Wall Street Journal: Shell Eased Rules in Mid-1990s

On Accounting for Energy Reserves

By CHIP CUMMINS and ALEXEI BARRIONUEVO

Staff Reporters of THE WALL STREET JOURNAL

March 18, 2004; Page A1

Royal Dutch/Shell Group's guidelines on accounting for natural-gas reserves were relaxed as early as the mid-1990s, a move that appears to have played a role in Shell's overstatement of its energy holdings.

The loosening, as described by a former Shell executive, suggests that at least some of Shell's problems in accounting for its reserves may have predated the arrival of Philip Watts, the recently deposed chairman who headed Shell's exploration and production unit from 1997 to 2001. But the change in Shell's rules doesn't explain why significant natural-gas reserves booked on Sir Philip's watch weren't removed from the company's tally once they were tightened again at the end of 2001.

The change appears to have led Shell to overstate or prematurely book reserves in two big natural-gas fields in Australia and Norway. In particular, Shell's actions involving an icy natural-gas field off the coast of Norway show the energy giant could be much more aggressive than its partners in booking reserves, a measure of oil and natural-gas holdings closely watched by investors.

It is unclear why the guidelines were relaxed so significantly, though at the time Shell was facing intense pressure from investors and analysts to keep up with peers in finding new reserves of crude oil and natural gas. It is also unclear if other guidelines -- for booking crude-oil reserves, for instance -- were similarly relaxed. U.S. accounting guidelines require only "reasonable certainty" from companies in accounting for reserves, giving them leeway in making their own geological and financial assumptions.

A Shell spokesman declined to comment on the reserve-booking changes, citing Shell's continuing internal investigation.

Sir Philip, ousted as chairman by Shell's twin boards this month, led the exploration and production unit when much of the overbooking occurred. Shell's boards also removed Walter van de Vijver, who succeeded Sir Philip as head of exploration.

The Securities and Exchange Commission and European regulators are probing the overstatements. The Justice Department, which has the power to bring criminal charges, has also opened an investigation into whether Shell's reserves were reported accurately and whether they were knowingly inflated, according to a person familiar with the investigation. The inquiry, reported yesterday by the New York Times, is being spearheaded by the U.S. attorney's office for the Southern District of New York.

The Shell spokesman said that, to the best of his knowledge, the Justice Department hadn't contacted the company.

Shell in January cut its reserves by 20% after it said they were overstated by the equivalent of some 3.9 billion barrels of oil, of which about one-third was natural-gas reserves. Of that total, the natural-gas fields in Australia and Norway made up roughly half.

The ousters came after an internal review team looking into the overbooking briefed the boards on its initial findings. Internal correspondence, described to The Wall Street Journal by people familiar with the situation, indicate senior Shell executives -- including Sir Philip and Mr. van de Vijver -- were aware of possible overbookings as early as 2002.

Neither Sir Philip nor Mr. van de Vijver could be reached for comment.

Proved reserves, or hydrocarbons that a company expects to commercially extract, are included each year in filings with the SEC. In the early 1990s, Shell's own reserve-booking guidelines, contained in a two-volume document updated each year, allowed executives to book proved natural-gas reserves only if Shell had signed a sales contract for the gas.

In the mid-1990s, however, Shell loosened the rules to allow gas-reserve bookings with only a "reasonable expectation" of an available market, according to a former Shell executive.

Shell guidelines were amended again at the end of 2001 to warn that gas from "major" projects shouldn't be booked as reserves until agreements had been signed concerning Shell's commitment to invest money in the project, according to the former Shell executive.

At the Gorgon field in northwestern Australia, Shell began booking gas reserves in 1997, even though a final investment decision at Shell isn't expected until next year. The Gorgon reserves, which ultimately totaled some 557 million barrels of oil equivalent, weren't taken off the books until Shell's January overstatement disclosure.

Though Gorgon has attracted the attention of analysts and industry consultants, Shell's lesser-known reserve mistakes at Ormen Lange, an offshore gas field in northern Norway, underscore how different Shell's booking standards were from those of many of its peers. Shell began booking reserves at the Norwegian field years before Shell and its partner companies at the site worked out difficult technical and marketing hurdles on the project.

In 1999, just two years after the field was found, Shell started booking gas reserves that eventually grew to some 109 million barrels of oil equivalent. The company said in a daylong presentation early last month that it erred in the booking.

Partners Norsk Hydro ASA, Statoil ASA, BP PLC and Exxon Mobil Corp. all held off booking reserves at Ormen Lange until just a few months ago, only after all of the risks had been thoroughly vetted, according to officials at those companies.

When Shell booked Ormen Lange reserves in 1999, the consortium partners had drilled just two exploration wells and done some preliminary feasibility studies, said Thor Tangen, senior vice president with Norsk Hydro and the project's director until this past January.

Shell and its partners struggled with the tremendous technical challenges of drilling a field in the deep Norwegian waters. Subzero temperatures could freeze pipes at the site, where 8,000 years ago a giant "submarine slide" had dumped sediment equivalent in mass to Iceland on the sea floor, according to studies reviewed by Norsk Hydro. The slide caused a tsunami that spread debris across the seabed as far as England and wiped out many of the early settlers of Norway's western coast.

The partners were so concerned that the project might trigger another disaster that they conducted a $100 million study to establish its safety, according to project managers at Norsk Hydro. That study, begun in early 2000, wasn't completed until mid-2003. It found the project safe, allowing it to proceed.

But until last year, partners were still struggling to determine whether European markets could absorb the supply of natural gas from the field. Market-related concerns caused the partners in 2001 to move the projected date for first gas flow to late 2007 from 2006. The consortium completed an investment plan only in December, after the British and Norwegian governments approved a 747-mile sub-sea pipeline -- the world's longest -- to export gas from Norway to the eastern coast of England.

In the early-February reserves presentation, Mr. van de Vijver said the early bookings at Ormen Lange were attributable to Shell being "optimistic about the quality of the source and the demand in the market," according to a transcript provided by CCBN StreetEvents.

He said Shell made a final investment decision in December and, therefore, planned to rebook the Ormen Lange reserves. The Shell spokesman reiterated that the company still expects to rebook Ormen Lange's natural-gas reserves.

--Susan Pulliam in New York contributed to this article.