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The Scotsman: Shell set to try and ride out oil reserves storm  


Wed 28 Jan 2004  


AFTER a decade of under- performance, investors in Royal Dutch/Shell are agreed on one thing: "Waves of change" - to hijack the company’s unwittingly appropriate corporate slogan - are long overdue. Shareholders also know that the next fortnight, ahead of the results announcement on 5 February, is probably the best opportunity in years to force the company to reform. Shell is reeling from its admission this month that it had been over-stating its proven oil and gas reserves by 20 per cent. It needs to offer an olive branch to appease the City.


But can Shell really be transformed into the oil and gas powerhouse that investors believe it should be?


For its thousands of shareholders - Shell accounts for around 1-2 per cent of the typical UK equity fund - this is an urgent question. Investors have already watched Shell’s shares shed 14 per cent this year, closing at 362p last night, compared to a historic high of more than 600p.


Analysts say that Shell has been failing to deliver the returns it should be capable of since the early 1990s. The shares trade at a 10 per discount to BP and ExxonMobil, its comparable peers. Deutsche Bank in Edinburgh points to the company’s "tremendous asset base" and complains: "All we see is underperformance."


Shell certainly has its strengths. Its asset reach is the most prized of all the majors, extending into all the key reserves regions. Its liquid natural gas assets - a market where it realised the potential well before its competitors - are particularly formidable. It is also one of only two international players, next to Total, to be admitted back into Saudi Arabia to explore and pump natural gas.


But the company has also been criticised for a string of failures. It missed out on the consolidation wave that swept the industry in the 1990s. Belatedly, it stumped up about £7.3 billion to buy Enterprise Oil, a price that most industry observers believed was too dear. Meanwhile, it has been failing to replace the oil and gas it pumps with new reserves. It can continue at its current rates of production for nine to ten years before its proven and probable reserves run dry. That compares with almost 14 years at Exxon-Mobil, and nearly 15 years at BP.


Too often, investors say, Shell’s management seems to have had the wrong focus. When oil prices plunged in the late 1990s, Shell took action by embarking on a massive cost-cutting drive. But it was still engrossed in that strategy when prices began to recover and its rivals upped their exploration budgets. This culminated in Shell’s chairman, Sir Philip Watts, admitting just weeks after he took the helm that the firm would miss its 5 per cent annual production growth target. 


When investors ask why Shell has fallen down, many believe that the problems come down to is its corporate structure. Royal Dutch/Shell is a partnership that dates back to 1907, with the Netherlands-based Royal Dutch and UK-based Shell investing 60-40 in almost 150 energy companies. Each of the two parent firms has a board, and their members, along with assorted executives, meet regularly in a "conference" involving no less than 22 directors, to set strategy, review decisions, and appraise projects.


Some investors claim that this complicated, top-heavy structure is the root cause of problems of accountability. It also raises questions about the speed with which decisions can be taken. Shell’s official response is that its dual board structure is a "tremendous strength". It says its dual listing gives the company a broader employment pool for recruitment and avoids the cult of the personality - a problem that BP will have to face up to when John Browne departs.


Shareholders also enjoy the advantage of being able to buy in to Royal Dutch/Shell in alternative currencies. But investors appear unconvinced. A London-based fund manager for a Scottish company said yesterday: "We’ve tended to take for granted that it [the dual structure] will always be there - it’s one aspect of the business that hasn’t really been debated.


"But the need for a change is the natural conclusion to draw when you see an event like the one we’ve witnessed with the reserves."


An oil analyst added: "We’ve had a lot of corporate governance people contact us from the investors [in light of the reserves shortfall]. The question they’re asking is: ‘What was it structurally about Shell that allowed this magnitude of mistake?’"


Whether Shell will bow to investor pressure and reform its structure is another question. One fund manager said: "It’s easy to say they should break up the dual structure and have separately listed companies. But who knows the ramifications? Potentially it could destroy value."


Another barrier to root and branch reform is raising investor support from Dutch shareholders, who are less active on matters of corporate governance.


One fund manager said: "The UK has a fairly strong tradition of shareholder activism. And Shell does have guys on the board who used to run Bank of Scotland [former governor Sir Peter Burt] and Reuters [former chief executive Sir Peter Job]. But can you really generate the same degree of shareholder pressure given the involvement of Dutch investors?


"If this was BP it would be straightforward, you’d have a lot of upset UK and US investors. With European investors it’s a different case."


Perhaps the bigger obstacle to reform is that Shell’s problems, grave as they are, may not be enough to risk radical reforms. One analyst said: "While the reserves downgrade is extremely embarrassing, it’s not like BP in 1992, when it was literally about to go bust and had a huge restructuring caused by a financial crisis.


"At Shell, you’ve got a chairman the City has decided it doesn’t like and an embarrassing reserves announcement. So most likely we’ll get nothing [in the way of reform] on 5 February. We’ll probably get a presentation and a few updates and they’ll try to say as little as possible about the reserves issue and the questions it raises."


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