The Economist: Royal Dutch/Shell: Sick and tired about lying: “I AM becoming sick and tired about lying.” Those are not words shareholders want to hear from a senior executive. They are certainly not words anybody ever expected from an heir-apparent at Royal Dutch/Shell, one of the world's largest—and until recently, one of its most admired—oil companies.”: “The report into how the phoney numbers emerged paints a picture of deception and backbiting at the top—and, despite ongoing board efforts to exonerate the new management, contains plenty to encourage shareholder lawsuits and, maybe, criminal prosecutions, not least in America, where jail may await. More senior Shell people may yet have to quit.” (ShellNews.net)
Apr 22nd 2004
From The Economist print edition
The crisis at Shell has become much more serious
“I AM becoming sick and tired about lying.” Those are not words shareholders want to hear from a senior executive. They are certainly not words anybody ever expected from an heir-apparent at Royal Dutch/Shell, one of the world's largest—and until recently, one of its most admired—oil companies.
And yet, as a new report revealed this week, those words of exasperation did indeed come from a senior Shell executive. Walter van de Vijver, until recently the firm's head of exploration and production (E&P), wrote them in an angry e-mail to Sir Philip Watts, then the firm's chairman, in November 2003—fuming that he was tired of covering up for shortfalls in the firm's reserves that resulted from “far too aggressive/optimistic bookings”. Alas, the over-zealous booker was none other than Sir Philip, who preceded him as head of E&P.
The overbooking finally caught up with both men when, in January, Shell was forced to reclassify a whopping fifth of its “proved” reserves. When preliminary investigations pointed the finger at the two men, both were forced out.
This week, Shell's board unveiled part of the final results of those investigations. An analysis of reserves, done by Ryder Scott, an audit firm, explained what happened to the numbers, and an investigation of documents and processes by Davis, Polk & Wardwell, a New York law firm, explained how and when it happened.
The big unanswered question, however, is why it happened. Was it just Shell's “technocratic hubris”, as one manager called it, leading it to ignore the increasingly strict rules of America's Securities and Exchange Commission (SEC) about booking reserves, without pausing to think about the consequences of, in effect, lying? Or had Sir Philip been deliberately inflating the figures, taking full advantage of Shell's own, loose, guidelines to conceal disappointing exploration results and so book himself into the top job?
The report into how the phoney numbers emerged paints a picture of deception and backbiting at the top—and, despite ongoing board efforts to exonerate the new management, contains plenty to encourage shareholder lawsuits and, maybe, criminal prosecutions, not least in America, where jail may await. More senior Shell people may yet have to quit.
In the mid-1990s, it is now clear, Shell lost its way, finding it ever harder to replace the oil and gas reserves that it was pumping out of the ground. In 1997-2001, when Sir Philip was head of E&P, the firm inflated the reserves that it reported to the SEC as “proved”. The SEC defines proved as reserves that the company has firm plans to get to market quickly. Many oil executives dismiss this measure as a misleading guide to the value of a firm. But, nonetheless, it is a legal requirement for oil companies listed in America.
This week's Ryder Scott report “de-books” a further 1-2% of proved reserves, less than some analysts had feared. Shell's numbers may now, at last, be believable. Oddly, auditors do not routinely scrutinise reserve figures, despite their use in valuing oil companies. Shell now has only 14.5 billion barrels of proved oil and gas, which represents about ten years' worth of current production. BP has 18.3 billion barrels, enough for over 14 years; Exxon Mobil has more than 21 billion, which could keep it going for almost that long. Shell has been falling behind its peers for years in reserve replacement—and massaging the numbers to conceal the fact.
The report by the lawyers cited memos, e-mails and details of private meetings to show how Mr Van de Vijver and Sir Philip fought over the handling of the firm's shaky reserves position. The lurid details (for example, talk of a “script” and of keeping investors “fooled”) make it clear that both men knew that reserves were inflated—although Mr Van de Vijver alone seemed to want the truth to be made clear.
One possible interpretation of all this has Sir Philip doing his best to cover up his past over-bookings, while Mr Van de Vijver struggled in vain to become a fully-fledged whistle-blower. But one senior director describes instead a prolonged drift at Shell as top management slowly came to realise that their numbers had strayed far from the SEC rules. Says one insider, neither Sir Philip nor Mr Van de Vijver really understood how “serious, serious” the situation was becoming. Directors also say, bitterly, that Shell's auditors failed to point out that the firm's reserving guidelines did not comply with SEC rules.
The report suggests that Judy Boynton, the (now-ex) chief financial officer (CFO), and Jeroen van der Veer, Sir Philip's replacement as chairman, were informed about the problems—as was the committee of managing directors. Mr Van der Veer says that he did not “appreciate the magnitude and severity of the situation”.
Robert Roseman of Spector, Roseman & Kodroff, one of several American law firms now bringing class-action suits against Shell, is delighted: “This makes our case a whole lot easier, because these e-mails show that people high up in Shell clearly knew what was going on and hid it from investors.”
The two boards that control the group (Royal Dutch and Shell) tried this week to spin the reports as the definitive cleansing of its sins. The two board chairmen exonerated all members of the current management and boards, claiming that “none of them bore a material responsibility for the difficulties.” Judy Boynton, the CFO, had to step aside, but her integrity was “unimpeachable”; she will remain as an adviser. The chairmen insisted: “We have complete and unreserved confidence in the leadership of Jeroen van der Veer.”
There is already reason to consider such faith unjustified—and not just because various American authorities are investigating. The big worry goes back to that basic question left unanswered by the reports—why did things go so wrong at Shell?
Dealing with what ails the firm will not be easy. The measures floated this week may help. But they seem unlikely to be enough to change the culture of the place. The awkward bi-national structure, with two weak boards and a committee of managing directors, leads to an inward-looking bureaucracy that breeds arrogance. A more straightforward reporting structure with one board, a chairman and a chief executive might do better, although in the Netherlands, where Royal Dutch/Shell stills enjoys huge respect as a national champion, there has been little appetite for change—and Dutch shareholders have the voting power to block it.
Some British directors have been advocating a single board and a dual listing for years. Perhaps the new reports will wear down Dutch resistance. However, to transform the culture would probably require an accomplished outsider in the top job, willing to question everything and push through changes. But the boards seem unlikely to opt for that.
At least the crisis has had no significant impact on Shell's cashflow. Indeed, it may demonstrate impressive underlying strength on April 29th, when its first-quarter results are likely to show a “clean” profit of some $3 billion. Hence Mr Van der Veer's grand claim: “Despite the difficulties of recent months, Shell is a sound and profitable group. We are making the changes to our reserves practices to ensure that that remains the case.” We shall see.