The Sunday Telegraph: Shell's seismic shock

(Filed: 07/03/2004)

The ousting of Sir Philip Watts for the disastrous overstating of reserves has prompted a bout of soul-searching at the oil giant, writes Sylvia Pfeifer. 

The group of directors filing into the impressive headquarters of Royal Dutch/Shell in The Hague last Wednesday knew that a difficult few hours lay ahead of them.

To most of the Shell employees it must have looked like the start of just another regular meeting of the executives of the company's two boards, from Royal Dutch and its UK counterpart, Shell Transport & Trading. But those who looked closer might have realised that the group was not complete. There was no sign of Sir Philip Watts, the embattled chairman.

In fact, no executives were present. For on the agenda at the meeting - which consisted of members of the supervisory board of Royal Dutch and Shell non-executives - was an interim report on the company's shock announcement in January that it was cutting its proven oil and gas reserves by 20 per cent - or 3.9bn barrels.

The report's initial findings, prepared for the group audit committee of Shell's non-executives by an outside counsel, made for grim reading. So grim in fact that the company's executives, including Watts, were not present at what had originally been a scheduled meeting of "the conference", a group made up of the 24 executive and non-executive directors from both Shell's Dutch and British boards.

The report looked at the processes and controls surrounding the overbooking of reserves between 1996 and 2002. At the heart of the probe was how the company handled reserves in the Gorgon field in Australia which were booked by Shell in 1997. Neither of its partners, TexacoChevron and ExxonMobil, had booked their reserves.

Last week's interim report was damning and is believed to have concluded that it was at best a breakdown of management control, at worst bad faith that led to the overbookings.

Faced with such conclusions, it did not take Shell's directors, led by the chairman of the Royal Dutch supervisory board, Aad Jacobs, long to come to the conclusion that the boards' confidence in both Watts and Walter van de Vijver, the head of exploration, had been irrevocably lost. For Jacobs and his directors there was only one more thing to do: to demand that Watts and van de Vijver resign.

Such a move was unprecedented for a company known for being conservative and inward-looking. But the real issue is whether Watts's forced resignation and the continuing debacle over the booking of reserves will lead to major change.

Initial signals being sent by Watts's successor, Jeroen van der Veer, the Dutch former head of Shell chemicals, last week appear to be positive.

Investors are hoping that Watts's departure would act as a catalyst that could force Shell to shake up its cumbersome dual structure, which includes two boards and dual head offices.

But although Watts was clearly under pressure from investors, few observers had expected him to be ousted quite so soon. In fact, some even argued that he was listening to their concerns.

Only last month, at Shell's annual results presentation on February 5, Watts had publicly declared that the missbookings had taken place "on his watch". He was "determined to fix it" and had "the wholehearted support" of Shell's boards.

A similar message had been received by investors. One leading shareholder who had met Watts the week before in America said this weekend that the former chairman had given no sign of knowing what was about to hit him just a few days later.

"I was talking to someone who had very definite plans for the next 18 months," said the shareholder. "He mentioned to me that there were still two scheduled board meetings to come before the annual general meeting in April."

Last week van der Veer - one of Shell's many "lifers", who is in his 33rd year with the group - was doing his best to limit the damage. He tried to draw a line under the crisis caused by Shell's shock admission in January by promising "to go very deep" in trying to find out the root causes.

The departures of Watts and van de Vijver were due to a "loss in confidence in the leadership of the two directors," he said. "These investigations have not finished, so I'm not going to speculate on that. I am not aware of all the precise facts," is all he would say.

Nevertheless, for all the cryptic comments about recent events, van der Veer and his colleagues face immense challenges. Not only must executives try to restore the oil group's severely battered reputation, they also have to deal with the investigation into the misbookings by the US Securities and Exchange Commission, which began last month. In addition, the company faces a number of class action lawsuits from investors in the US.

Last week van der Veer identified three short-term priorities: sorting out the issue of the reserves, running the business, and reviewing Shell's complex structure.

None of these will be easy tasks, especially turning around Shell's underperformance. Over the past three years Shell's shares have underperformed ExxonMobil by around 60 per cent and BP by around 30 per cent.

Shell has set a target of replacing its reserves by over 100 per cent over the next five years. But this is below many rivals' rates of 130 per cent and some analysts believe Shell needs to be more aggressive if it is to close the gap with its peer group.

But van der Veer's biggest long-term challenge will be how to deal with investor demands to simplify Shell's structure. The company is split 60-40 between Dutch and British shareholders, with separate boards in The Hague and London. In recent weeks shareholders have said they would prefer Shell to be run more like a UK plc, with a clear reporting line to the top.

Van der Veer has responded that he is still "in the listening phase" and will spend the next few weeks consulting with more shareholders about their views. Nevertheless, he played down the suggestion that Shell would follow Unilever, the Anglo-Dutch consumer products group, in streamlining its dual board structure.

Any changes, he added, will be made by April next year, when new corporate governance guidelines are introduced in the Netherlands.

Investors said last week that they would continue to put pressure on Shell to change the structure. Eric Knight of Knight Vinke International Partners, an institutional investment fund backed and partly owned by Calpers, the biggest US pension fund, said he was also concerned at the way last week's departures had been handled.

"This appears to have been an internally controlled process which seems to have been done in some haste. These are key decisions. You could run a club on that basis but not a multinational company," he said.

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