Business Day: Overstatement raised oil giant's profit by $432m: “Last Monday the leaders of Royal Dutch/Shell asked shareholders for forgiveness and time to revamp the oil giant.”

5 July 2004

WASHINGTON The Royal Dutch/Shell Group said the overstating of its oil and gas reserves and "inappropriate" accounting in other business segments exaggerated its profit by $432m.

The revision followed an embarrassing series of disclosures that reduced the company's reported reserves by nearly a quarter and led to the departure of several of its top executives.

The biggest downward revision was for 2002, when the faulty accounting resulted in the company's profit being overstated by 208m. In 2001 the reduction was 56m, in 2000 it was $122m and prior to 2000 it was $46m.

The company disclosed the overstated profits in a filing with the US's Securities and Exchange Commission late on Friday.

It explained that it had also erred in the way it accounted for exploration costs, certain gas contracts and the earnings per share of its parent companies.

However, because of a change announced on Friday in the way Royal Dutch/Shell will now account for its inventories, the energy giant said its net income for 2002 was actually higher than previously reported at $9,72bn, up from the $9,42bn it reported in February last year.

The accounting overhaul caused Royal Dutch/Shell's 2001 net income to drop to $10,35bn, down from the $10,85bn it reported in February 2002, while its 2000 net income increased slightly to $12,87bn, up from $12,7bn reported in early 2001.

In a string of four restatements that started in January, Shell downgraded its proven reserves by 4,47-billion barrels, or 23%. Proven reserves are the amount of oil and gas a company expects to commercially pump to the surface, a crucial measure for investors of an oil company's performance and future value.

Overstating reserves led to the resignations of chairman Philip Watts, head of exploration and production Walter van de Vijver, and chief financial officer Judy Boynton. It also drew the attention of regulators in the US and Europe.

Last Monday the leaders of Royal Dutch/Shell asked shareholders for forgiveness and time to revamp the oil giant.

Shell has an unusual, binational structure in which Royal Dutch Petroleum of the Netherlands controls 60% of the group and Britain's Shell Transport & Trading holds the remaining 40%. Investors and analysts alike have blamed this cumbersome structure for the breakdown in governance that led to the significant overstatement of the company's oil and gas reserves.

Shell's restatement was released after the US markets closed. Shares of Royal Dutch Petroleum closed up 11c at $51,72 on the New York Stock Exchange, where shares of Shell Transport finished 13c higher at $44,65.

The overstatement of its proven oil and gas reserves resulted in its profit being inflated by 276m between 1998 and 2002. The inaccurate accounting of exploration costs and certain gas contracts caused its profit to be embellished by $156m between 2000 and 2002.

Yet the company increased its final tally of profits in 2000 and 2002 as a result of a change in the way it calculated the cost of the oil products sold during the year. Royal Dutch/Shell said it was switching the accounting method for its North American inventory to conform with the way the cost for the rest of the company's inventory was calculated, known as "first in, first out" or Fifo.

Because the cost of a raw material such as crude oil varies over time, an oil company's inventory will include barrels of crude acquired at various prices. When a barrel is taken from that inventory and sold for revenue, the company needs to subtract a cost for barrel to calculate the profit on that barrel. Under the Fifo method, a company uses the cost of the oldest oil in its inventory.

The company's decision to use the Fifo method inventory resulted in a $511m increase in previously reported net income for 2002, a $446m decrease in net income for 2001 and a $269m increase for 2000. Sapa-AFP

Jul 05 2004 07:00:36:000AM  Business Day 1st Edition