Over its 27-year history, the Center for Chemical Process Safety (CCPS) has observed that the first step toward implementing a strong process-safety-management program is obtaining top-management commitment. The CCPS has learned that communicating the business case for process safety is an important part of the process of obtaining this commitment. Using a fictional incident as a case-study example, this paper will illustrate that process safety can have financial, as well as ethical and professional, benefits.
Introduction
The CCPS has identified four dimensions in which process safety can influence the value of the business:
- Corporate responsibility
- Business flexibility
- Risk reduction
- Sustained value
These dimensions affect financials in both quantitative and qualitative ways, addressing both cost savings and revenue enhancement. Table 1 illustrates the alignment of these four dimensions.
The Incident
One January day several years ago, a major process vapor line ruptured in the core unit of the Phlogiston Chemical Company Western Plant. Minutes later, a serious explosion ripped through the unit. The blast wave dislodged a nearly empty vessel, ripping it from its connecting piping. The vessel contained a toxic material that dispersed downwind, along with thick black smoke from the fire that resulted from the explosion.
The company’s emergency-response team, along with local firefighters, responded rapidly. While residents took shelter, the responders set up a water curtain to mitigate the toxic release and worked to extinguish the fire. Unfortunately, when the response team sounded the all-clear signal 4 hours later, nine workers and one town resident were dead. Another 25 families gave thanks that their loved ones would recover from their injuries.
Ultimately, investigators determined that a main flange in the vapor line had been bolted incorrectly and that the mounting brackets of the vessel containing the toxic material had corroded. A root-cause analysis showed that the technician assigned to the plant’s mechanical-integrity program had simply been “checking the boxes” for the previous 5 years and that management never spot-checked the mechanical-integrity program to verify that it was being practiced as written.
On the day of the accident, Phlogiston’s share price dropped by 5%; the stock dropped 10% the following day and another 10% the next. By the end of the following week, the stock traded at half its preaccident price before recovering to just below its preaccident price, driven by investors seeking a bargain. Those speculators should have known better: 1 month later, the first wrongful-death lawsuits were filed, and 3 months later, the first regulatory fines were levied.
Before long, reconstruction was under way, this time with greatly enhanced (and more-expensive) metallurgy. A brand new safety-integrity-level-3-rated shutdown system had been ordered, as had a state-of-the-art electronic-maintenance-tracking system. The nine lost workers had been replaced, and two additional employees, added to each shift, had been hired and were being trained.
As the following year began, the plant returned to full production. However, the plant’s operating margin was reduced from the period before the accident, and it was clear that if demand dropped, the plant would be the first one of the company’s six similar plants to be shut down. That was no surprise to the management team; what surprised them was that an accident that cost USD 25 million to repair, largely covered by insurance, erased nearly USD 400 million of shareholder value, with the final costs of the incident still undetermined. (Table 2)
The Cost
Profit-and-Loss (P&L) Statement. The P&L statement shows how much money the company earned or lost during the year. First, the total revenue is provided, and then the various categories of operating expense (feedstocks, operating costs, research and development, sales and marketing, and general and administrative) are deducted to leave the operating profit, also called operating earnings.
From operating profit is deducted the various finance costs and taxes (sometimes known as interest, taxes, depreciation, and amortization). The result is the company’s overall profit or earnings. Some analysts refer to operating earnings as “earnings before interest, taxes, depreciation, and amortization,” or EBITDA.
Table 2 demonstrates how the incident affected the company’s P&L during the year of the accident compared with the year before. It is assumed that the USD 25 million replacement cost was amortized (paid over time) at USD 5 million/yr for 5 years.
Cash-Flow Statement. It is important for a company to maintain a source of readily available cash in order to pay employees; buy raw materials and supplies; perform maintenance and replacement; pay travel expenses; and install new capital equipment, as well as meet other general operating expenses. Because of the incident, Phlogiston’s cash supply dropped by USD 25 million, plus the capital replacement cost of USD 25 million, less the amortization of USD 5 million, or USD 45 million. The actual capital replacement cost is used instead of amortization because actual cash is considered, not the tax accounting. Whether this is a problem depends on two things: the normal cash supply maintained by the company and the timing of the cash-flow supply. If the company normally had less than USD 45 million of cash equivalent available, it is clear that it would have needed to find an alternative source of cash. But even USD 45 million might not be enough. As a company accumulates cash through sales and disburses cash for expenses, there may be periods of time when there is a lag between invoices due and payments for goods sold. In such cases, it would again be necessary to find an alternative source of cash.
Balance Sheet (Asset Statement). The ultimate measure of a company’s value is the value of its net assets, as shown on its balance sheet and, by extension, by its book value and share price. To determine the company’s net assets, the value of all capital facilities is first determined. Then, the value of other assets is added, including accounts receivable and inventories. From that quantity is subtracted the company’s liabilities, including amounts borrowed, accounts payable, and amounts that the company knows it must spend in the future as a result of regulatory and legal action.
This interim value is termed the book value. In the absence of complications, at steady state, and in the simplest case in which the company issues only one kind of stock, the book value divided by the number of shares (including shares owned by the company) equals the share price of the company’s stock.
An intangible quantity termed “goodwill” is also added. Goodwill is a quantity that essentially reconciles differences between the share price as determined from tangible net assets on the one hand and the actual share price on the other. Goodwill may be positive, such as in cases in which the company is viewed to be well managed, its earnings are growing steadily, and continued growth is expected. Goodwill may also be negative when the opposite is true. In Phlogiston’s case, the accident clearly affected earnings but also called into question the overall management of the company.
As a result of the accident, the company’s balance sheet was affected severely, with tangible assets reduced because of the sale of some of its business and reduction of inventories to meet demand during the outage. The company reserved USD 20 million against the pension-fund lawsuit, also deducting from assets. The largest impact, however, was that of negative goodwill. Before the accident, the company was considered to be on a healthy, if modest, growth track, with a share price slightly above book value. After the accident, the company was considered damaged and poorly managed, with a number of unquantified potential future liabilities.
How the Case Study Illustrates the Business Case for Process Safety
Corporate Responsibility. The incident resulted in both fines and lawsuits—qualitatively determined costs. Neither of these costs is easy to predict beforehand, and to a great degree their magnitudes tend to be developed in the court of public opinion. As such, their magnitudes can be influenced by the reputation of the company (and indeed the industry) before the accident, and the degree to which the accident becomes perceived as a failure in competence or as the result of neglect. It is to the company’s (and indeed all companies’) benefit to work on enhancing its reputation as a justifiably competent manager of its process hazards.
Business Flexibility. The response to the incident required Phlogiston to dedicate significant resources to investigation, reconstruction, legal defense, and divestiture activity. The company had a choice either to add staff to address all these activities or to divert its existing staff from their normal business of productivity improvement and business growth. Phlogiston chose to add staff. Either way, they would incur a qualitative negative effect on revenue imposed by the loss of business flexibility—there was no choice but to respond to the incident.
The incident caused a second qualitative impact on Phlogiston’s business flexibility. Having had the accident, they lost the trust of the nearby community, which would be difficult to regain, and also lost the trust of communities around their other plants not involved in the incident.
Risk Reduction. The most obvious component of the business case for process safety is the quantitative avoidance of loss-related costs. Phlogiston was fooled by the many years that passed without a major incident, growing to accept their low loss-related costs as a right. From now on, the company should evaluate near-misses to estimate the losses that could have occurred if incidents or minor accidents had occurred under less-fortunate circumstances. The estimate can then be used as a metric to be reduced through the implementation of process-safety improvements.
Sustained Value. Phlogiston’s leadership may have been tempted, in the wake of the damaging financial situation in which they found themselves, to cut spending in process safety as they cut costs in all other areas. Fortunately, they realized that an investment in process safety was an essential part of what they needed to do to rebuild the company. Additionally, after a number of years of demonstrated improved process-safety performance, they were able to realize reduced insurance premiums as well as reduced workers’-compensation costs.
This article, written by JPT Technology Editor Chris Carpenter, contains highlights of paper SPE 157592, “The Business Case for Process Safety,” by Scott Berger, Center for Chemical Process Safety, prepared for the 2012 SPE/APPEA International Conference on Health, Safety, and Environment in Oil and Gas Exploration and Production, Perth, Australia, 11–13 September. The paper has not been peer reviewed.