How Conflicts of Interest Hinder Offshore Drilling Regulation

Business will never embrace regulation. The market yearns to be free and regulation, most of the time, places restrictions on unbridled capitalism. Some rules improve the competitive landscape for nearly all stakeholders, but that is the rare case.

One constant problem regarding regulation is the question of who does the regulating.

In order to provide proper oversight of something, you naturally must know a good deal about it. For example, if you have never traded securities on Wall Street, it is very difficult to have enough knowledge of all the nuanced realities that take place in that arena. This is just common sense. You can study, research and inquire as much as you want, but there will always be something lacking in your understanding if you have no first-hand experience.

Generally, the ideal person to oversee something, particularly when it is a complex, specialized marketplace, is a person from that marketplace.

Of course, the rub is that anyone who has existed within that marketplace long enough to learn all these complexities will also have developed relationships and biases. If Steve the securities trader worked in a trading room for 20 years, he likely was passed over for jobs by some companies and had a bi-weekly steak dinner with peers from various firms. He developed affinity for some companies and colleagues while developing resentment for other industry players and practices. So if he is to later become a watchdog of those people, it is hard to believe he will not bring those biases with him — intentionally or not — in his rule enforcement.

The SEC and Treasury departments have long been criticized for this.

The offshore drilling regulation world is similar. And a new report by AP shows just how pervasive the concern is among industry players and regulators with interests in the Gulf of Mexico.

Documents obtained by The Associated Press show that about 1 of every 5 employees of 109 involved in inspections in the Gulf has been recused from some duties because of the risk of coming into contact with a family member or friend working for a company the inspector regulates. Ten people hired since mid-August 2008 were barred for two years from performing work where they could be in a position of policing their previous employer—a company or contractor operating offshore.

In the Lafayette, La., office of the Bureau of Ocean Energy Management, Enforcement and Regulation nearly 35 percent of inspectors have been disqualified because a friend or relative works for a company they could interact with on the job. In Lake Charles, La., nearly 30 percent of inspectors held their last job with an oil and gas company, meaning they can’t perform any duties involving their former employer for two years.

The numbers come from recusal forms under a new ethics policy instituted last year by the Obama administration to identify and prevent possible conflicts of interest before they arise.

Offshore drilling regulation does not have the resources or manpower of the SEC. So it is important that the smaller number of people regulating this segment of the energy sector do so well. And who else but industry vets could know all the ins and outs surrounding practices like ensuring proper anchoring standards for various types of oil rigs, installing blowout preventers and determining safe levels for gas releases?

Then again, if so many of the public servants (at least in name) transitioning from industry to the regulation side of things, how can you trust them to leave their biases at the door? (Especially when there is, like Wall Street, a revolving door practice of people who go from industry to regulation and then back to industry?)

In an ideal world, you would hope that a person who becomes a regulator could take that responsibility seriously enough that their conflicts of interest, while real, do not impede them from creating and enforcing good rules to govern the industry.

And I’m sure that in many instances, that would be the case. But these recusal policies are understandably necessary. And the degree to which they are being issued perhaps highlights a larger question.

How can a regulatory body properly operate when up to 35% of its inspectors are deemed to have conflicts of interest?

The Gulf Oil Spill: One Year Later

One year ago today, there was an explosion on BP’s Deepwater Horizon oil rig in the Gulf of Mexico that ignited a fire that killed 11 workers. The inferno blazed for two more days before the giant metal structure succumbed, collapsing to the seabed and triggering the largest environmental disaster in the history of the United States.

We didn’t know the full extent of the spill for a few more weeks, but now that we do, we will be spending years trying to learn all the lessons of this horrible catastrophe.

Today, on the anniversary of what started it all, I spoke about the fallout of the Gulf spill with Bob Glasser, or as he’s better known in the industry, “BI Bob,” managing director and head of the business interruption and insurance claims practice at BDO Consulting.

Oil on a beach in Gulf Shores, Alabama, June 12, 2010

Jared Wade: What was your immediate reaction last April when you actually started to understand the gravity of the Deepwater Horizon explosion?

Bob Glasser: We thought that due to an explosion on the oil rig, there would have been a property damage that could have been a peril that would have triggered a lot of insurance claims under contingent business interruption. Everyone thought that was the tie-in to trigger their policies. But apparently, I mean I have to be frank, I have not been involved in one insurance claim associated with this catastrophic event — which is just unbelievable. I’ve only been involved with filing business claims against the Gulf Coast Claims Facility.

Many companies, the big hotel chains, for example, had coverage for all this, but their policies didn’t respond due to exclusions. When you’re dealing with your major hotel chains that have extremely sophisticated manuscript policies, I’ve spoken with them and we’re all scratching our head about how they could have had different language in their policy that would have covered this. It just ended up being not a coverable event — as was the volcanic eruption [last summer]. It was a catastrophe in itself that ended up being a non-coverable event because there was no property damage and there were no real triggers that gave rise to getting coverage for a business interruption loss.

Two unique situations within one year that no one would have ever anticipated and, yet, the insurance industry went unscathed.

Wade: Would you say then that this is a wake-up call for risk managers to some of these so-called “black swan” events? The main thing with insurance is that it gives you the peace of mind that if something goes wrong, you have a policy for that. But if two things can happen in one year where the language is such that it isn’t covered even though it was related to perils you thought you had coverage for, doesn’t that stress that risk managers need to be a little more creative in negotiations to get better language?

Glasser: Correct. Broader language and possibly fewer exclusions — going to, perhaps, a more “all risk”-type policy. And for all we know, policies in 2011 and 2012 will, in certain industries, have language dealing with volcanic eruption and how their policy will respond to it. If you’re willing to pay a premium to transfer the risk associated with loss of business — you always have to balance how much the premium is worth to transfer that risk to someone else — if companies deem that that balance is worth it, insurance companies surely will contemplate and look into covering that event.

Same thing with the Gulf oil spill. There may be broader language in future policies to talk about oil spills. Because when people contemplated pollution exclusions, they were really thinking more of sewage or other things happening over time. Because the impact on tourism wasn’t an “event,” it got excluded. But [the Gulf spill] was certainly an event on one day where, all of the sudden over a number of months, millions of gallons of oil went to the Gulf coast.

So you could have a redefinition of what is a covered peril with either broader language or specific language that addresses an oil spill and a volcanic eruption. And then, when the next unusual thing comes about, there will be an extension of a coverage covering that next unique thing.

Wade: So it almost seems that these insurance policies are sort of standing on the shoulders of what came before them? These events are unforeseeable as far as falling under a broad coverage that a lot of companies would have demand for. So when something strange happens, it sort of wakes everyone up?

Glasser: Certainly. Look at 9/11. And also what is happening in the Middle East and Northern Africa. Who would have thought so many countries within such short a period of time would have such political unrest and try to overthrow the leader in power. So it may open up the eyes of many different companies that may not have cared about political risk insurance. But now, maybe they get products from Egypt. Maybe they get products from Saudi Arabia — other than oil. And maybe they need coverage now. So, yes, as things happen, coverage evolves and capacity opens up to cover insureds with a desire to buy insurance.

Wade: So then does it behoove risk managers to try to think ahead to foresee everything that could possibly go wrong and then get that coverage before it becomes in demand? You could try to negotiate any coverage at any time, right? It’s only once everyone else catches on that it’s going to become expensive.

Glasser: Correct. It always makes sense. And this is where the risk manager has evolved into a much more important role in corporations and organizations. It’s not strictly looking at whether property gets damaged or if someone sues me for D&O coverage or if somebody slips and falls. The risk manager understands, through discussions with their broker, the plethora of coverage available. So it behooves the risk manager to be the facilitator within an organization. To meet with financial management, operational management, logistics management and all the key areas of an organization [and become] the central focus for determining “What happens here? What happens if this goes wrong? What if this happens?”

I recommend to my clients to have these discussions, in major meetings, about whether or not anyone has ever thought about what happens if this one key component becomes unavailable? Or something happens to the shipping lanes in Japan? Or there’s a shortage of containers? Or there’s a Middle East war? Whatever it is, and it may sound silly, but when you come up with the most obscure type of event, you may come up with some very good discussions among senior management as to how you handle it.

Wade: Would you say, then, that the primary duty of the risk management profession now is to not necessarily be the person that can look at all the known perils and find a way to mitigate them but to be a person who can be more of a creative thinker and connect the dots?

Glasser: Absolutely correct. He needs to be a creative thinker to get the strategic and, I’ll say, “catastrophic” thought process going in senior management of an organization so they all think out of the box about what could happen. And that includes thinking about what could happen to your suppliers.

You might not have any physical damage. You could be one big, very-large manufacturer or distributor in the U.S. and you’re not prone to earthquakes, to hurricanes, to tornadoes. You’re not near a river so you’re not going to have flooding. But you source components across the world so now you have to think about what could happen to my major suppliers. Because they’re in Japan. They’re in the Middle East. They’re in Haiti. Wherever. So you need to not only think of you and what could go wrong; you need to get senior management to think about what could happen to your suppliers.

And then on the other hand, you need senior management to think about what could happen to your customers.

If you’re a chemical manufacturer and 40% of your chemicals go into one industry or one customer, you need to think about, what if something happens to that customer? What’s that going to do to my business? If you sell to Walmart — Walmart’s huge, it’s the largest retailer out there — what if something happens to Walmart? Your stream of customers just dried up. It’s probably an unlikely case because nothing’s going to happen to Walmart, but my point is that the risk manager’s role has become more and more important and valued within the C-suite, if you will.

Wade: After the Gulf oil spill, I remember reading about how seafood companies, and even restaurants and commercial fishermen, up in Maine and Massachusetts were dealing with the fallout. It seems that everything has shockwaves now.

Glasser: I’m working with a major food distributor where we were helping them to determine, identify and quantify lost margins due to seafood sales. Not that their seafood sales decreased dramatically, but their profitability decreased dramatically because there was a substantial increase in seafood costs that they couldn’t pass along to customers.

The reality of it is that it did have a global effect. It also had a global effect in tourism. I know in dealing with some major hotels on the west coast of Florida, they had conversations with travel brokers and agents who basically told them that foreign travelers just presumed that all of Florida was covered with oil. And they just said “we’re not going to vacation there this year.”

There were just so many ramifications to what happened in the Gulf Coast.

Learning from Katrina: Storm Surge Protection Is Paramount

dutch dam

On August 29, 2005, the levees that were supposed to protect New Orleans failed catastrophically. The United States Army Corps of Engineers simply did not do the job it was tasked to do. As such, it was found liable for the flooding in court.

“It is the court’s opinion that the negligence of the Corps, in this instance by failing to maintain the MRGO properly, was not policy, but insouciance, myopia and short-sightedness,” U.S. District Court Judge Stanwood Duval Jr. wrote in his lengthy ruling, referring to the Mississippi River-Gulf Outlet canal.
“For over 40 years, the Corps was aware that the Reach II levee protecting Chalmette and the Lower Ninth Ward was going to be compromised by the continued deterioration of the MRGO … The Corps had an opportunity to take a myriad of actions to alleviate this deterioration or rehabilitate this deterioration and failed to do so. Clearly, the expression ‘talk is cheap’ applies here.”

“It is the court’s opinion that the negligence of the Corps, in this instance by failing to maintain the MRGO properly, was not policy, but insouciance, myopia and short-sightedness,” U.S. District Court Judge Stanwood Duval Jr. wrote in his lengthy ruling, referring to the Mississippi River-Gulf Outlet canal.

“For over 40 years, the Corps was aware that the Reach II levee protecting Chalmette and the Lower Ninth Ward was going to be compromised by the continued deterioration of the MRGO … The Corps had an opportunity to take a myriad of actions to alleviate this deterioration or rehabilitate this deterioration and failed to do so. Clearly, the expression ‘talk is cheap’ applies here.”

Clearly, the man-made protection was not up to par. The storm surge that rushed inland was too great for it to restrain.

As many have noted in the past five years, however, there were other safeguards that historically protected New Orleans: coastal wetlands and barrier islands. But for decades, as National Geographic notes, these were allowed to erode away to the point that they could offer little resistance to the rising tides that ultimately breached the levees.

When Hurricane Katrina smacked the Gulf Coast in August 2005, the protection from powerful storm surges provided by coastal wetlands and barrier islands had gradually been whittled away. Since the 1930s, Louisiana had lost 1.2 million acres of coastal wetlands. More than two dozen dams and thousands of miles of levees on the Mississippi River had trapped sediment that otherwise would have replenished them. At the same time, wetlands were drained and filled to enable oil and commercial development in the Gulf region. Even as the Army Corps of Engineers failed to adequately maintain levees to keep the floodwaters at bay, this loss of natural protection worsened the catastrophe.

Of course, this is not an issue unique to New Orleans.

Across the globe, protective wetlands are disappearing. At the same time, coastal populations are expanding. The combination is deadly and means that wind storms and flooding that would have been less catastrophic to society just a few decades ago are now inherently capable of creating more damage more easily to more people. The NatGeo piece uses the current, historic flooding in Pakistan and the 2004 Indian Ocean tsunami as examples of major disasters that could have been less disastrous if the natural protective barriers had not been allowed to degrade so dramatically.

With some investment, however, scientists believe that such ecosystems can be restored and again provide protective benefits.

Just as we buy home insurance and life insurance to protect ourselves and our families from catastrophic losses, so society now needs to “buy” disaster insurance to reduce the damage caused by floods and other weather-related events. By strategically investing in the protection and restoration of ecological infrastructure, we can begin to re-gain the benefits of nature’s services.

Some nascent efforts in this direction have at least been floated. Within a month of the Asian tsunami, officials in Indonesia–where more than 126,000 of the tsunami deaths had occurred and where some 1.6 million acres of coastal mangroves had been lost in the preceding few decades–announced a large-scale effort to restore the nation’s mangrove defenses. In the aftermath of Katrina, U.S. scientists have been studying the idea of diverting Mississippi River water back toward Louisiana’s disappearing coastal swamps, to supply the nutrients and sediments needed to rebuild them.

Overall, however, the story is one of inertia, neglect and missed opportunity. After the Great Midwest Flood of 1993, U.S. researchers estimated that restoration of 13 million acres of wetlands in the upper portion of the Mississippi-Missouri watershed, at a cost of $2-3 billion, would have absorbed enough floodwater to have substantially reduced the $16 billion in flood damages from that event. But instead of calling floodplains and wetlands back into active duty, officials in the region permitted even more floodplain development. Nicholas Pinter of Southern Illinois University estimates that 28,000 new homes and 6,630 acres of commercial and industrial development have since sprung up on land that was under water in 1993.

I interviewed former FEMA head James Lee Witt in 2008 (following the Sichuan earthquake in China and Cyclone Nargis that hit Burma soon after), and he was a proponent using natural barriers as well. Here he highlights one of the initiatives he enacted along the riverbanks of the Red River after devastating flooding there in 1997 caused some $3.5 billion in damages.

We utilized the mitigation and buy-out relocation programs [after the flood]. Mayor Pat Owens in Grand Forks [North Dakota] and Mayor Lynn Stauss in East Grand Forks [Minnesota] took all that space and turned it into green, open-space parks. And the Army Corps of Engineers did a fantastic job on the levee work there. You should see that town now. It is a model of prevention.

Mayor Strauss in East Grand Forks took the area we bought out-which still had all the infrastructure, streets and huge trees right along the river-and turned that into an motor home park where people can camp in the summer. It turned into an absolutely beautiful city.

The lesson in all this is that prevention, both natural and man-made, must be prioritized by city planners. If there is a threat of flooding, particularly if the natural barriers that have historically protected the city are disappearing, the municipality must find a way to refortify its shorelines and riverbanks.

Unfortunately, those who propose anything with the words “restore” and “ecosystem” in the same sentence are often quickly dismissed as tree-huggers who are overly concerned with protecting wildlife. With city and state budgets stretched thin, that is not something many citizens can get behind. But it is not about saving the whales — it is about saving people.

And, ultimately, from a protection standpoint, man-made barriers can be just as good in many locations. In New Orleans, for example, they are nearing the completion of a new protection system.

Nearly five years after Katrina and the devastating failures of the levee system, New Orleans is well on its way to getting the protection system Congress ordered: a ring of 350 miles of linked levees, flood walls, gates and pumps that surrounds the city and should defend it against the kind of flooding that in any given year has a 1 percent chance of occurring.

The scale of the nearly $15 billion project, which is not due to be completed until the beginning of next year’s hurricane season, brings to mind an earlier age when the nation built huge works like the Brooklyn Bridge, the Hoover Dam and the Interstate highway system.

The city’s reinforced defenses are already stronger than they were before Katrina. But even after 2011, experts argue, they will still provide less protection than New Orleans needs to avoid serious flooding in massive storms.

This new system is not a Dutch-level engineering marvel that will hold back virtually anything short of Armageddon. You would think that the the death of so many New Orleans residents would have spurred the same “never again” mentality that the Dutch took after they lost 2,000 of their citizens to a flood in 1953 — not the creation of a 100-year protective system (meaning that those who construct it essentially expect it will likely fail within a century when an unusually strong, but not unthinkably strong, storm strikes).

But it is certainly a vast improvement over what existed in 2005.

Now, if we can just get other areas to see the importance of holding back floodwaters before they devastate the community, we will really be making some progress.

Learning from Katrina

hurricane katrina

As we look back upon the fifth anniversary of worst hurricane in U.S. history, two windstorms churn through the Atlantic. The first, Danielle, fortunately veered away from the coastline, its destructive power withering by the hour. The second, Earl, on the other hand, is strengthening, with sustained winds already reaching 135 mph and a trajectory that has the whole Eastern Seaboard on watch.

Katrina taught us many things about disaster preparedness and response. It gave us vivid, appalling visions of a new worst-case scenario. Even more powerfully, Spike Lee put together two gripping documentaries that unveil the true, long-term magnitude of the tragedy, the second of which, If God Is Willing And Da Creek Don’t Rise, recently premiered on HBO and is a much-watch look into just how much the city has suffered — without crumbling — since the floodwaters receded.

At Risk Management magazine, ever since the storm, we have tried to tell some of the city’s other stories. I wrote an article about the New Orleans Museum of Art’s harrowing days after the storm and the commando art restoration team that saved collections throughout the city. Another story detailed how a casino risk manager in the midst of a major merger had to deal with $1 billion in lost property after his company’s riverboat was thrown 2,000 feet by storm surge. And we tried to find some semblance of a silver lining by offering these lessons that all of us can learn from a disaster of this magnitude.

Unfortunately, it seems as though few lessons have actually been learned. Oh, they have been discussed ad nauseum and the outrage expressed has generally been genuine. But actual behavior has largely remained unchanged. Still, most people admit that they are unprepared for disasters.

Hopefully, most companies and organizations are more confident. But many are not — or at least have no cause to be. Along these lines, we plan to spend the rest of this week (and much of September, which is National Preparedness Month) remembering what happened on August 29, 2005, and emphasizing the importance of disaster preparedness and response.

I encourage you to click some of the links above and check back soon for more.