The Economist: The next scandal? In the wake of the Shell scandal, there are doubts about reserves at other firms: “THERE is something strange going on in this industry,” says Jeroen van der Veer, the boss of Royal Dutch/Shell. He suspects that his firm, far from being the nasty exception it has been portrayed as being, is merely the first to face a problem that is industry-wide.” (ShellNews.net) Posted 12 Nov 04

Nov 11th 2004

From The Economist print edition

“THERE is something strange going on in this industry,” says Jeroen van der Veer, the boss of Royal Dutch/Shell. He suspects that his firm, far from being the nasty exception it has been portrayed as being, is merely the first to face a problem that is industry-wide. Mr van der Veer got the top job at Shell after a scandal involving overbooking of “proved” oil reserves that brought down his predecessor, Sir Philip Watts, and also prompted the firm to abandon its arcane bi-national dual-board structure. Industry analysts and investors are quietly saying that Mr van der Veer may be right, and that another big reserves scandal may be brewing somewhere.

Shell, says Mr van der Veer, is like a “naughty schoolboy that has been caught”. If other firms had to apply the rules on what can be called “proved” reserves set by America's Securities and Exchange Commission (SEC) as diligently as Shell now does, would they also have to make substantial revisions to their reserve figures? Lysle Brinker of John Herold, a consultancy, thinks so. “I would bet money that is the case,” he says. “But we just don't know at which firms.”

He worries most about firms that classify a large part of their “proved reserves” as “undeveloped” assets that have not undergone the irrefutable test of actual production. Analysts and investors now whisper that BP, with a high share of such undeveloped proved assets, is ripe for revisions—a charge the firm roundly rejects.

Consider Ormen Lange, a North Sea gas field shared by half a dozen oil giants. Though all have access to the same geological data, each firm has booked a different proportion of its stake as “proved”—ranging from Shell's estimate, revised, post-scandal, to about 20% (down from over 60%) to BP's at over 80%. BP will not comment other than to say that it is standing by its estimate, and to confirm that it is selling its stake in that field. “Why is BP booking the gas as 80% proved?” asks Eric Knight, an activist investor representing the giant CalPERS pension fund, “and why is it in such a hurry to sell?”

If the reserves problem at Shell does not grow into an industry-wide scandal, one reason may be today's high oil prices. Firms that had used unrealistically low cost estimates for extracting oil from ageing fields have suddenly been bailed out of trouble by the price rise, which makes extraction viable, and thus reserves proved, even at a higher cost. And perhaps the Shell affair may force the SEC to update its rules for proving reserves, which Mr Brinker calls “archaic”. They make no use of modern technologies such as seismic testing and lateral drilling, for instance.

Mr Knight would prefer the SEC to require instead a measure known as “2P”— proved plus probable reserves. Using that measure, Shell would have avoided trouble. The SEC opposed using 2P, but recently said it will allow seismic data to be used in judging whether reserves are proved, but only in the Gulf of Mexico—a decision that one oil executive called “capricious and bizarre”.

Meanwhile, Mr Knight is pinning his hopes on external auditors. “If Shell agrees to an external audit of all of its reserves, this would strongly encourage others to do likewise and would help to eradicate inconsistencies in the application of the SEC's standards that have undermined market confidence in the sector.” Over to you, Mr van der Veer.

http://www.economist.com/business/displayStory.cfm?story_id=3387223&sponsorTranMode=UK

Two related archive articles from The Economist:

1. The Economist: Humiliation: A once proud firm, brought down by its own flaws, needs a thorough shake-up: "IT IS the corporate equivalent of a Shakespearean tragedy. For more than a century, Royal Dutch/Shell was one of the proudest and most admired companies in the world.": "Its old corporate slogan, “You can be sure of Shell”, seemed a mere statement of fact. Now it seems as if the opposite is the case.": "this week's gale of bad news has shattered the firm's credibility": "“I am becoming sick and tired about lying”, the striking phrase in an internal e-mail from Shell's second-ranking executive to its top-ranking one, has been broadcast to the wide world, and will now be associated with the company's name for years to come." (ShellNews.net) Reposted 12 Nov 04

2. The Economist: Royal Dutch/Shell: Sick and tired about lying: “I AM becoming sick and tired about lying.” Those are not words shareholders want to hear from a senior executive. They are certainly not words anybody ever expected from an heir-apparent at Royal Dutch/Shell, one of the world's largest—and until recently, one of its most admired—oil companies.”: “The report into how the phoney numbers emerged paints a picture of deception and backbiting at the top—and, despite ongoing board efforts to exonerate the new management, contains plenty to encourage shareholder lawsuits and, maybe, criminal prosecutions, not least in America, where jail may await. More senior Shell people may yet have to quit.” (ShellNews.net) Reposted 12 Nov 04