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Daily Telegraph: Are there really any reserves out there?


(Filed: 24/04/2004)


Shell says the oil does exist - if only they can find it. Trouble is, they can't convince the SEC, reports James Moore


You can be sure of Shell. Well, not any more, you can't. After three months of anguish, rumour and departures at the top, the report into the oil group's reserves by US law firm Davis Polk & Wardwell this week destroyed its image and it will be a long time before investors will be able to see the famous slogan without wincing.


The American Department of Justice has barred publication of the full 463-page report, but even the 26-page executive summary was pretty shocking. Emails between the company's former head of exploration Walter van de Vijver and executive chairman Sir Philip Watts showed how they had been misleading investors about the true state of Shell's oil and gas reserves for years.


One of them, from van de Vijver to Watts, whom he replaced as head of exploration and production, revealed that he was "sick and tired of lying" about Shell's reserves.


What on earth has gone wrong at one of the most cautious and conservative of the world's big companies? In the past four months, 4.35 billion barrels of "proved" oil and gas reserves have been erased from Shell's books prompting some to draw comparisons with Enron, the energy trading giant which collapsed so spectacularly when its accounts were revealed as works of fiction.


Unless there is something much worse to come out, Shell is nowhere near this in the league of corporate disasters. The company believes that the oil and gas is there but cannot be "proved" to the standard demanded by America's chief financial watchdog, the Securities and Exchange Commission.


As Malcolm Brinded, now vice-chairman of Shell's committee of managing directors, puts it: "I am confident that following such a thorough examination of our reserve base by external and internal experts, these re-categorisations bring our total reserve base in line with SEC requirements and current guidance.


"As previously stated, we expect to book the majority of these reserves over time, some 85pc within the next decade, and some 50pc in the coming five years.


"It remains the case that the vast majority of the re-categorisation does not impact our view of the total resource base, or the volumes ultimately expected to be recovered."


Even through the Shell-smoke, the meaning here is reasonably plain and the market has already adjusted the share price for the other 15pc which now seems to have disappeared.


Yet it begs the question of why a company like Shell failed to comply with SEC rules in the first place. The SEC uses similar criteria to those of the Society of Petroleum Engineers, which has three categories for reserves: proved; proved and probable; and proved, probable and possible.


If a 1m barrel find is booked as proved, there should be a 90pc chance that it will be able to extract more than this in future years under "existing economic and operating conditions". Most of Shell's missing barrels are really "proved and probable", where there is only a 50pc chance of extracting more than the booked number.


In Shell's Australian Gorgon gas field, says the report summary, the "proved" reserves never met the SEC's standard of "reasonable certainty". Davis Polk could find no proper explanation why the field was so classified, adding that it only ever met Shell's loose internal guidelines for booking reserves as proved for a brief period.


In Oman, "proved" reserves were booked in response to encouragement from top management. Insufficient technical work was done to support this and the field soon ran into serious production difficulties.


In Nigeria, the report says, Shell's production never got near to the level needed to extract the amount of oil booked as "proved" before the company's extraction licences expired. In Brunei, much of the reserves booked as proved were not economically viable.


This is hardly up to Enron standards of misbehaviour. Yet it still smacks of the sort of treatment of reserves as a desperately optimistic exploration minnow rather than a blue chip oil major.


It now transpires that staff bonuses were linked to the booking of new reserves, without adequate checks, and human nature did the rest. Since nobody else knew, the glittering reserves figures propelled Watts to the top job, chairman of the company's committee of managing directors.


ABN Amro's oil analyst Peter Nichol says: "Basically they were under-investing for years. They were focusing on profitability at the expense of investment in reserves, which were dwindling."


Nichol points out that wrongly booking reserves has not really affected Shell's profitability. Its 2002 results have been revised down only slightly but adds: "The reserves are the reason you buy an oil company."


Commerzbank's Jon Rigby points out that on March 18, Brinded sought to reassure the market. In cutting its proven reserves for the second time, he said, further cuts were unlikely. Yet on Monday they were cut yet again, and credit ratings agency Fitch fears still more to come. It has cut its credit rating for the company.


The shares stand at significant discounts to their peer group of Exxon and BP, but confidence has been badly damaged. Only five brokers' analysts out of the top 16 - none of whom saw this coming - are encouraging buyers. Six are firmly on the fence, and five are negative. No wonder they don't know what to think.

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