Sanford Lewis, Counsel
Investor Environmental Health Network
ABSTRACT: Just as the paradigm of integrated corporate reporting begins to gain momentum, the BP oil spill highlighted significant shortcomings of current reporting standards and practice. Mere “integration” of current financial and sustainability disclosure standards could yield little more than “integrated spin,” neglecting substantial areas of risk.
To be of value, integration must include concepts poorly handled under current sustainability and financial disclosure standards:
1) Require timely corporate disclosure of substantial enforcement notices, orders and allegations issued by regulators;
2) Require corporate disclosure of credible scientific reports and concerns indicative of potentially catastrophic risks of a company’s products and activities, regardless of scientific uncertainty as to the likelihood of such disaster scenarios.
3) Require corporate disclosure of any facts or circumstances that may be needed to ensure that the management’s self-portrait of its sustainability strategies, goals and progress is not materially misleading.
-----------------------------
After decades of work by NGOs and investors to develop globally applicable corporate sustainability reporting standards, 2010 was a watershed year. The formation of the International Integrated Reporting Committee in August 2010, with its distinguished membership from accounting, regulatory, and government sectors, evokes endorsement of the idea of integrating socially relevant data into corporate annual reports.
But in the same year, the Deepwater Horizon oil spill highlighted shortcomings of existing financial and sustainability disclosure standards and practice. Viewed in retrospect, it is apparent that both BP’s financial and sustainability reports veiled core weaknesses in how the company managed pivotal issues of maintenance and safety. Assertions of NGOs that BP’s sustainability claims were greenwash came through with a vengeance. As such, the Deepwater Horizon experience provides essential lessons for thinking about how to ensure effective integrated reporting, rather than “integrated spin.”
BP and its Sustainability Reporting: a Model Corporate Citizen?
The Global Reporting Initiative (GRI) is a network-based organization that has developed a framework for sustainability reporting. This standardized framework aims to assess organizational performance on multiple fronts, such as commitment to sustainable development and reducing greenhouse gas emissions.
BP is a prominent and touted GRI sustainability reporter. It has even received awards and recognition for its Global Reporting Initiative formatted reports. Some investors may have chosen to increase or sustain their investing in the company because its reporting made it “best in class.”
Although BP sustainability reports from 2005 through 2009 portrayed a company of high values and integrity, they omitted disclosure of available facts, opinions and metrics that would have contradicted this portrayal. Simple integration of BP’s flawed sustainability reports with its financial reports would not have yielded a useful “integrated report” from the standpoint of stakeholders. It would only have established “integrated spin.”
The Global Reporting Initiative’s Guidance for preparation of GRI sustainability reports (currently referred to as the G3, as in third-generation of guidance) emphasizes the need for a company to “Describe the Management Approach” to an issue – asking companies and their managers to offer their rendition of corporate goals, policies, and practices. Consistent with this guidance the BP sustainability report of 2005 , reported these excellent company goals and values:
Our values.
Responsible. We are committed to the safety and development of our people and the communities and societies in which we operate. We aim for no accidents, no harm to people and no damage to the environment.
Performance driven. We deliver on our promises through continuous improvement and safe, reliable operations.
These values guide us in the conduct of our business. In all our business we expect our people to meet high ethical standards and to act in accordance with our code of conduct.
The 2005 sustainability report also contained nearly 1000 words explaining in detail the company’s risk management processes; the reader was given the impression that the company was doing much to manage risks to both its finances and its stakeholders. In retrospect, however, the following passage and the risk management section may seem particularly prescient:
Risks to our reputation could be created if it is perceived that our actions are not aligned to our high standards of corporate citizenship and our aspirations to contribute to a better quality of life through our products and services. For example, risks could arise from incidents of non-compliance with laws and regulation or ethical misconduct; or if it is perceived that we are not respecting or advancing the economic and social progress of the communities in which we operate.
The Jarring Reality of BP Safety Culture
In contrast to the shining image of a company working hard towards sustainability and safety presented in the company’s sustainability reports, in the aftermath of Deepwater Horizon numerous reviews suggest a company that was cutting corners on safety spending. Numerous press articles after the Deepwater Horizon disaster asserted that there was a persistent cultural problem, skimping on safety, at BP. For instance, an AP story that was typical, described the problem in numerous ways. Associated Press, “Documents: BP cut corners in days before blowout,” June 15, 2010.
- “BP made a series of money-saving shortcuts and blunders that dramatically increased the danger of a destructive oil spill in a well that an engineer ominously described as a 'nightmare' just six days before the blowout.”
- BP rejected the advice of Halliburton, Inc, a subcontractor, in preparing a cementing job to close up the well. Halliburton recommended using 21 centralizers to make sure the casing ran down the center of the well bore. Instead, BP used 6 centralizers. In an email on April 16th, a BP official in the centralizer decision said, “It will take 10 hours to install them, I do not like this.” Another official responded, recognizing the risks of proceeding with insufficient centralizers, but commented “Who cares, it's done, end of story, will probably be fine.” – Id.
- Waxman and Stupak (Congressional Energy Subcomittee on oversight and investigations) state that “the common feature of these five decisions [questionable decisions BP made before the explosion], is that they posed a trade-off between cost and well safety.” – Id.
Oil industry expert and geophysicist Roger N. Anderson was interviewed by Columbia Magazine about the technical aspects of the Gulf of Mexico disaster. He noted that drilling mud is expensive. He is quoted in the magazine as saying:
- “They were also rushing to finish the well, which had been fighting them the whole time, making them weeks behind schedule. The people on the rig called it the “Well from Hell.” On the morning of April 20, the crew from Transocean (the owner of the rig), over the strong objections of their own drilling superintendent, was ordered by BP to take the heavy drilling mud out of the drill pipe and replace it with seawater. That was the triggering event that allowed the gas and oil to blow out onto the Deepwater Horizon rig floor — then a random spark ignited a tremendous explosion. The rig sank, allowing the free release of the pressure and the energy of all that oil and gas into the ocean. The rest is history.” [emphasis added]
Examining Company Follow-up on the Texas City Refinery Disaster
It will take years for the courts to determine the degree to which BP was at fault in events leading to the Deepwater Horizon disaster.
However, examination of other aspects of the company’s record bear out the notion that an internal culture of cost cutting contrasted with its external disclosures of diligent attention to safety. See, for instance: Years of Internal BP Probes Warned That Neglect Could Lead to Accidents, Pro Publica, June 7, 2010.
Perhaps nowhere is the contrast between how the company portrayed itself in its sustainability reporting and its actual practices better illustrated than the record of disclosures and actions after the Texas City oil refinery disaster of 2005. BP was assessed $50 million in penalties for felony safety violations leading to the disaster. The company’s 2005 sustainability report expressed remorse for what happened in Texas City, where 15 employees were killed and 170 people were injured in the massive explosion. In the aftermath of the disaster, BP sustainability reports portrayed a company that was learning from experience and moving toward safer performance. The company sought to present an image in which unsafe operations were a thing of the past. In its 2005 Sustainability report BP noted:
- “We responded to the industrial accident at the Texas city refinery with a thorough investigation and a fundamental review of systems and processes, leading to a range of new measures and investments being taken to maintain the safety of our people and the integrity of our plant”
Over the intervening years, the company reported various investigations and programs that to improve safety. For example in its 2009 BP Sustainability Report the company noted in its continuing follow-up on Texas City that:
- “BP continued to make significant progress in delivering its programmes to strengthen process safety capability at all levels.”
- “BP has taken a number of steps to strengthen its process safety culture, and its leaders support process safety positively and sincerely.”
- We have taken action to close out our six-point plan, launched in 2006 to address immediate priorities for improving process safety and operational risk management at our operations worldwide, following the incident at Texas City in 2005 involving a fire, explosion, fatalities and injuries.
No doubt, the company must have improved safety in some areas of its operations. It abated about 500 of the 900 or so issues identified by Occupational Safety and Health Administration (OSHA) as needing abating after the Texas City disaster. OSHA also found hundreds of other instances in which the company had not done the needed abatement -- violations in instrumentation controls in the complicated Texas City refinery that were identified as lacking in 2005. The OSHA reinspection completed in October 2009 found 439 instances of “willful” violations, most or all of which were designated with gravity of 10 on a scale of 1 to 10. OSHA stated that:
“Our information indicates that for some identified hazards, BP either has not specified or allocated the specific layers of protection needed, and for other identified hazards where BP has specified the layers of protection it will use to control the hazards, the specified instrument controls have not been installed or are not operational.”
In September 2009, OSHA issued a warning that its audit had identified “systemic deviations from the industry standards” at the Texas City facility that had yet to be addressed. Specifically, areas of concern included a failure, four years after the blast, to complete a determination of which alarm functions in each unit were critical to process safety. “BP given new warning over Texas refinery,” Financial Times, (FT.com), September 23, 2009.
Despite notices of these violations and the availability of that information online on the OSHA website, neither the company’s 2009 annual report filed with the SEC nor its 2009 GRI sustainability report contained reference to this enormous volume of pending willful violations of the highest possible gravity. On August 12, 2010, OSHA reached an agreement with BP for it to pay a $50.6 million penalty for these failure to abate violations. OSHA reported this was by far the largest penalty ever paid.
It is worth emphasis here, that these were not violations leading to the Texas City disaster of 2005; they were violations occurring afterwards due to the failure of BP to follow through and implement the needed fixes. The Secretary of Labor stated, “the size of the penalty rightly reflects BP's disregard for workplace safety.” The Assistant Sec. of Labor added: “ It is perfectly within BP's financial means to make this facility safe and they've admitted they have the ability to make it safe.”
Little if anything was reported by the company on OSHA allegations during the 2009 reporting year. However, the company’s 2009 sustainability report Did contain the following cryptic statement regarding safety instrumented systems:
Safety Instrumented Systems (SIS) – US Refining developed a portfolio-wide plan to mitigate higher-level process risks through measures such as SIS by 2016. Lower-level risks will be mitigated on a site-by-site basis. More than 40 SISs are now in service at US refineries, but elements of the SIS life cycle management systems that are required by BP’s internal standards, including SIS documentation, training and auditing, remain to be implemented on these existing systems. US Refining is developing a plan to address these requirements.
Was this statement actually referring in part to the fact that the company was deferring instrumentation system fixes that were deemed grave violations by OSHA? Did the reference to higher-level “process risks” include the 439 instances identified in the Texas City plant that needed immediate remediation according to OSHA? If so, it would have been of interest to readers to know that this timetable of completion by 2016 was inconsistent with the timetable expected by regulators overseeing remedial solutions at Texas City.
Descriptions of the “Management Approach”: an Invitation to “Spin”?
As noted above, the guidance for GRI sustainability reports encourages companies to “Describe the Management Approach” to various issues. The expression “management approach” is used at least 26 times in the G3 Reporting Guidance, the currently operative guidelines for corporate sustainability reporting. Typically, the guidance asks the management to describe the relevant corporate goals, policies, and broadly speaking, their practices. It turns out that it is very easy for management to describe a strategy, policy or goal that may give stakeholders an impression that the company is “doing the right thing.” These statements of management approach can be relatively subjective; is not so easy to ascertain whether the reporting company is “walking its talk” or only presenting an idealized, marketing version of internal realities.
The undisclosed realities of internal corporate culture can easily trump a company’s self-portrait of strategy. As Marcy Murninghan of the Murninghan Post has noted in personal correspondence with the author, the strong pressure on companies to issue these reports can easily create two side-by-side cultures within BP and other firms – a culture of reporting and a culture of practice. While the reporting culture may focus on stating the kinds of values and goals that would be coherent and admirable when viewed by outside stakeholders, the culture of operational practice may nevertheless perpetuate the worst tendencies, focusing on short-term profitability and cost minimization. Current sustainability disclosure standards do not require disclosure of potentially contradictory evidence -- documenting when regulators or scientists find the company’s practices, implementation or behavior inconsistent with “management’s approach.”
Some observers have gone as far to state that in current practice the sustainability report should be understood as a corporate marketing tool rather than an effective means of holding companies accountable on sustainability issues.
Nevertheless, company reputations may be elevated, rightly or wrongly, by sustainability reporting that principally describes the management approach. Such reporting went a long way to seeing BP recognized for its efforts in sustainability. For instance,Fortune magazine ranked BP as the 9th out of 10 most accountable big companies in 2008. The Global Reporting Initiative (GRI) listed BP as a finalist for two categories in the Readers’ Choice Awards for sustainability reporting.
Integrating EHS Personnel to Integrated Reporting: Beyond Sustainability Marketing
Issues of compliance and safety have been a poor stepchild of the forward-looking criteria of sustainability performance encouraged by the GRI reporting framework. The reduced emphasis on legal compliance issues is probably attributable to the outlook that “compliance” is a lagging indicator of companies’ forward-looking, innovative performance and planning – activities that go “beyond compliance.” But, in the aftermath of Deepwater Horizon as well as the Massey Energy coal mining disaster, we understand that knowing the status of a company’s current regulatory compliance challenges is a baseline for understanding risk.
Regulatory inspectors engage in some of the most detailed examination of facilities and products – the fact that they are finding and alleging problems can be some of the most important information for stakeholders to know when it comes to sustainability risk. Yet under current reporting frameworks, “sustainability” personnel work to portray the forward-looking vision of a company in addressing energy and resource management issues, while the environmental health and safety (EHS) staff of the same company may be wrestling with issues of prevention and compliance that are not necessarily reflected in the public sustainability reports. Effective “integration” may mean, among other things, recovering significant sources of intelligence regarding risk and management that current sustainability reporting frameworks fail to capture.
Bridging the Regulatory Disclosure Gap
While issues of legal and regulatory compliance may be a lagging indicator of sustainability innovation, we now understand they represent a baseline needed by investors, and can be leading indicators of sustainability risk.
The recently enacted Financial Reform Act in the US includes new disclosure requirements for mining companies regarding certain serious enforcement actions, orders and penalties issued to coal mining operations only. This set of disclosures goes much further, and with much more specificity, than what is otherwise required to be disclosed in SEC filings regarding ongoing litigation and enforcement actions. The new disclosure requirements can be an inspiration and model for new standards by sustainability and financial regulators –extending far beyond the coal mining sector, to provide an approach for all sectors where compliance issues may be a leading indicator of sustainability risk.
Going beyond the coal mining example, in the US and worldwide, most health or safety related regulators have categories of violations that are “severe,” or “health threatening.” Disclosure standards should include metrics that ensure disclosure and breakdowns of the number of such major violations once they are alleged by regulators. In addition, certain types of agency actions should be designated as per se material and trigger disclosure requirements:
- Order to close facilities based on health and safety concerns.
- Order to withdraw products based on health and safety concerns.
- Suspension of existing or new permitting for any period of time based on health and safety concerns.
- Cumulative amounts of penalties paid.
Disclosing Scientific Literature Findings Regarding Catastrophic Risk
Where, as with BP, the scientific literature is full of credible studies showing hazards of a company’s products or activities, disclosure of these risks is necessary, but not consistently disclosed in sustainability or financial reporting. What is needed is less the management’s assessment of such studies, but rather an objective trigger for disclosure when a company’s activities – e.g. a major product line or activity like deepwater drilling – are implicated by studies warning of catastrophic risks.
Although treated as news after the Deepwater Horizon disaster, the uncertainties and risks of Deepwater drilling were well documented in industry literature. As energy companies transitioned from shallow to deepwater oil drilling, experts identified several technical problems resulting from the more extreme conditions. Higher pressures, for instance, can cause seals to fail and choke and kill lines to collapse. Similarly, the lower water temperatures can affect the ability of seals to function. Other concerns include the formation of hydrates, which plug equipment.
Most importantly, many experts were concerned about the inability to control blowouts if they should occur—a prescient sentiment given the Deepwater Horizon spill. In a 1999 article Offshore: World Trends and Technology for Offshore Oil and Gas Operations, Paul Saulnier of Cudd Well Control admitted that well control companies had not been putting enough resources into developing methods to control deepwater drilling blowouts. In recognition of such concerns, the International Association of Drilling Contractors (IADC) and the Offshore Operators Committee (OOC) sponsored a task force to develop guidelines for deepwater drilling between 1997 and 1998. The report details many of the potential problems and solution of deepwater drilling, recognizing that “a serious deepwater incident could set deepwater exploration and development back many years.”
The US National Commission on the BP Deepwater Horizon oil spill and offshore drilling, convened after the spill, reiterates that these deep water drilling concerns were known within the industry, in its “Brief History of Offshore Oil Drilling”:
It was also recognized within the petroleum industry that deepwater conditions create special challenges for critical equipment, including the blowout preventer. In a 2007 article in Drilling Contractor, Melvyn Whitby of Cameron’s Drilling System Group described how blowout preventer (BOP) requirements got tougher as drilling went deeper. “Today,” he said, “a subsea BOP can be required to operate in water depths of greater than 10,000 ft, at pressures of up to 15,000 psi and even 25,000 psi, with internal wellbore fluid temperatures up to 400° F and external immersed temperatures coming close to freezing (34° F).” One possible enhancement he discussed involved taking advantage of advances in metallurgy to use higher-strength materials in ram connecting rods or ram-shafts in the BOP. He suggested that “some fundamental paradigm shifts” were needed across a broad range of BOP technologies to deal with deepwater conditions.
* * *
Perhaps the greatest risk factor was the very feature that made the deepwater boom so big in the first place. The prodigious flow rates in the deepwater help create “elephants,” industry slang for wells whose production is considered especially high by historic standards. Such fields have very high daily output and good overall economics. But in cases of an uncontrolled blowout, high flow rate becomes the enemy as great volumes of oil and gas are spewed into the environment. This special risk of the turbidite reservoirs was both obvious and largely ignored in public discussions before April 2010.
Were Public Information and BP’s Securities Filings Sufficient to Forewarn Investors?
Although most of the specifics discussed above were not in BP securities filings and financial reports, it is also true that some investors were able to read the handwriting on the wall about BP’s practices and risk-taking just based on some of the visible problems the company had, and reported in its Form 20-F (foreign company annual report ) filed with the Securities and Exchange Commission. For instance, the 2005 Texas City refinery disaster and its resulting felony charges, and the 2006 Prudhoe Bay Alaska oil spill resulting from corroded pipelines, were public knowledge and disclosed in the company’s filings. This information was sufficient warning to some investors to decide to disinvest from BP, despite the company’s artful sustainability presentations and branding.
The financial reports also reportedly revealed BP spending that was significantly lower than some other companies, which also could have been seen as a warning flag. However, assessing just how much this was effective frugality, and how much it involved cutting corners on necessary safety or maintenance, would be difficult to do without added disclosure.
Even though some information was available, the company’s state-of-the-art sustainability reporting and relative lack of public visibility of ongoing regulatory enforcement charges, especially in relation to Texas City, surely painted a confusing picture for other investors.
Going Forward Toward Truly Integrated Reporting
The new momentum for integrated reporting, combining financial and sustainability reporting in a single report, poses numerous challenges for those who have been laboring for these years to develop the idea of sustainability reporting. GRI Deputy Chief Executive Nelmara Arbex said that "the goal for refinement of GRI standards over the next few years is to develop a "standard ready" reporting framework, one that is ready for adoption by regulators, financial analysts, among other stakeholders."
Presumably, such standards would also be geared to preventing the kind of “spin” that was evident in the BP reporting experience.
From the standpoint of many investors and NGOs, and as amplified by the BP experience, the standards developed by GRI still have many gaps and shortcomings, and a need for inclusion of additional metrics to provide some of the most material information needed on corporate risk and performance related to sustainability. Yet there is also a cross current of concerns raised by the reporting community, seeking to reduce the volume of reporting and find those “fewer” metrics for sustainability that “really matter.”
Various scenarios exist to reconcile these two views. For instance, the new emphasis on integrated reporting could yield a global practice of issuing streamlined integrated reports, while disclosure of additional, standardized, periodic and real-time sustainability data and analysis exists on company websites for those who wish to drill down further.
Recommendations for Integrated Reporting
Whether integrated reporting reflects integration of sustainability reporting standards into financial annual report requirements, or a new set of standards that adopt some elements of sustainability reporting, to avoid “integrated spin” there is a need for inclusion of criteria currently neglected in both sustainability and financial reporting practice.
1. Disclosure standards should include metrics that ensure timely disclosure and breakdowns of the number of major violations once they are alleged by regulators. In addition, certain types of agency actions should be designated as per se material and trigger disclosure requirements:
- Orders to close facilities based on health and safety concerns.
- Orders to withdraw products based on health and safety concerns.
- Suspension of existing or new permitting for any period of time based on health and safety concerns.
- Cumulative amounts of penalties paid.
2. Standards should require disclosure of emerging scientific and technical issues that demonstrate the potential for catastrophic risks to humans, the environment or society.
• Disclosures should summarize credible scientific studies that may relate to public health or environmental risks associated with potentially catastrophic risks of products or activities. The disclosure of these significant developments should be required even if there is scientific debate or uncertainty, such as some studies finding a lack of such impacts.
• Describe the severity and scale of the potential problem, such as the percentage of the company's expected sales volume that a potentially problematic product comprises, the potential extent of workplace exposures where materials are used in the fabrication of goods, or overall potential human health effects and to the greatest extent possible qualitatively or quantitatively describe the magnitude of potential liabilities or opportunities associated with the issue.
• Review measures being taken to minimize adverse impacts or maximize business opportunities associated with the issue. Examples could include consumer education, research, materials modification or substitution, development of new products or services, exposure reduction, public policy efforts, fieldwork, third-party auditing, adoption of new codes, insurance, employee training or other actions.
3. Require disclosure of any additional information needed to ensure that sustainability disclosures are not materially misleading.
The existing GRI guidance already contains general provisions requiring under many of the categories of disclosure that reporting companies provide additional relevant information required to understand organizational performance, such as:
• Key successes and shortcomings;
• Major organizational risks and opportunities;
• Major changes in the reporting period to systems or structures to improve performance.
This approach utilized by GRI still represents the process of self portraiture. Instead, analysis should be required from the standpoint of a reader -- asking whether they would be misled by what they are reading. Integrated reporting should adapt the principle applicable to all disclosures to investors under SEC rules – the standing obligation to disclose any additional information necessary to make what has been disclosed not materially misleading. SEC Rule 10b-5.
As integration brings disclosure of sustainability data into the context of legal credibility checks and enforcement, and further from the suspicion of being a mere marketing tool, such a generic requirement for disclosure of information necessary to not mislead the reader will be an important litmus test.
Conclusion
Robert G. Eccles, who convened the Harvard Business School Integrated Reporting conference, and who is coauthor with Mike P. Krzus of the seminal book on the topic, “One Report: Integrated Reporting for a Sustainable Strategy” says that he has been asked by various observers whether effective integrated reporting could have prevented the Deepwater Horizon oil spill.
Certainly that is a lot to ask of any disclosure standard. Nevertheless, it is possible that if a company like BP were more accountable for how it balances efficient business operations and the prevention of harm to society, it might make better, more precautionary decisions that would avoid some of these catastrophes. Certainly, “integrated reporting” will never replace regulatory controls or civil society; we can hope that it would synergize with other elements in the corporate internal and external environment to produce true corporate social responsibility.
The author wishes to thank Genevieve Byrne and intern Samantha Ostrowski for their research assistance on this paper and Adam Kanzer, Marcy Murninghan, Bill Baue, Richard Liroff and John Harrington for their helpful review and feedback. Any errors or omissions are my own.
