do the tools differ
from those used to manage other types of business risk?
‡ Should Chevron make company wide use of quantitative
risk management tools like DEMA?

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 What risks is Chevron management
worried about?
‡ Risk of damage to the natural environment, human health,
and corporate profitability or all of the above
‡ Environmental externalities and impact on public goods at


 of their value chain
± Public good, non rival (one¶s consumption does not impact others)
and non excludable (consumption can not be restricted)
‡ A cake is not a public good
± ïheir value chain --from raw material extraction to the pump
± Contingent environmental costs (cleanup costs, example
superfund, RCRA) from past operations
± Cleanup in the future related to current operations

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 What risks is Chevron management
worried about?
‡ Cost of business interruption
‡ Loss of goodwill and reputation
± How sensitive is Chevron to goodwill and reputation?
‡ Is Chevron concerned about protecting firm value
or are they concerned about the environment?
± Are these the same things?
± How does a firm executive think of environmental risk
compared to an executive of an environmental NGO?

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 Specific risks
‡ ïransportation of crude oil and refined products
‡ Leaking underground tanks at service stations
contaminate ground water
‡ Emissions from the tail pipe
± Smog
± Particulate matter
± Greenhouse gasses
‡ Other businesses
± Coal mining
± Chemical manufacture
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 Factors that impact environmental
business risk
‡ ïhe probabilities of different adverse events
± Example: marine oil spill
± mitigate by investing in double-hulled tankers to reduce the probability of
a spill
‡ ïhe total social burden if an event occurs
± Invest in rapid response cleanup teams to reduce the social burden
‡ ïhe fraction of those burdens for which the firm is responsible
± Buy insurance against a spill reducing the fraction of the burden for which
the firm is responsible in exchange for a premium
‡ ïhe quality of the information that is available to the firm for each of
the above items
± Conduct research on the causes and consequences of spills

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 ïools to manage environmental risk

‡ ïool 1: Internal command and control regulation

± Policy 530
‡ ïool 2: Employee education and training programs to reduce the
probability and severity of environmental damage
‡ ïool 3: Corporate wide emergency response programs reduce expected
losses
‡ ïool 4: Insure against environmental liability risk with external
contracts
‡ ïool 5: Management evaluation and promotion as tool for creating
incentives
± Environmental performance does not play a large role in determining
managers¶ bonuses
‡ ïool 6: Implicit threat of ³consequences´

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 If you are the CEO at Chevron, are you more worried that line
managers in the field will spend too much, or not enough
money on environmental risk management?
‡ ïools 1 and 2 lead to increased investment in
environmental risk management
‡ ïools 3 and 4 lead to decreased investment in
environmental risk management because they are partially
protected from the consequences of an accident
± Mitigated by the size of the deductible
‡ ïool 5 may increase investment in environmental risk
management unless they belie short term profits are a more
important determinant of bonuses.
‡ ïool 6 will increase managers investment in risk reduction

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 Should Chevron be more systematic and
analytical in managing environmental risk?

‡ Understand true costs of environmental incidents

‡ Effect of different investments on the probability
and magnitude of those incidents
‡ Will this effort make environmental risk
management more efficient?
‡ Is this possible given the incomplete information
available to make these decisions?

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 Possible answers
‡ Answer #1: Yes because the system will clarify
the true costs and benefits of different risk
reduction proposals and enable the company to
reduce more risk for a smaller outlay.
± Experience with DEMA at the Richmond refinery and
internal operations
± DEMA saved ³several millions´ at the Richmond
refinery.
± Richmond is 5% of Chevron¶s total income
± An attempt at an estimate: Several million is $3 million
times 20 equals a company wide savings of $60 million

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 Possible answers

‡ Answer #2: Yes because it forces long-term

consequences of current behavior
± Without some analytical system like DEMA long term
consequences of current practices could be ignored.
‡ ïhis would transfer risks to future shareholders
‡ In an efficient market with full understanding of risks long
term consequences should impact current stock price
± ïhe increased managerial attention from a system
brings about greater creativity with respect to risk
management and greater efficiency

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 Possible answers
‡ Answer #3: No, because although the improved
analytical capability is valuable, it is outweighed
by the additional risk of bad publicity that a firm
creates by generating and using explicit valuations
of different risk endpoints.
± Environmental groups, communities where the
company does business and government regulators will
not react favorably to company tradeoffs between
environmental quality or community safety against
dollar opportunity costs of different risk reduction
proposals.

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 Possible answers

‡ Answer #4: No, because the improved

analytical capability is not very valuable.
± ïhe conversion factors are bound to be so
arbitrary that they will not provide any useful
information.
± Arbitrary conversion factors will undermine
line managers and external stakeholders
confidence in the company¶s environmental
management system as a whole.
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 Possible answers
‡ Answer #5: No, because DEMA is intended to
maximize net benefits and this may not be the
appropriate goal for corporate risk management.
± DEMA compares projects expected values
± Does not include intangibles, biases and high level
experience
± Example two projects that cost $500,000 with expected
values of $1 million
‡ Project A reduces from 50% to 40% the probability of an event
that will cost $10 million if it occurs
‡ Project B reduces from .01% to 0 the probability of an event
that will cost $10 Billion if it occurs

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Where on the value chain does Chevron¶s
environmental risk start and stop?

± Environmental risk for the value chain --from

raw material extraction to the pump
± Does chevron need to manage environmental
risk past the pump?

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 Connection between environmental
risk and economic risk?
‡ Is Chevron¶s goal to manage environmental risk or
are they really managing both short and long term
economic risk?
‡ Is management of any type of business risk
(interest rate risk, foreign exchange risk etc.) a
subset of management of economic risk?
‡ Insurance is the hedge for managing
environmental risk
± More difficult to manage than financial risk (e.g.
currency risk) where instruments exist to hedge risk

à