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The New York Times: S.E.C. Investigating Shell's Restatement of Oil and Gas Reserves

Published: February 20, 2004

LONDON, Feb. 19 - The Royal Dutch/Shell Group said on Thursday that the Securities and Exchange Commission had begun a formal investigation into the company's surprise restatement of its oil and natural gas reserves last month.

The development raises the pressure on Shell's chairman, Sir Philip Watts, who has been sharply criticized for the way the company handled the reclassification. Shell announced on Jan. 9 that it had overstated its proven oil and gas reserves by 20 percent, or 3.9 billion barrels. The disclosure rattled investors and the shares of the two companies that control Shell tumbled more than 7 percent that day.

The January announcement was followed by a year-end earnings report that was weaker than expected and a disappointing production outlook for the year. As result, Shell executives, once seen as a stalwart model of conservative management, are coming under fire. Some investors have called for the resignation of Sir Philip and criticized the company's structure.

Shell will need to be more "centralized and disciplined," said Gene Gillespie, an analyst with Howard Weil Labouisse Friedrichs. The reclassification was a sign that in the past, "they gave regional managers too much latitude," he said.

Shares of the two companies that control Shell rose on Thursday, Shell Transport and Trading gained 0.2 percent, to 352.5 pence in London trading, while shares of Royal Dutch Petroleum rose 1.2 percent, to 38.09 euros.

Shell has been in contact with the S.E.C. since January. "Shell will continue to cooperate fully with the S.E.C.'s investigation," the company said. In a formal investigation, the commission has the power to subpoena documents and request that witnesses testify under oath.

Shell's revision of reserves occurred in part because oil and gas in an Australian project was classified as proven in the late 1990's, even before the fields were developed. None of the other oil companies involved classified the same field so positively. At the time, Sir Philip was head of the Shell exploration and production unit, with responsibility for classifying reserves.

Investors have been increasingly critical of Sir Philip and his management style. Many of them expressed dismay that Sir Philip did not participate in the company's conference call to announce the reserve change.

Shares fell further when the company reported a drop in fourth-quarter 2003 net income and disappointing production projections on Feb. 5.

In the company's earnings presentation on Feb. 5, Sir Philips said that he had no plans to step down before his scheduled retirement in the summer of 2005.

Formal S.E.C. investigations can take days to years to resolve, and the outcome can vary from no penalties to millions in fines and banishment from the securities industry.

"It will be very hard for the S.E.C. to prove anything here," said Neil McMahon, an analyst with Sanford C. Bernstein, because reserve classification is a "gray area."

To define a reserve as proven, companies need to ascertain that oil or gas is not only physically present, but that the removal and sale of it is economically viable, according to S.E.C. regulations.

In response to investor outcry over the reserve changes, Shell said this month that it would consider making more fundamental changes, including rethinking its unique two-headed structure. The company has headquarters in London and in The Hague, and managers report to two separate boards.

Shell is not the only energy company to recalculate its reserves this year. The El Paso Corporation said this week that it would cut its proven natural gas reserves by 41 percent and take a $1 billion charge. The company called the S.E.C. to tell it of the change, and has not been notified since of any pending investigation, an El Paso spokesman, Mel Scott, said on Thursday. Oil industry experts, however, say they do not expect such severe revisions throughout the industry. Most large energy companies have publicly reaffirmed their reserves since Shell's January announcement.

The S.E.C. has not formed a task force to look at reporting requirements in regard to reserves in the industry, nor are there formal proposals before the commission to redefine requirements for reserve reporting, said John D. Heine, an S.E.C. spokesman.


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