The Sunday Times: You can’t be sure of Shell
By Lucinda Kemeny and Louise Armitstead report
February 08, 2004
Sir Philip Watts is clinging to his job after eating humble pie over Shell's phantom reserves. But can he fix the damage done to the oil giant?
Sir Philip Watts, chairman of the world’s fourth-largest oil group, Royal Dutch Shell, has never trained for the stage. The 58-year-old Leicestershire physicist has spent most of his career buried in books, but last weekend he had to take a crash course in acting.
Watts spent two days holed up in the group’s London headquarters learning the art of expressing humility, and he knew he couldn’t fake it. The following Thursday at London’s Tower Thistle hotel, just yards away from the scene of many brutal executions at the Tower of London, he had to face a crowd of angry shareholders at the annual results presentation. The next day he would have to repeat the exercise in New York.
Watts knew the results, however good, would be eclipsed by one issue. He would have to explain away a public relations disaster that had inflicted huge damage both on himself and the company. Shell announced last month that it was slashing 3.9 billion barrels off its proven reserves, equivalent to one-fifth of the oil reserves it had previously stated.
The revelation stunned the City and led to a class action from American investors. The damage was compounded by the fact Watts and his finance director, Judy Boynton, had refused to talk either to shareholders or the media. Instead they left it to an ill-equipped investor-relations executive. Watts went to ground, which led the press to mount a “Where’s Watty” campaign.
When Watts took to the stage at the London hotel, the room was packed with 400 people and the atmosphere was electric. He looked tired and humbled, but he gave the crowd what they wanted to hear. He said: “I’m sorry I got it wrong”.
On Friday he gave the same speech in New York, although the setting could not have been more of a contrast to the Tower Thistle. The St Regis Hotel on Fifth Avenue and 55th Street is so posh even the lifts have crystal chandeliers. In the hotel’s Louis XVI meeting room, analysts and investors sat on gilt chairs and breakfasted on mini-muffins as Watts explained what had gone wrong. “Today was supposed to be about the results and I was going to talk about how 2003 in total seemed to be a good year,” he said. “But sadly this meeting is overshadowed by other questions.”
He apologised for not attending the inital teleconference when the reserve catastrophe was revealed. “Frankly, with hindsight, that was a mistake. I regret that I wasn’t there and I hope today will make amends.”
His colleagues later took over the presentation and Watts sat down, but a hint of relief was visible across his face. For the time being he has saved his job, but at a price. As part of his apology Watts said he would re-examine the Anglo-Dutch group’s antiquated, dual-board structure and make bold changes.
THE decentralisation of Shell, with its committee of managing directors and plethora of individual country managers used to be a source of praise rather than shareholder activism. But times have changed, and the opaque organisation has become a cause of growing concern for shareholders. Up to now, Shell has been in a position to arrogantly dismiss critics, but it no longer enjoys this privilege. It has been overtaken in the global league tables by Exxon Mobil and BP, and the group has stored up big problems trying to maintain its oil production and reserves following years of underinvestment.
Last month’s shock reserves warning highlighted why investors have had these concerns over the internal reporting lines. In 1997, local managers working on Gorgon, a frontier Australian field, started booking reserves of oil and gas as “proven”, when Exxon Mobil, its partner on the project, did not. Similar events took place in other major fields, including Ormen Lange in Europe, Kashagan in Kazakhstan, Nigeria and others. Alarm bells started ringing late last year when an analysis of the Nigerian interests found that at least part of the booked reserves did not meet the requirements under the guidance set down by the Securities and Exchange Commission (SEC). Proved reserves means that there is reasonable certainty that the oil or gas can be delivered.
The results were devastating, and 20% of the reserves were found to have been prematurely booked. “Judgments were made in the past that would not be made today,” said Walter van de Vijver, head of Shell’s exploration and production division, at last Thursday’s meeting.
He explained that in some cases, such as Kashagan, the booking took place because of an agreement with the government that the fields would be developed quickly, but instead those negotiations had to go back to the drawing board. In Shell’s defence, he said the material impact of the reclassification on the bottom line added up to only $86m (£47m) — hardly a wrinkle on the face of the organisation.
Nevertheless, having to restate a big percentage of the reserves, and attracting the interest of the SEC, has highlighted all too clearly the gap that has opened up between central management and their staff.
This is not the only example. Last week’s results presentation was marred by poor performance in the group’s American business, comprising both petrol stations and refineries, which Shell bought when it acquired Texaco’s interests in Equilon and Motiva in 2002.
Shell argued that it had to do the deal or lose its status in America completely, but analysts were scathing about the performance of the business, which has been hampered by technical problems, and questioned whether Shell really knew what it was buying when it took the business on.
Fadel Gheit, an analyst with Oppenheimer & Co in America, asked: “Did they do their homework to see what was wrong with the US business?” Against a background of mistakes and losses, shareholders and analysts are now also being told that oil production — the key measure of success at an oil company — is going to fall until 2006 because of asset sales and the ending of certain production agreements around the world.
Investec quickly downgraded its 2004 estimates on Thursday by 2% to take into account the underperformance of the US refineries and increased cost pressures. The fund manager also cut its 2005 estimates by 4%. Such falls in earnings would leave Shell looking weak compared with BP.
Other analysts followed suit, including those at Deutsche Bank, who cut their price target from 410p to 400p.
Irene Himona, an analyst at Morgan Stanley, said: “The shares have come down 20% in the past six weeks and that is all to do with credibility. While investors have seen Shell as the most conservative of companies, it turns out that it is not what we thought. The market is traumatised and shocked.”
Watts himself — a Shell man born and bred, is a living testament to how inward-looking the company has become. Uncomfortable in the limelight, he has been lambasted by shareholders as being one of the poorest communicators in the FTSE 100. Now, as he begins a roadshow where he will meet 35% of the shareholders in Royal Dutch Shell, he will need all his charm and persuasion to cope with what will be a very difficult few weeks.
WHILE Watts was preparing to eat humble pie, shareholders wasted no time making up their minds. Last Monday afternoon a group of fund managers who collectively own 35% of the company picked their way through London’s damp streets and convened at 51 Gresham Street, near St Paul’s cathedral in the City.
It was nearly two weeks since they had all received a letter from Peter Montagnon, head of investment affairs at the Association of British Insurers (ABI), inviting them to his offices for a secret meeting with the embattled oil giant.
Lord Oxburgh, Shell’s senior non-executive director, whose job it is to liaise with investors, had also received an invitation, and was hurrying towards the ABI offices. Having been completely wrong-footed when he set off on a geology trip to Antarctica in the aftermath of Shell’s shock announcement, this was an appointment he couldn’t afford to miss.
Oxburgh was accompanied by Jyoti Munsiff, Shell’s company secretary, and Sir Peter Burt, a former Bank of Scotland chief who is a well-respected non-executive director.
As they filed into the meeting room at the ABI, their line-up sent a clear message about how seriously the company was taking the fall-out with its investors. The meeting was chaired by Robert Talbut, chief investment officer of Isis Asset Management.
One fund manager who attended the meeting said: “We wanted to talk to Oxburgh about the profit warning and find out exactly what happened. But the real point was much broader. We had two main questions: why has Shell been a persistent underperfomer for the past decade, and what’s going to happen to make it into an outperformer going forward?”
Oxburgh, Burt and Munsiff fielded a barrage of searching questions, not just about recent events but also about Shell’s management, direction, communications and structure.
“There was a lot of focus on the company’s structure,” said one fund manager. “We put it to them that Shell’s peculiar structure was the reason why it had not been as nimble, bold or aggressive as its competitors, and as such had underachieved for so long. We also made it clear that if the firm refuted our views on the structure, we wanted its decision to be based on a thorough review of it.”
In advocating the normal Anglo-Saxon company structure with its characteristic, strong chief executive role, criticism of Watts was unavoidable.
“It is clear that Watts has got it wrong,” said one investor. “But we don’t want a knee-jerk reaction to make a scapegoat of him. We need to find out how the structure allowed such mistakes to happen.”
For all the hard talk, the fact remains that British shareholders’ influence is subordinate to that of the Royal Dutch investors who control 60% of Shell.
One adviser close to Shell said: “This is something that has been on the blocks for ages but the Dutch institutions have been against it and that has made it very difficult.”
Watts has an uphill struggle and nobody is yet laying odds that he will be around long enough to effect change.
INSIDE THE ENERGY GIANT
ROYAL DUTCH SHELL comprises two companies — the Royal Dutch Petroleum Company, based in the Netherlands, and Shell Transport and Trading, domiciled in London.
Royal Dutch is the dominant partner, with a 60% interest and 740,000 shareholders, while Shell has 250,000 shareholders. Some of the equityholders have an interest in both companies.
The shares of one or both companies are listed and traded on exchanges in eight European countries — Austria, Belgium, Germany, Luxembourg, the Netherlands, Switzerland and the UK, as well as America.
The parent companies control a number of businesses with operations in more than 145 countries around the world.
There are five operating companies: exploration and production, which engages in exploring and drilling for sources of oil; gas and power, which processes and transports natural gas, develops power plants and markets gas and electricity to customers; oil products, which transforms crude oil into Shell products; chemicals, which produces and sells petrochemicals to industrial customers; and renewables, which focuses on solar and wind energy.
The group is split along geographical lines and is divided between Europe, Africa, Asia Pacific, the Commonwealth of Independent States (including Russia), the Middle East and South Asia, and the Americas.
It company is run by its Committee of Managing Directors, which considers and develops the group’s objectives.