Environmental Risk Management: Take It Back from the Lawyers and Engineers
Merkl, Andreas, Robinson, Harry, The McKinsey Quarterly
It's time to follow three new golden rules
Matching the right risks with the right remedies and the right owners
Corporate environmental liabilities in the United States now stand at more than $250 billion. Many remain hidden on balance sheets, only to emerge as surprising and painful charges against earnings. Despite the scale of the problem, most corporations do not manage the environment as an integral part of their everyday activities. Because of legal and technical complexities and the emotional and public relations baggage associated with environmental matters, basic business principles are rarely applied to environmental risks. Instead, the facile mantra of "zero risk, zero violations" echoes in corporate boardrooms across the land. As a result, environmental liabilities are managed piecemeal by lawyers and engineers who lack the training, tools, and incentives to tackle them systematically.
This need not be the case. The solutions to risk management issues are multiplying, permitting unprecedented discretion, flexibility, and effectiveness in the management of risk. The benefits of using the new tools and taking a systematic approach to managing environmental risk are huge. A typical oil or chemical company can avoid creating new liabilities and see its current ones fall by 20 to 40 percent.
We believe them are three basic rules for developing integrated environmental risk management:
* Rule 1: Focus on risk, not liability (invest in the right risk)
* Rule 2: Choose your weapons carefully (invest in the right remedy)
* Rule 3: Don't keep it all to yourself (find the right owner).
Let's consider how these three rules operate in a hypothetical case: the Goodoil company. Goodoil is active in oil exploration, refining, and distribution. Its pipeline division has a portfolio of over 100 remediation sites, ranging from simple storage tank leaks to potentially disastrous large spills into high-flow aquifers. In response to recent legal action, top management has issued a call for a comprehensive assessment of liabilities and an action plan for wiping out existing liabilities and moving toward a "zero spill" operating environment.
Rule 1: Focus on risk, not liability
Influenced by lawyers and engineers, many companies focus their efforts on those sites with the greatest liabilities. As we will see, this doesn't make much sense. Such sites are often the poorest candidates for investigation and investment.
A better approach is to target risk, not liability, and to look at two criteria: the possibility that a liability might escalate in scope and cost, and the availability of efficient solutions. Goodoil would do better, for instance, to spend its resources on a $500,000 problem that is rapidly worsening - because physical contamination is spreading, legal standards are becoming stricter, or lawsuits are being filed - than on a $10,000,000 site that is essentially stable.
Segmenting Goodoil's environmental portfolio in line with Exhibit 1 yields the following hierarchy of sites:
Immediate remediation (act while you study). Goodoil's portfolio includes several sites that qualify for immediate remediation: the potential for cost escalation is high and efficient solutions are available. Consider a site where two pumps are leaking small amounts of refined gasoline close to waterways and community wells. The damage could be considerable, but the solution is straightforward: build berms around the pumps, and excavate as necessary. In a handful of urban sites, the cost of immediate remediation is dwarfed by the benefits, setting the stage for an accelerated remediation approach.
Many companies fail to act on cases like this because no regulatory or shareholder pressure is being brought to bear, and budgets have little room for discretionary expenditure. Yet these are the only sites that must be dealt with immediately; money spent here is earned back many times oven To characterize sites in this way can steer regulators away from mandating endless remediation of sites that pose no change in health risk, and toward the far more productive reduction of genuine risk. …