Reference no: EM13880303

As noted in the text, top management of BP adopted a "lax" approach to safety in its aggressive pursuit of oil discovery. Consider two alternative safety stances it could have adopted. Emulating Exxon Mobil, BP might have taken an "ultraconservative" approach to safety, implementing extensive training of personnel, allowing for generous margins of error, closely monitoring drilling operations, and formulating backup systems and contingency plans in the event of an emerging drilling problem. Or

it could have taken a "standard" middle-of-road approach, closely following accepted safety practices of other firms in the industry.
Consider an oil drilling site that is expected to yield $2 billion in profit over its economic life, if no unforeseen disasters or spills occur. By following standard safety practices, BP can limit the risk of a disastrous spill to a 1 percent probability. The cost of adopting standard safety practices (in terms of time and money) at the site is $160 million. Instead, adopting an ultraconservative approach (at a cost of $240 million) would reduce the disaster risk to .5 percent. Finally, BP's lax safety approach costs only $40 million and implies a disaster risk of 3 percent.

a. If a disaster were to occur, the best estimate of the ultimate cost to BP is $10 billion. This expected-value estimate considers a range of costs-from the tens of millions if an oil spill is immediately plugged by emergency measures to as high as $40 billion (BP's estimated cost of the 2010 spill) in the worst-case scenario. Of the three operating options, which is most profitable? Equivalently, which has the lowest net expected cost?

b. How would BP's operating choice change if, because of wishful thinking, it (wrongly) believed that its lenient safety policy implied only a 2 percent disaster risk? Or if it believed that its expected disaster cost would be $5 billion (instead of $10 billion)?