Port Management and Economic Growth
3.3 RISK ASSESSMENT (RA) AND RISK MANAGEMENT (RM)
HOW FAR CAN WE GO?
This section aims to evaluate the role of risk analysis in port management and the mari- time industry and define its major components in a port’s growth.
In 2010, IMO’s Maritime Safety Committee 85 (MSC 85/26/Add.1) adopted, among other amendments to the ISM Code, a revision of clause 1.2.2.2, which stipulates the necessity for the maritime industry to evaluate the risks to ships, employees, and the envi- ronment deriving from shipboard operations (USCG NAVCEN 2010). Namely, enforced as of 2010, ISM’s objective is to “assess all identified risks to its ships, personnel and the environment and establish appropriate safeguards” and its implementation, and define their role. The implementation of the risk assessment regulations is another significant landmark for the maritime industry, since comprehension of the risk element will enable port managers and the maritime industry as a whole to become safer and achieve sustain- able growth.
Risk may be defined as the product of two elements: (a) the probability and (b) the severity of consequences (UN FAO 2013). Hence, the equation derives where
Risk Assessment = Probability × Single Hazard (3.7) Risk may derive from a single hazard, or with regard to a specific event–outcome combina- tion, where multiple hazards (e.g., composite risks) are involved, for example, a Category 5 hurricane, and the multiple risks involved (loss of life, property, and the environment) within a specific radius in the vicinity of a port (NIST 2007). Figure 3.1 demonstrates the multiple risks that pertain to port management and the maritime industry as a whole.
A Composite Risk Index may be estimated as follows:
Composite Risk Index = Probability × Impact of Multiple Hazard Event (3.8) The US Coast Guard typically assesses the effect of the risk incident on a 1–5 scale:
severity is measured from 1 to 5, where 1 denotes lack of severity and 5 is equal to a disaster. Likelihood of the implications is measured from 1 to 5, where 1 is equal to remote possibility, 3 offers a 50%/50% probability, and 5 foresees a high likelihood of occurrence (USCG 2013).
A ship in harbor is safe—
but that is NOT what ships are built for.
John A. Shedd
Risk analysis is rather difficult to measure, owing to the practical inability to measure the possible likelihood and impact of a complex risk. Elements such as time, resources, and human error make the risk management process rather complicated. In mathematical terms, risk magnitude equals the probability of incidence multiplied by the event’s overall impact:
R
i
Magn=
∑
Lip Li( ) (3.9)Risk analysis consists of three major components, that is, (1) risk management, (2) risk assessment, and (3) risk communication. At the same time, these components deal with the three principal elements of hazard: (i) probability, (ii) consequences, and (iii) impacts.
Over the past few years, the process of risk analysis has been increasingly upgraded and refined from segmented port operations and business evaluation to long-term cor- porate forecasting and planning. The typical sequence to be followed in risk analysis requires the risk managers, that is, the corporate decision makers, to form teams that will identify and assess possible risks.
Figure 3.2 depicts a sample of a port’s risk assessment record sheet, which demon- strates how risk identification, mitigation and prevention, or recurrence is a part of the risk analysis and risk management process.
Port authorities need to commit to the hazard identification, monitoring, and miti- gation, and commit to a continuous process improvement. The risk analysis process should encompass the port authority management and employees throughout all the levels of authority. Their expertise, qualifications, and observation can be a crucial component of risk assessment process. The port’s risk assessment process will involve trustworthy internal
Maritime risk
Financial risk:
Investment;
Asset sale and purchase;
Budget allocation;
Cash flow
Resource allocation risk (factors of production)
Strategic port planning and forecasting
risk
Logistics integration risk
Negotiations, new business and old business retention;
contracts cancellation risk
Infrastructure accessibility and connectivity risk
Competition management risk
Operational efficiency, technical and
maintenance reliability risk Emergency response and
regulatory compliance risk: HSQE (safety, security, environment, social
responsibilities) Time management
risk Traffic control, bottlenecks risk Warehousing and storage availability and protection risk
FIGURE 3.1 Maritime risk areas. (Courtesy of M.G. Burns.)
and external communication networks of information exchange, such as port clients, the Coast Guard (Port State Control), supply chain partners, and so on.
Risk management measures, monitors, and controls the larger decision process: it brings together risk assessment methodologies with resolutions on how to tackle the risk. There are five elementary risk management approaches, which encompass several adaptations among the following options: (i) risk avoidance, (ii) risk mitigation, (iii) risk acceptance, (iv) risk outsourcing, and (v) risk sharing, that is, to third parties or allied organizations that are designated, available, and willing to support the port’s risk miti- gation, by providing financial, technical, operational, or other form of assistance. The entire risk management approach entails strategic and synchronized response or proce- dures that are developed to (i) eliminate the risk impact generated by an event–outcome combination; (ii) eliminate the likelihood of that event–outcome combination; (iii) rein- force, guide, and support emergency responders; (iv) expedite incident investigation, root cause analysis, and crisis management response; and finally (v) assist in recuperation.
Risk mitigation strategies are categorized under three wide headings: financial, engineer- ing, and managerial (NIST 2007).
The risk manager follows the risk assessment process, commencing with problem for- mulation and developing into five steps: (1) hazard identification, (2) hazard assessment
FIGURE 3.2 Port’s risk assessment record sheet.
and characterization, (3) risk control development, (4) control implementation, and (5) supervision and evaluation (US Army 2006). Since the maritime industry is a high- risk, high-profit industry, it is imperative to implement risk communication as a nonstop, sustainable process.
Figure 3.3 demonstrates this holistic process that is applied to the entire business entity while enabling different company segments and divisions (e.g., terminals, ship types, etc.) to collaborate effectively.
Enterprise risk management alternatively defined as strategic or holistic risk man- agement is a twenty-first century management discipline that demands global companies to identify all the possible risks they are likely to encounter, while centering on the upside, or increase of risk, as well as its downside, or decline. Risk managers have to decide which areas of risk should be evaluated and integrate these into the company’s action plan, which must also be available to the stakeholders. ERM consists of accidental losses, as well as financial, strategic, operational, and other risks. Its success is determined by striking a balance between enhancing profits and managing risk.
Risk1.
assessment
Risk2.
management 3.
communicationRisk
Hazard identification
Risk assessment characterizationand
Risk control
development Risk control implementation
Risk control monitoring and
evaluation
FIGURE 3.3 The components of risk analysis. (Courtesy of M.G. Burns.)
Risk assessment is a methodical practice for identifying and assessing potential risks and measuring the impact or hindrance in achieving the port authorities’ objectives, favorably or adversely. These incidents may occur externally (e.g., global financial devel- opments, consumers, supply chains, trade routes, regulatory framework, and competi- tion) or internally (e.g., personnel, process, and infrastructure). When these incidents intersect with an organization’s targets, or can be forecasted to do so, they become risks (PWC 2012).
Typically, the maritime industry distinguishes risk into four major categories:
i. Strategic, pertaining to the port’s values and long-term goals, which include com- pany’s reputation, innovation, differentiation, and internal and external compe- tition, as well as the entrepreneurial aspects of negotiations, new business and old business retention, ability to meet contractual deadlines and obligations, cus- tomer loyalty, business cancellation, and so on.
ii. HSQE, physical and regulatory compliance risk, focusing on occupational health, safety, security, social responsibilities, and environmental risk. This risk segment encompasses the physical threat of natural disasters and environmental hazards, as well as the regulatory compliance, emergency planning, contingency planning, and response.
Port plans include physical risks, such as search and rescue, media handling, pollution (counterpollution; air, soil, and noise pollution), HazMat, HazWOper, chemical spillage, fire, grounding, collision, sinking, security (including bomb threat, terrorism, and piracy), emergency response and medical emergency, and so on. In addition, it covers operational, technical, and maintenance risks that are likely to derive pursuant to a physical or compliance hazard. Chapter 10 demonstrates the methodology for the risk assessment of physical risk. These econometric formulas address the asset’s integrity, while incorporating the con- tribution of the human factor in the emergency response.
iii. Operational, focusing strictly on the port’s operational efficiency, technical, and maintenance reliability risk, as well as encompassing the efficiency of the entire multimodal transportation and the supply chain, such as hazards related to infrastructure accessibility and connectivity, time management, traffic control, bottlenecks, warehousing and storage availability, logistics integration, and so on. Operational risk assessment may be estimated as follows:
OpSec OpSec
Scope OpSec
base total
total
= −
100 + (3.10)
LC Scope LC
Scope OpSec
base total
total
= × ×
+
0 1. (3.11)
iv. Financial, which entails capital investment, banking and mortgage, currency, inflation, assets’ sale and purchase, budget allocation and control, the eco- nomic aspects of the factors of production, cash flow, liquidity, taxation, and so on.
Financial-based assessment methods and strategies focus on three principal corpo- rate areas:
1. A conditional value at risk (CVaR) is a portfolio risk measurement application that investigates financial risk exposure by employing a conventional algorithm formula that calculates the return on investment, over a specific time period. It is employed by risk managers, investors, and portfolio managers that wish to monitor and eliminate the likelihood of future financial losses.
In a typical mean-variance versus mean-conditional value-at risk scenario characterized by a normal distribution of returns, both VaR and CVaR may be projected using just the initial two instances of the return distribution (see Rockafellar and Uryasev 2000a,b). Assuming that there is an estimate confi- dence level of 95%, the probability level for the VaR and CVaR is fixed at 5%, hence resulting in a portfolio with mean deviation μp = 10% and a standard deviation σp of 20% (Xiong et al. 2010). Consequently, the VaR and CVaR of the portfolio are VaRp = 23% and CVaRp = 31.2% of the portfolio’s commencing value, respectively, which would be expressed as
VaRp = –μp+ 1.65σp (3.12)
CVaRp = –μp+ 2.06σp (3.13)
2. Loan-to-value (LTV) ratio is a financial risk assessment ratio that is used by banks and investors in order to evaluate the risk of investment when purchasing an asset. Frequently, evaluations with higher LTV ratios are regarded as “higher risk,” and this may be reflected in the contractual arrangements between the port authorities and investors. It is reflected as
LTV ratio Investment sum Evaluated asset price
= (3.14)
3. Credit analysis, a common method used by investors. A risk assessment focused on a future financial partner’s credit data will help the investor or the bank to conclude on an investment agreement and will likely assist in the stipulation of the repayment terms and conditions:
Cash Returned on Capital Invested: EBITDA
Equity (3.15)
where EBITDA pertains to earnings before interest, taxes, depreciation, and amortization.
Capital employed equates to a corporation’s long-term funds employed by the firm, that is, its equity plus noncurrent liabilities. Hence, it reveals the earnings and overall financial performance of a firm’s capital investments.
Return on average capital employed (ROACE) estimates the average of open- ing and closing funds employed for a fiscal year or for a specified period to time.
Depreciation and amortization need to be calculated separately.
ROACE = EBIT*(365/time)/((FP1[b][E] + FP1[b][NCL] + FP1[e][Equity]
+ FP1[e][NCL])/2) (3.16)
where FPb refers to the financial position at the beginning of the time period, FPe refers to the financial position at the end of the time period, E is the equity, and NCL denotes the noncurrent liabilities.
Current Ratio: Current Assets
Current Liabilitiess (3.17) Debt-Equity Ratio: Total Liabilities
Shareholderss Equity’ (3.18) In financial and strategic terms, risk is frequently considered as the prerequi-
site of profit: the “Risk-Reward Concept,” alternatively quoted as “High Risk, High Gains,” is one of the maritime industry’s favorite mottos and guiding prin- ciples, suggesting the proven fact that the higher the risk of a specific venture, the higher the return.
Similar risk types are applicable to globalized, capital-intensive, technology- oriented, and regulatory-driven industries such as oil and gas, logistics, and manu facturing, to name a few.
Difficulties may arise when conducting risk assessment in global ports or trade and transport companies, as stakeholders may not be willing to share information as to past risks and future threats. For every hazard, a risk esti- mate is based on the likelihood of occurrence and the severity of the hazard.
Difficulty also arises as a result of the difficulty to objectively assess a complex set of risk possibilities. A risk manager’s perception on risk typically ranges between reluctance, prudence, and overconfidence.
3.3.1 The Risk Assessment Methodologies
The ability to grasp the extent and dimensions of risk is always dependent on internal and external factors affecting the port, the economy, and the market’s volatility, which typi- cally are unforeseen. Nevertheless, risk assessment offers sufficient feedback to the port management in order to pinpoint the elementary risks, prioritize the risk management resolutions, and formulate the port’s strategy.
The methodologies to assess risk are categorized in three broad segments:
1. Qualitative risk assessment, which is based on statistical facts and figures. Risk is hereby classified as high, low, or medium. The limited sources of data gathered generate a rather biased or insufficient numeric and empirical basis. However, the accuracy of this primary data, coupled by specialized knowledge and recog- nition of possible areas of concern, may allow the risk identification and classifi- cation (PWC 2012).
2. Semiquantitative risk assessment, where a mathematical risk appraisal is calcu- lated by using a combination of qualitative and quantitative data. An accurate outcome for this category of assessment will require a plethora of secondary data
that would be required in a full quantitative risk assessment, plus the selected, specific primary data used in a qualitative risk assessment.
3. Quantitative risk assessment, which needs calculations of two risk elements:
the magnitude of the potential loss (L), and the probability (p) that the loss will occur. This assessment type offers numerical risk expressions and warnings of the potential risk hazards and uncertainties (WHO 1995).
The most commonly used quantitative technique of risk assessment is the Annual Loss Expected (ALE) model, which derives from the principle of expected loss. This is reflected by estimating the probability of negative risk and subsequent losses. It is expressed as follows:
ALE = (Risk Probability) × (Value of Loss) (3.19) and
ALE=
∑
= I O Fi i in
( )
1
(3.20)
where I reflects the potential loss caused by a future risk, O pertains to a number of unfa- vorable consequences, and F pertains to the event’s frequency (Rot 2008).
In this quantitative econometric formula, the risk function variables have precise numerical values.
R = AV * EI,V,T * PV,T (3.21) where risk (R) is evaluated in money terms, that is, loss of investment or loss owing to physical threat. V and T reflect the vulnerability and threat factors, which together with the exposure (E) and probability (P) factors, are initially measured in terms of levels 1–5 in the Risk Assessment Matrix, and consequently converted in a percentage. Time is expressed in years, months, or days.
3.3.2 Risk and Business Longevity
The element of risk is present in every business transaction. In fact, the maritime industry is considered as a high-risk, capital-intensive industry, together with all global trade and transport companies. Although port authorities are risk prone by nature, to some extent, they are capable of minimizing the repercussions, because of government support, that is, subsidies, and state, or regional backing, that is, European Union Funding.
The private sector, on the other hand, may be more exposed to risk. In particular, shipping companies that have penetrated multiple markets may be exposed to risk to a higher extent.
Successful companies in the early twentieth century had a life span of approximately 60 years, whereas this figure decreased to 25 years in the last decades of the twentieth century, 15 years in the first decade of the twenty-first century, and only 7 years in the second decade of our century. A company’s longevity is the strongest possible marketing
tool, as it verifies the company’s successful strategies in risk assessment, forecasting, investment strategies, cash flow, alliances, and so on.
Here is a brief write-up on Odfjell Company, a 100+-year-old terminal and shipping major with a youthful and highly energetic attitude.
CASE STUDY: ODFJELL—CELEBRATING 100 YEARS OF ACHIEVEMENTS While the risk factor is most common among seaports and maritime companies, some corporations prove their value and dynamics by longevity and sustainable achievements. Longevity proves safety, quality, and respect for people and the environment.
Odfjell has proven that successful longevity is a company’s most powerful mar- keting message.
LESSONS ON HOW TO CREATE A 100-YEAR COMPANY, WITH HIGH-RISK, HIGH-GROWTH STRATEGIES
Odfjell was established in 1914 when Mr. Odfjell founded a shipping company with the purpose of buying, owning, and operating dry cargo ships, namely, carrying tim- ber. Since then, the Odfjell family has taken great expansion leaps into a number of private companies and different market segments, through the establishment of Odfjell Tankers, Odfjell Management, Odfjell Terminals (Figure 3.4), and Odfjell SE, to name but a few. In 2014, that is, 100 years since the company’s inception, Odfjell has achieved a leading global presence characterized by intelligent entrepreneurial strategies, penetration of the world’s most profitable and productive market segments, but most of all a fine reputation of integrity, leadership, and dynamic vision for the future. The corporation is headquartered in Bergen, Norway, yet has offices in multi- ple strategic maritime and terminal centers in Europe, the Americas, Africa, and Asia.
Odfjell is a leading company in the global market for transportation and storage of bulk liquid chemicals, acids, edible oils, and other special products. The com- pany owns and operates chemical tankers in international and regional trades, in
FIGURE 3.4 Odfjell Terminals, Houston (Texas, USA). (Courtesy of Odfjell Tankers.)
addition to a network of tank terminals, which are traditionally named after trees, as a reference to the company’s origins in the transport of timber (http://www.
odfjell.com/Tankers/Pages/default.aspx).
Odfjell commenced the construction and commercial operations of the first small chemical tanker ships in 1937 and has gained a leading global market share in the industry’s radical expansion since WWII. In the 1950s, Odfjell prevailed in the global chemical tanker trade (Figure 3.5), and in the 1960s, they innovated the first tanker with stainless steel tanks (M/V Lind).
Odfjell’s strategy is to maintain and enhance their position as a leading logis- tics service provider for global customers. This will be achieved through efficient and safe operations of deep-sea and regional chemical tankers and tank terminals.
Strategic trading patterns and economies of scale through volume and purchasing benefits are components of the corporate strategy leading to expansion and opti- mum fleet utilization.
Odfjell Tankers Ship Management undertakes the superintendence, crewing, tech- nology management and development, risk and QHSSE management, planning and control, and training and procurement. With offices in Bergen, England, Houston, the Philippines (Training Academy), Sao Paulo, and Singapore, the company currently manages and oversees 54 vessels, while recruiting 2350 seafarers including cadets.
The aim of Odfjell Ship Management is to persistently generate a work culture able to elevate their safety performance to a higher level. With this objective in mind, Odfjell has developed their organization through continuously delivering enhanced technical and marine superintendence capacities within the various groups (fleets), strengthen- ing their training programs and implementing an efficient, well-defined key perfor- mance indicator (KPI) program (http://www.odfjell.com/Tankers/ShipManagement/
Pages/ShipManagement.aspx).
ODFJELL TERMINALS
Odfjell Terminals constitutes a component of Odfjell SE, specializing in chemi- cal tanker shipping and tank storage services. The company’s head office for their global tank terminal activities is located in Rotterdam (The Netherlands), one of FIGURE 3.5 M/T Bow Sky, chemical tanker, DWT: 40,005 T. (Courtesy of Odfjell SE.)