The Sunday Times: Why auditors closed the door on Shell
The oil giant’s annual accounts were never even put before its auditors, reports Lucinda Kemeny
28 March 2004
SHELL’s auditors pulled the door closed and gave their client the bad news. They would not be able to sign off the accounts.
The internal finance staff were disappointed but it came as no great surprise. At least one of the joint auditors, KPMG, had prepared the company for this outcome. Over many weeks of meetings spent poring over the numbers it had become clear that the accounts were far from complete. And it was the auditors’ duty to inform the company.
Shell denied last week’s Sunday Times story that the company’s auditors had refused to sign off its accounts. The oil group said that no accounts for the past year were ever put before KPMG, which is responsible for auditing Royal Dutch, the business quoted in the Netherlands, or Price Waterhouse Coopers, the auditor of Shell Transport & Trading, which is listed in London.
This led to Shell’s shock announcement this month that it would have to postpone publication of its annual results until April and delay the annual meeting until June.
But the real story was that the auditors could not have signed off the accounts. They were too worried about the potential liabilities.
Even with all their sophisticated technology, the Big Four auditors have become increasingly concerned at the ever-growing number of investors using class actions in America to sue when the value of their shares falls.
The last thing KPMG or PWC needs is to become a target at a time when the profession is desperately trying to repair its battered image after a string of corporate scandals that they failed to prevent.
Ever since January, when the company announced it was going to have to reclassify 3.9 billion barrels of oil, equivalent to 20% of Shell’s proven reserves, American law firms have been gearing up for the assault.
The US Securities and Exchange Commission (SEC) is carrying out its own investigation while the Justice Department, which can bring criminal charges, has also informed Shell of its intention to make inquiries. This is aside from the probes being carried out by Euronext, of which the Amsterdam stock exchange is a member, and the Financial Services Authority in Britain.
This has all given ammunition to Milberg Weiss, the American class-action specialist, and several others, who have filed lawsuits.
Milberg Weiss’s complaint alleges that Shell management “deliberately violated accounting rules and guidelines relating to oil and gas reserves”. Sir Philip Watts, the oil group’s former chairman, is personally named in the suit and he has hired the US law firm Crowell & Moring to defend him. Analysts said this claim alone could top $1 billion (£549m).
Shell used to be regarded as one of the most conservative companies in the world. One long-serving former employee described it as working for the “Shell civil service”.
This image was shattered in January. Watts and Walter van de Vijver, the head of exploration and production, were forced to resign for losing the confidence of the board.
Meanwhile, almost daily leaks to newspapers have told of a company that realised a decade ago that the rate at which it was replacing its oil reserves, a key measure of profitability, was getting worse.
Too many exploration wells were being dug in too many countries and often in places where the size of any oil finds would not be big enough to make a material difference.
It is alleged that management, facing a looming crisis, decided to relax the rules applied to classifying reserves. This would then allow more oil to be booked as “proven”, a category used by the SEC to imply that the oil or gas will be produced with reasonable certainty using current technology.
And so it seems that years of overbooking finally led to the crisis in January. For a company so introverted, the resulting internal angst must have been very painful.
What has been made clear since is that Shell hired Ryder Scott, an American consultant, to go through all the reserves with a fine-tooth comb and report back anything that does not fit with the SEC guidelines.
While this study will not be completed before the end of April, the early effects became known 10 days ago when Shell wiped a further 470m barrels of oil from its proven reserves and put back its accounts and annual report.
This announcement has given far more ammunition to the lawyers.
Milberg Weiss senior partner Steven Schulman said the latest news would significantly increase the potential damages.
“In my opinion the latest news expands the period where Shell may be liable and further strengthens our claims overall,” he said.
“We are talking about very, very large damages. Billions of dollars,” he said.
He added that many more shareholders would be able to join the action because the time frame would be put back following the revelations.
In the light of the regulatory investigations as well as Shell’s internal review of its reserves, can it be any wonder that the auditors have declined to put their signatures on the accounts? Despite their obvious aversion to signing off incomplete figures, the issue has highlighted a deeper problem that may involve the accountants whether they like it or not.
At present, the guidelines governing reserves booking are those set by the SEC some 30 years ago, and, while technology has moved on in leaps and bounds, the principles have not.
The reason behind Shell’s move to downgrade proven reserves 10 days ago was because 3D seismic equipment was used to calculate the reserves available at the Ormen Lange gasfield in Norway. While this is perfectly acceptable for an oil company, the data collected from this are not admissible for SEC purposes. The question is, should the rules be changed? One industry executive said the booking of reserves was complex and estimates of available reserves in one field could be very different depending on which company’s data were used.
“The rules are not crystal clear and they are not up to date. There is a lot of computing power now that was not available when they were fixed in the 1970s,” he said.
The SEC is aware of the problem. At the moment, the subjective nature of reserves booking means the figures do not form part of the financial statements in annual accounts but are listed in a separate category called “supplementary information”.
The SEC has tried in the past to come up with an accounting standard for oil that would mean the reserves would become part of the financial statements and therefore be audited by accountants, but it gave up in the end.
Accountants are already wondering whether the SEC might try again. Oil-industry executives said they would welcome such a move because it would bring clarity.
Thierry Desmarest, chief executive of Total, the French oil giant, said he preferred an industry solution. “I’m in favour of having guidelines at an industry level to determine how the assessment of reserves should be made.”
He said a working group could be set up by the Society of Petroleum Engineers, which could standardise exactly how proven reserves should be calculated rather than using the subjective standards of the SEC.