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How Energy Companies Reduce Risk

Risk is always a double-edged sword; the greater the exposure, the greater the risk — but also the greater the opportunity for profits. Some prefer conservative operations, expecting continual, long-term profits to grow the organization. Others choose to embrace the risk, believing that their ability to avoid it better than others will lead to a short-term windfall and a quickly expanding presence in the marketplace.

Where a company falls on that sliding scale depends on its risk appetite. (Unfortunately, too many companies never clearly define exactly what their risk appetite is … but that’s a whole other story for another post.)

Energy companies often embrace risk.

In the video below, faculty from Harvard Business School discuss this fact and professor Forest L. Reinhardt sums up the general attitude that those in the sector have towards risk. “The fundamental question for energy leaders is what risks they confront and how they can most cheaply reduce the exposures that they don’t want while getting compensated for bearing exposures that they want to retain.”

Of course, in energy, an industry whose risks are often — literally — volatile, failures of risk management stand out gravely when they occur. Lives can be the collateral damage. There has been a rash of high-profile catastrophes related to the energy sector of late: Gulf oil spill, Massey mine collapse, the Chilean mine rescue and the San Bruno explosion, to name just those that made major headlines. The contentious safety and environmental debates over deepwater oil drilling (and the equipment used), hydrofracking for natural gas and extracting crude from tar sands have opened other worm cans.

Meanwhile, energy companies are among the most profitable in the world. Three of the top four companies on this year’s Fortune 500 list, for example, make their money off of energy. (Exxon is second after Walmart, followed by Chevron and ConocoPhillips.) Seven others whose operations focus on petroleum or pipelines appear in the top 100. (#24. Valero. #29. Marathon Oil. #68. Sunoco. #74. Hess. #80. Enterprise Products Partners. #99. Plains All American Pipeline.)

Does the recent wave of disasters represent unlucky streak that will inevitably happen from time to time in any industry that faces such extreme risks? Or are perhaps too many companies within the energy realm being too cavalier with their risk appetite?

I’m not qualified to answer that question. And any company is of course entitled to shower its shareholders with wealth if they can make it while obeying relevant laws and regulations. But it seems as though, even in a sector as competitive as this, companies could re-invest a larger percentage of the profits into loss prevention without significantly hurting their quarterly results.

Could Hydrofracking Cause Cancer?

Hydraulic fracturing (hydrofracking), or the fracturing of rocks far below the earth’s surface for the recovery of oil and natural gas, has become a hot topic of conversation among conservatives, liberals and environmentalists, to name just a few interested parties. And most would agree — fracking is a controversial issue.

Environmentalists denounce the idea because of the risks posed to not only the environment, but also to humans.

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In fact, a recent Democratic report states that millions of gallons of hazardous chemicals and known carcinogens were injected into wells by leading oil and gas service companies.

Between 2005 and 2009, drillers injected 32 million gallons of fluids containing diesel into wells in 19 states, an investigation by Representative Henry A.

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Waxman (D-Calif.) concludes. Just as it recovers its footing from the 2010 Gulf of Mexico oil spill, the Administration faces a new threat, again involving a risky drilling technology and charges of lax regulation. Obama is “evaluating the need for new safeguards for drilling,” says White House spokesman Clark W. Stevens. “It’s likely that the science is going to say we need to regulate fracking,” says Tyson Slocum, director of the energy program for Public Citizen, a liberal advocacy group.

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“But Obama’s political team is going to say don’t regulate, and I think the political team will win.”

Though the Democratic report may ignite a firestorm, there are some who truly believe in the benefits of fracking. Scientists claim that switching to natural gas, the cleanest of the fossil fuels, could help slow the approach of climate change by cutting carbon dioxide emissions by 17%.

So with growing criticism towards fracking, but staunch supporters of the gas extraction method, we are left to make our own conclusions. Do the risks outweigh the benefits?

Check out the June issue of Risk Management for an in-depth article on the risks fracking presents to the insurance and reinsurance industry.