Financial Times: Shell's lessons for oil industry regulation

By Adrian Michaels in New York

Published: April 25 2004 17:58 | Last Updated: April 25 2004 17:58  

Shell's admissions last week on how it played fast and loose with the estimates of its reserves highlight how little investors know of these measures of performance, and how regulators have faced difficulties in overseeing the oil industry.

There has already been plenty of criticism of regulators for not picking up some of the problems in reserving.

People close to Shell say it has considered arguing when it meets regulators that the accounting rules on reserving are so vague as to allow very wide interpretation.

Reserves are not recorded on the balance sheet and they are not checked by the company's outside auditors. But they are a crucial yardstick for investors.

The Securities and Exchange Commission, the US's chief financial regulator, has simply relied mostly on trust when assessing company reserve reports.

The SEC's division of corporation finance, which checks company filings, was stretched during the latter half of the 1990s when Shell's reserve issues might have started to become apparent. The staff were so busy overseeing initial public offering documents from dotcom start-ups that they had already fallen way behind in reviews of company annual reports.

That became clear after the scandals at Enron and elsewhere.

But it is also a fair criticism, SEC watchers say, that different reserve estimates from different oil companies on the same oil fields were similarly overlooked.

The SEC, oil industry consultants say, had no engineering staff for most of the 1990s, adding a geologist only in 1998 and later two petroleum engineers.

One problem is "proved undeveloped" reserves, a category of reserves thought to be particularly cloudy. A confidential consultants' report seen by the Financial Times, which was prepared for Milberg Weiss, one of several law firms in private litigation against Shell, urges an analysis of how such reserves are defined as a precursor to building a legal case against the company.

After all the accounting furore of the past few years, it is hair-raising to read, as investors in Shell could have last week in the company's new admissions that "from its inception, the [Australian field] Gorgon 'proved' reserves did not meet the overriding SEC standard . . . There is no written audit trail indicating who made the decision to categorise the Gorgon reserves as proved, or the basis for that decision . . . Gorgon had long 'stuck out like a sore thumb', but . . . debooking of the reserve was 'too big to swallow'".

With few checks from the SEC, it is worth reflecting that Shell reported the problems itself without regulatory prompting and could have gone on playing with reserve numbers for a while longer.

But it is difficult with the minimal reserve disclosure from companies to see how the SEC could have done better.

Reserve deposits are not broken out by field. Shell's reserves last year were given in supplementary data - pages G34 to G36 - of one document sent to the SEC and separated into only two categories - the eastern and western hemispheres. Shell says it will be improving the situation.

Other companies are not much better. Although the Financial Times has reported that five companies involved in Ormen Lange, the Norwegian natural gas field, booked widely different percentages for their shares in the field with the same data, no outside investor could have worked that out from SEC filings.

Analysts say it is assumed that the SEC has asked individual companies for more non-public information, and that has happened only on an occasional basis. It is also known that the SEC is asking large oil companies a host of serious questions in light of the Shell debacle.

Doug Leggate, an analyst at Smith Barney, says the issue of reserving has been "totally arbitrary and open to management discretion with no consistency . . . The whole debacle has put the issue under the microscope".

Mr Leggate says the regulator could make life easier for investors by changing its public reporting requirements. "Company disclosure clearly has to improve," he says. "How it improves is a different question. The SEC will struggle to come up with a set of rules that will cover all eventualities."

Estimating reserves, says Mark Flannery, an analyst at Credit Suisse First Boston, is "done with great difficulty". But for Mr Flannery, the problem is one of trust.

"In most cases the aggregate reserve statements [of the industry] have tended to accord well over time with production. There hasn't been a problem . . . Once you get into undermining the trust in the numbers, there isn't a second level you can go to."

During the late-1990s a similar debate took place over pro-forma accounting. Dotcom start-ups were wooing investors by focusing on revenue projections rather than profit - trumpeting revenue numbers in the headlines of press releases that were not allowed on an income statement because they were non-standard comparisons with previous periods.

From now on, Shell says, its reserve numbers will be independently checked by outside experts. Its peers are certain to feel investor unease over the damage to trust in the industry. Additional reporting by Carola Hoyos in London