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The Times: Shell shock for investor confidence

By Carl Mortished, International Business Editor
January 10, 2004  

A FURIOUS row was erupting late last night between three of the world’s top oil companies after an admission by Shell that 3.9 billion barrels of oil and gas, a fifth of the energy giant’s proven reserves, were not worthy of the name. 

ChevronTexaco and ExxonMobil were forced into hasty denials last night that they had booked any reserves at Gorgon, a giant gasfield in Australia, after Shell admitted it had wrongly classified Gorgon’s gas as “proven”, as early as 1997. Executives at ChevronTexaco, the operator of Gorgon, are believed to be angry with Shell for its decision to declare the Gorgon gas “commercial” ahead of its partners. 

The admission that Shell’s oil executives had been lining the balance sheet with barrels that had not achieved “reasonable certainty” provoked a stock market rout and a warning from Standard & Poor’s, the debt rating agency. 

Investors were stunned by the sudden shrinkage at Shell of one of the core measures of an oil company’s performance. After the removal of almost four billion barrels of hydrocarbons, Shell’s reserve life — measured in years of future production — falls from more than 13 years to just ten. 

“It’s the scale of it,” remarked one analyst. “I have seen things likes this at small exploration companies, generally because of technical problems, but this is over optimism.” 

S&P said that it had placed Shell’s long-term debt on credit watch for a possible downgrade from its current triple-A rating.  

Meanwhile, investors dumped Shell Transport & Trading stock, causing the share price to slide by 8 per cent to 330p. 

Loss of triple-A status would be a devastating blow for Shell, which takes pride in its financial strength and conservatism. Both are in question after yesterday’s evidence that it boosted reserves by booking gas that had not yet found a buyer. 

Shell was at pains yesterday to discount any financial impact from its decision to shift the 3.9 billion barrels from the “proven” category to the less certain “probable” category. Shell said: “It is anticipated that most of these reserves will be rebooked in the proved category over time as field developments mature.” 

However, the oil company was forced to admit in its surprise announcement that it would only replace between 70 and 90 per cent of its production this year. The decision to relegate assets that were once considered to be on the verge of production is an indication that Shell is struggling to maintain its reserve base. “It’s a major issue,” said Derek Butter, an analyst at Wood Mackenzie. “Investors in Shell are going to be very upset.” 

In a tense conference call with investors and analysts, Shell’s investor relations team said that the decision to review the reserves came after a number of studies were undertaken. Speculation centres on a recent inquiry by the US Securities and Exchange Commission into reserve accounting among all the Gulf of Mexico oil producers. However Shell said that the SEC inquiry was not related to its own investigation. 

The barrels removed in yesterday’s decision relate to the Gorgon project in Australia and to Shell’s Nigerian onshore operations, as well as other East Asian assets, including Shell’s assets in Brunei. 

Shell insisted that no blame was being attached to any individuals involved in the booking of reserves. 

Shell’s head of investor relations said that the decisions were based on a different assessment of what constituted reasonable certainty. The decision to book the Gorgon gas assets, he said, was based on “letters of intent for gas sales which had not panned out”. 

The recategorisation will reduce Shell’s proven reserves by 3.9 billion from 19.4 billion barrels. No material impact is expected on Shell’s financial statements for 2003. 

Why the reserves 'evaporated' 

OIL majors spend billions drilling wells — but a strike does not always equal riches, which is why companies do not “bank” their finds the minute the first drop of oil comes out of the ground. 

Companies first make a “guestimate” of how much oil or gas makes up the find, which they report as “hydrocarbons in place”. Geologists then determine how much oil can be recovered, and the find is reclassified as “contingent” or “probable” reserves. But the company still has to make a profit on the discovery. Only when a company can prove “reasonable certainty” to regulators that a find is technically and commercially recoverable, can the find be reclassified again as “proven reserves”. 

It is at this point that Shell appears to have stretched the definition, promising oil and gas finds would be turned into cash. The problem appears to have been particularly accute at the Gorgon gasfield off the coast of Australia. Shell decided to book the Gorgon gas on the basis of letters of intent, only to see the buyers disappear as demand for energy evaporated in the Asian financial crisis.,,8209-958133,00.html

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