FINANCIAL TIMES: Shell needs something in reserve: “…the company is in difficulty - even though its downstream refining, marketing and chemicals businesses performed well last year”: “… analysts are scathing about the latest reserves cut and the culpability of the current management team, which has been in place for almost a year.” (ShellNews.net) 4 Feb 05

By James Boxell in London and Ian Bickerton in the Hague

Published: February 4 2005

On the face of it, Royal Dutch/Shell would appear to be in rude health.

Profits in 2004 of $18.5bn (£9.8bn) on the back of record crude oil prices even led to calls from some British politicians yesterday for a windfall tax on this "disgraceful" profiteer.

But drill deeper and the company is in difficulty - even though its downstream refining, marketing and chemicals businesses performed well last year.

The management appear confident they have finally put the reserves scandal behind them, hence the offering of their own "heads on blocks" if they fail and the commendable embrace of accountability - an alien concept at Shell until last year.

The only apparent challenge to the company's much reduced reserve figure of 12.95bn barrels could come from the US Securities and Exchange Commission, which must accept Shell's new calculation.

But Jeroen van der Veer, chief executive, believes there is little more his company can do to make sure it is compliant.

He says: "We looked at 1,500 fields and analysed 12,000 wells. It feels to us like we had hired every expert in the world. We are talking about absolute compliance with SEC guidelines.

"Maybe this is the best that human beings can organise. Maybe we have even been too conservative."

Now, the problem Shell faces is how to get back to the business of finding oil and replacing those reserves.

The revelation yesterday that Shell had replaced only 15 to 25 per cent of the depletion in its reserves last year shows how far it has to go to hit its target of 100 per cent reserve replacement on average over the next five years.

Admitedly, the company gave itself an insurance policy when it said this recovery would be "back-loaded" towards the end of the five years.

But yesterday's presentation offered little new evidence of how Shell might achieve this.

Malcolm Brinded, head of exploration and production, returned to his theme of insisting Shell's underlying resource base was unchanged and that it had 60bn barrels of potential oil and gas under its control.

The trick will be getting these resources into a state where they can be recognised as commercially viable by the SEC.

Mr Brinded hopes that by spending $10bn a year on exploration and production, he can unlock another 13bn barrels of reserves from that 60bn barrel pool.

Shell can also do much to replace reserves by bringing back the third of its proved oil and gas it has been forced to debook in the past year.

To do so it must demonstrate to the SEC that reserves it previously had considered uncommercial can now be profitably extracted.

However, this hardly indicates a strong company and would just leave Shell standing where it was before the reserves debacle.

Sanford Bernstein, the analysts, have pointed out that oil companies need a 137 per cent reserve replacement ratio just to ensure modest yearly production of 3 per cent.

Mr Brinded also lauded Shell's reinvigorated exploration drive with the drilling of 15 "big cat" wells last year, aimed at making discoveries of 100m barrels of oil or more.

He said it had made five discoveries but none of these had so far proved to be the huge finds that it needs.

The oil industry as a whole has struggled for exploration success recently and one former rival exploration executive says: "There is no way Shell can 'find' its way out of trouble."

The company also has a hard task in restoring damaged morale within the core exploration and production unit and recruiting the 1,000 engineers it needs to get itself back on track.

Many analysts are scathing about the latest reserves cut and the culpability of the current management team, which has been in place for almost a year.

Says one: "This is pretty bloody disappointing. The life of their reserves now goes down to 9.2 years, which is in line with Amerada Hess [the smaller US independent oil group]. It is nowhere near the 14 years of Exxon and BP."

There are also complaints about why Shell had not made the news of its latest cut available sooner, as it was market-sensitive. The company says the final proved reserves figure was only finalised this week.

Another solution would be for Shell to buy its way out of trouble by acquiring other companies, although Mr Brinded insists that his 100 per cent reserves replacement target does not depend on this.

The company has been linked with bids for US independents such as Unocal and Amerada, as well as Britain's BG Group.

But despite accusations from some analysts that problems at Shell are being masked by high oil prices and the rise in its share price because of purely technical issues related to its recreation as a single London-listed company, Mr Van der Veer remained upbeat.

"We are not completely over all of our problems but we have a very sound strategy and I feel very good about how we are going to organise the company. Morale is coming back."

TECHNICALITIES BEHIND THE LATEST REVISION Royal Dutch/Shell claimed yesterday that much of its latest downward revision was of a technical nature, and when looking at two of its projects in Canada it is difficult not to feel some sympathy,writes James Boxell. Shell claims to have about 600m barrels of petroleum reserves held at its Athabasca oil sands project in Canada. The heavy oil is trapped in a complex mixture of sand, water and clay. But because Shell must use open pit mining rather than drilling to extract the oil from the sands, the US Securities and Exchange Commission forbids the inclusion of the 600m barrels in its proved reserves figure. This means that Shell is in the absurd position of producing 80,000 barrels of oil a day from Athabasca but is unable to book the reserves. The company was also forced to remove bitumen production from its Peace River site in Canada, which helped cut its reserve replacement ratio by 14 basis points.