Strategy Development in the Global Oil, Gas & Petrochemical Industry - British Petroleum - Case Study Example

Global Corporate Strategy: Case Study of the Oil, Gas and Petrochemical Industry 2008 Executive Summary The global oil and gas industry is characterized by a set of paradoxes in which the large and growing yet complex business environment provides immense opportunities for growth yet is ridden with the pitfalls that may result in organizational and social failure. In the pursuit of maximizing shareholders’ value, oil and gas companies often ignore other stakeholders, resulting in issues in corporate governance, business ethics and corporate social responsibility. As a result, dangerous explosions have occurred in BP’s refineries and Shell’s operations have resulted in environmental damages (M&As). As a result of globalization and developments in the global industry, markets and technology, oil and gas companies operate in a very complex business environment. Organizations get access of resources through joint ventures but their success depends on the synergies of the various assets. Lack of synergies, insufficient knowledge management and organizational learning lead global alliances to fail. Therefore, BP needs to adopt organizational learning more seriously so that it can prepare itself for changes in business environment rather than respond to such changes. Only this will allow the company to resolve the paradox between maximizing employee performance and maintain corporate social responsibility. Introduction The oil and gas industry now spreads across various countries. Multinational companies engaged in exploration, production, refining and distribution of oil and gas companies have to operate under diverse business, economic and political factors. As a result, they are faced with issues and paradoxes that are not limited to a particular national or business context. In this paper, I will analyze the corporate governance and ethical issues that prominent oil and gas MNCs, British Petroleum (BP) and Shell, have faced in terms of the stakeholder theory and the agency theory. Then, I will discuss BP’s globalization strategy in terms of transaction cost theory and the resource-based view. Finally, I will discuss the managerial strategy that BP needs to adopt in the context of the complex business environment so that it can adapt to chaotic situations. Corporate Governance and Business Ethics of BP and Shell An organization has a number of stakeholders that it affects and is affected by their behavior as well. The company has extensive duties to stakeholders like employees, customers, suppliers, communities, government and so on. Typically, managerial responsibility of most companies is driven by the goal of maximizing shareholders’ value. But in the presence of various stakeholders of the company interacting in diverse ways, it becomes difficult to meet the goals effectively if the other stakeholders are not addressed to, resulting in paradoxes of the firm’s aims (Heath and Norman, 2004). The stakeholder theory was first suggested by Freeman (1984), who defined a stakeholder of an organization as “any group or individual who can affect or is affected by the achievement of the organization’s objectives” (quoted in Jonker, 2004). The organization needs to manage the stakeholders effectively for a collective development process through proper identification of stakeholders, set up processes to organize relationships with the stakeholders as well as the transactions with them. The stakeholder map, which details the two-way cause and effect between stakeholders and the organization is not static but may change over time with changes in the business as well as the political and social structure (Donaldson and Preston, 1995). Oil companies like BP and Shell have corporate social responsibility to its most important stakeholders, the community. Although oil is the most consumed energy source and expected to remain so in the future, it is the slowest growing energy source. Hence, there is a need for all companies to diversify into sustainable energy sources. Despite the evidence that oil consumption is not sustainable if produced and consumed at the present rate, most companies like BP and Shell concentrate on oil exploration and production instead of natural gas, which is less carbon emitting. Hence, the companies have done little to address the environmental effects of the business (EIA, 2008). Oil and gas companies, in order to minimize costs that would maximize profits and hence shareholders’ value, often overlook critical maintenance and risk-mitigating steps. In 2006, a major pipeline in Alaska that was operated by BP had a leakage that was undetected for many days despite warnings from the company’s employees. The company neglected repair works in order control costs (Common Dreams, 2007). Similarly, in 2005, a BP refinery in Texas exploded, killing 15 and injuring over 100. Even before this, BP plants in Texas faced a number of deadly explosions. This particular plant employed 1,800 workers, refining 433,000 barrels of oil a day, which is 3 percent of the US’ oil supply. In addition to the deaths and the injuries, there were adverse health effects on the 40,000 citizens of Texas City, arising from air contamination through release of carcinogens produced by burning naphtha (World Socialist Web Site, 2005). In the mid 1990s, Shell planned to sink the Brent Spar Oil Platform in the Atlantic Ocean, which would destroy fish in the ocean. In the face of huge opposition, the company had to abandon the plan. Shell was also accused of supporting an authoritarian regime in Nigeria and for destroying fisheries with its Sakhalin II project in Russia. Corporate governance also involves management-employee relationships. According to the agency theory, a firm is system in which the principal wants to induce the other to perform a task in the organization. The principal can bring this about through moral persuasion or through incentives. In a real-life situation, the principal-agent theory takes the form of the employee-employer relationship in which the incentive mechanism does not necessarily function better than the moral persuasion, although the former is emphasized in the literature (Heath and Norman, 2004). Usually, the employer, the employee and the shareholders have a common interest in the success of the company but the interest mechanism does not function always. In such situations that there is a breakdown of harmony, there arise moral hazards. The agency theory may be applied to the case of BP and Shell. The merger of BP and Amoco raised many issues on corporate governance regarding another major stakeholder, the employees leading to a moral hazard. For example, Amoco’s salaries were higher than BP’s. Also, Amoco’s stock option plan had no performance clause and was set at a higher level than BP’s. The issue was resolved by setting the rewards higher and making it performance related. Shell, too, faced corporate governance issues in 2004 when it made a disclosure that it had wrongly categorized 3.9 billion barrels proven reserves of oil. It delivered a report to the General Audit Committee that not only were its business targets not being made but the disclosures on the SEC filings were also erroneous (Financial Director). Hence, the company failed the main principal and stakeholder, the shareholders. Globalization Strategy of BP Since the end of the Cold War in 1989, the global economic order has changed with multinational companies ruling world trade and global economic order (Held and McGrew). Hence, multinational companies are expanding into new markets, especially in the eastern hemisphere, areas which were earlier closed to western companies during the Cold War. BP, in particular, has expanded to countries like Russia and China, which have huge oil and gas resources and large markets for fuel respectively but where closed to BP prior to 1989. The global oil industry is undergoing massive changes, with demand shifting to emerging economies. Emerging economies are the newly industrializing countries that are increasingly consuming more energy. Thus the epicenter of global energy consumption is shifting from industrial to emerging countries. Since the BP-Amoco merger in 1998, BP has expanded globally, mostly concentrating on opening new markets in emerging economies. First, it forged a 50:50 joint venture with TNK in Russia in 2003. TNK-BP has now become the largest oil asset in Russia, including those in west Siberia, the Volga-Urals and East Siberia (bp.com). In 2005, BP-TNK, along with Slavnett Oil and Gas Company in which it owns 50 percent, produced 1.82 million barrels a day. BP-TNK has fiver refineries in Russia and 2,100 retail service stations across Russia. The merger brought BP a huge inventory of old oil fields that other oil and gas majors were not interested. Banking on the BP technology in exploration and production, the venture soon became profitable for BP. But, the business environment in Russia is still not conducive enough for foreign companies, as bureaucracy is still strong. As a result, the joint venture has been in trouble since 2006 as a result of issue of work permits for its employees, after an employee was charged of espionage, and disputes with Gazprom, the state oil and gas utility, over sale of a large oilfield in Siberia and building of pipelines (New York Times, 2008). On the other hand, BP’s joint ventures in China have been more successful. BP has two joint ventures to run more than 700 gas stations in Guangdong and Zhejiang provinces and plans to increase the number to 1000 along the 34,000 km network of roads (China CSR). BP has invested $3 billion in China, boosted by the dizzying economic growth that the country has shown over the last decade. It has three petrochemical units in China, of which two are in joint venture with Sinopec, the largest oil and gas utility in China. BP’s strategy in China is distinctly different from that in Russia. While in Russia, one of the largest oil producing countries, the intention was to acquire oil producing assets, the main driver in China was the fast growth of the economy and hence growing demand for oil. Hence, in China, BP has focused on expanding the retail network (Observer, 2005). In most theoretical literature, joint ventures are analyzed in terms of transaction costs, in terms of market failures of intermediate inputs, asset specificity and uncertainty of performance (Tsang, 2000). On the other hand, the resource based view of the firm begins by assuming that the firm is driven by the aim to gain strategic competitive advantage through which it achieves economic rents and above average returns. For the firm to develop strategic competitive advantage, the firm needs to access key resources that have value, entry and duplication barriers. Through these resources, the firm can develop strategic competitive advantage in the product markets (Fay and Smithy, 1999). According to the resource-based theory, therefore, all strategic choices and decisions of the firm are driven by the management identifying, developing and deploying key resources. The firm’s decision on strategic alliances or M&As, therefore, depends on its view on its internal and external resources and deficiencies/ shortages and the possibilities of accessing key resources required to gain strategic competitive advantage in the particular market. Thus, the transaction cost theory and the resource based view are complimentary in the sense that the former looks at the costs of the JV while the latter at the benefits. BP identified that its global resource base would benefit if it entered into a strategic alliance in Russia as this would bring with it additional, mature oil and gas reserves. This was the principal motive for the JV between BP and TNK. To gain access to oil and gas reserves, BP chose to enter into a strategic alliance rather than M&As. However, it has been found from empirical studies that strategic alliance are successful when the business environment is stable and transaction costs are reasonable. For this to happen, the alliance needs to have a formal, hierarchical organization structure. Transaction costs are also associated with the agency theory, according to which asymmetry in information leads to efficiency losses, which are known as agency costs (Saubert, 2005). Strategic competitive advantage from the additional resources would depend on the synergies of the resources acquired through the specific association, whether strategic alliances or M&As. Greater is the firm’s proportion of synergy-sensitive resources, that is greater is the possibility of idiosyncracies of the combined resource endowments, the greater is the resultant rents (Saubert, 2005). But, this was not the case in BP’s strategic alliance in Russia, which resulted in the failure of the partnership. The hierarchical order in BP-TNK was not formally laid out as a result of which business decisions got delayed. Also, there was asymmetry in information sharing between the two partners as well as the government. Hence, it resulted in a situation in which the government interfered into the employee choice, resulting in higher transaction costs. On the other hand, the strategic alliance with Sinopec in China did not result in resource-rents. Instead, the need for investment funds in China for the development of the retail oil network made the strategic alliance a synergic proposition. Knowledge management and Organizational learning by BP BP has become an extremely complex organization as it has expanded through globalization of exploration, production and retailing of oil and gas, through strategic alliances as well as mergers & acquisitions. It operates in a global market in which the business environment is not static and predictable any longer. In the context of the complexity and chaos theory of management, the concept borrowed from natural sciences, strategic planning and management becomes redundant (Rosenhead, n.d). However, the global oil and gas industry is essentially an oligopolistic one in which a handful of global organizations have come to control the resources across the world. Modern researchers have found that even oligopoly markets demonstrate chaotic behavior, which cannot be explained by linear, deterministic models (Alasty, et al, 2008). The paradox between maximizing profit (which is essentially a linear relationship) and controlling the non-linear chaotic behavior has come to be a crucial organizational challenge. In the chaos theory, organizational change is a non-linear system in which it has to adapt to instability, which is subject to a high degree of uncertainty and unpredictability (Kiel, 1995). Although chaotic situations neither necessarily converges towards equilibrium nor oscillates across a stable system, chaotic behavior, though random, occurs within definable parameters. However, in most cases, chaotic behavior occurs without precedence and results in interaction of simple interactions of data that leads to a complex set of data. Hence, a deterministic organizational pattern is then found unsuitable to meet the challenges of the chaotic situation. In the oil and gas industry, disaster management in times of chaotic situations then become unusually difficult to handle particularly in the face of the paradox that a global organization needs to put in place strict controls that would result in profit maximization and ethical business practices. In such a situation, the firm has to develop a management style that takes into account a continuously changing business environment so that it can become a productive one, through improved work culture, as well as perform its corporate social responsibility and corporate governance in an ethical manner. To meet the challenges of the chaotic business environment, managers need to realize that a return to a stable system is not necessarily the only option. Instead, chaotic episodes provide the opportunity to explore new and alternate behavior. The erratic behavior that creates uncertainty and unpredictability provides learning opportunities for the range of options possible. However, chaotic behavior bears the risk of reaching a new position of stability that has a different set of uncertainty and improbability (Kiel, 1995). For the company to operate effectively and competitively in a complex business environment, the most crucial aspect of management is organizational learning behavior that can tackle the chaos in the business environment. Drucker (1964) said in his seminal work “What does make a business distinct and what is its peculiar resource is its ability to use knowledge to social, economic and managerial advantage” (quoted in Blackman and Henderson, 2002). An organization that strives for continuous acquisition, management and distribution of knowledge is typically called the learning organization. Typically, organizational knowledge is categorized according to 1) ‘know what’ comprising data and information, 2) ‘know how’ comprising procedures, 3) ‘know why’ comprising understanding and wisdom and 4) ‘know who’ comprising the persons who are depositories of particular knowledge (Ackoff, 1989 cited in Krohwinkel-Karlsson). In addition, Caryannis (1999, cited in Krohwinkel-Karlsson) also included ‘knowing what you know’ and ‘not knowing what you know’ as elements that needs to be analyzed more closely by the management. The difference between knowing what knowledge one has and not knowing so is all the more enlarged by the fact that organizational knowledge may be explicit (when key knowledge is documented and shared formally) or tacit (when knowledge is embedded in personal experience and skills of individuals). Sharing of tacit knowledge requires a socialization process for the acquisition, management and dissemination to be effective. Nonaka and Tekeuchi (1995, quoted in Krohwinkel-Karlsson) finds that in order to form a “knowledge-creating company”, various elements like the national and organizational culture regarding communication processes and an effective dialogue between policy-makers and those involved in the operation process are crucial. Cyert and March (1963) maintained that rules and routines are susceptible to external shocks in the face of chaotic behavior that lead to absorption of new knowledge thereby acquired. They noted that an organization “changes its behavior in response to short-run feedback from the environment according to some fairly well-defined rules. It changes rules in response to longer-run feedback according to some more general rules, and so on” (p 101-2, quoted in Krohwinkel-Karlsson). In contrast, Argyris and Schon (1978) differentiated between single-loop and double-loop learning. When the organization responds to first order problems without necessarily changing the rules of the game, it is called single-loop learning. Such organizations may be characterized as adaptive organizations as they tend to respond to problems. On the other hand, when the organization begins to question the basic terms of reference of operations and gives a second thought to its strategic directions, it is said to undertake double-loop learning. This is generative learning, when there are systemic enquiry, team learning and shared vision. In a subsequent study, Argyris and Schol (1996, cited in Krohwinkel-Karlsson) have added the triple-loop learning, which represents the “highest” level of learning when the members of the organization may in fact question the validity of the existence of the organization. At this level, the organization has incorporated learning as an integral part and is not just an espousal of its values (Schein, 1992 cited in Krohwinkel-Karlsson). Each level of the learning process is interrelated and some researchers have even found a cyclical process of learning in which each stage of learning leads to an alteration of the earlier one (Pedler and Boutall, 1992, cited in Krohwinkel-Karlsson). In the earlier era of Resource based View (RBV), the firm’s competitive advantage rested on its strategic asset that was scarce, expensive, non-substitutable and non-imitable. However, in the modern era of knowledge-based values, gaining competitive advantage through knowledge management has overtaken the previous attitude (Hofer-Alfeis, 2003). Halawi et al (2005) has shown that a knowledge-management (KM) led approach for competitive advantage may be developed from the RBV approach. Hence, BP’s performance of knowledge management becomes crucial in the context of the knowledge intensive oil and gas industry. BP’s strength in the technology of oil and gas exploration, development and refining gives it the strategic competitive advantage. But, it needs to manage the knowledge effectively in order to drive growth. In order to be successful in the complex global business environment, BP needs to undertake organizational learning very seriously. BP has already set up a knowledge management team that aimed to assess the knowledge existing in the organization, use and enhance it (Inside Knowledge, 1997). Through a web-enabled technology, the 100,000 employees of BP can share technical and business knowledge. However, the company needs to be in double-loop, or even triple-loop learning process so that its strategic decisions can be modified on the basis of the learning process and not simply respond to changes in the business environment. Through such a process, BP would be able to adequately develop technical knowledge on the oil and gas industry as well as the business environments in different countries that it operates in and the employee situations in these countries. It needs to continuously monitor its projects and develop tacit knowledge about the environmental and political risks in its operations. This is the only way to improve employee performance while also avoid risks of technical faults that result in taking lives of people. Conclusion The global oil and gas companies operate in a set of paradoxes: 1) between profit maximization and corporate governance, 2) between transaction costs and resource-based views of global expansion, and 3) between chaotic behavior in an increasingly complex business environment and imposing controls for disaster management. The key to organization performance is to strike a balance between these paradoxes. A stakeholder approach to business behavior would result in profit maximization in the context of corporate governance. Adopting the transaction costs and resource based views as complementary rather than competing approaches would lead to stable joint ventures and organization learning through chaotic behavior may prevent disasters in the oil and gas industry. Works Cited Ackoff, R.L. (1989). From Data to Wisdom. 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