The Independent: Shell shocked Watts determined to stay on. Will City let him?

By Jeremy Warner

06 February 2004

Sir Philip Watts was terribly sorry for what had happened. He got it wrong and regretted it deeply. He admitted his mistake and there was an unqualified apology for all the furore it had caused. As mea culpas go, they don't come more grovelling than the one issued yesterday by the Royal Dutch Shell chairman. Yet as it happens, he wasn't apologising about the company's calamitous reappraisal of reserves; only for his failure to appear in person to explain them to the City when they were first announced on 12 January.

As for the downgrading itself, or the reasons why reserves came to be overbooked in the first place, two hours of presentations to analysts and the press yesterday failed to cast much light on the darkness. Was it cock-up or conspiracy that had led the company to overstate its proven reserves by as much as a fifth? We seem to be no nearer knowing the answer. Sir Phil would only say that judgements made in the past were not ones that would have been made today. Once he realised there was a problem, his instructions to the company were clear; "Get the facts and do the right thing".

So what sparked the downgrade? The company attributes it to two "catalytic" events. One was the realisation that the oil wasn't coming out of the ground in Nigeria as fast as it was supposed to. The other was a similar problem at Shell properties in Oman. Subsequent reviews showed there to be a big shortfall in proven reserves. This triggered a global review of reserves that uncovered further overestimates, particularly in Australia. What the company seemed incapable of explaining is why previous audits had failed to identify these problems at an earlier stage.

Nor was the company able to explain why it had booked substantial reserves for the Gorgon find in Western Australia when other partners in the same project ­ Chevron and Texaco ­ had booked nothing at all. Did not Shell talk to its partners about reserving policies? Well, no; that's not apparently usual practice in such matters, a state of affairs the company attributes to "part of the mystique of the oil industry".

Jolly handy, that mystique, for it enabled Shell to show it had added to its reserves in a year which would otherwise have shown a fall. More puzzling still, the find was categorised as a revision to reserves in the accounts, rather than a discovery, which meant that even eagle-eyed City analysts were not able to spot that Shell was booking things others weren't.

Sir Philip wanted yesterday's outpouring of apologies to be one of those "let's put all this behind us and move on" statements, but I'm not sure he'll be allowed so easily to spin his way out of trouble. The reality is that Shell continues to underperform its leading peers on a number of key measures, most importantly of all in its ability to replace spent reserves. Even under the old, inflated measure of reserves, the replacement ratio was only a little over 80 per cent over the last five years. On the new measure, that ratio sinks to just 60 per cent.

Of course, the beauty of the recatagorisation process is that rebasing reserves at a lower level makes it easier to replace them. This is more especially the case as about 85 per cent of the recategorised reserves are expected eventually to be clawed back as proven. As a result, the reserve replacement ratio is projected to exceed 100 per cent over the next five years, including any rebooking of previously recategorised reserves. So having poleaxed the replacement ratio for the last five years, the recategorisation process has at least succeeded in flattering it for the next five. Clever, or what?

None of this helps Sir Phil's position. He's determined to stay on, but with his credibility shot to bits, is he really the man to see through the root and branch change that now looms? Assuming the reserving fiasco was largely down to management failure, rather than a deliberate attempt to cook the books, then the mischief cannot wholly be laid at Sir Phil's door. Part of the problem of Shell is that the buck doesn't stop at the top. The culture and structure is one of shared, collegiate responsibility. The dual listing, split board and double domicile makes generally accepted standards of accountability still harder to achieve and enforce.

Shell insiders insist that there are big advantages for multinationals in dual nationality, yet the antiquated structures that go with it seem too often to create paralysis in decision making and make rapid response to fast changing circumstance all but impossible. From the public relations fiasco of Brent Spa to the company's failure to match best performance benchmarks, the present set-up has let shareholders down so many times in recent years that you have to wonder what those advantages might be.

Sir Phil says he's open to change and he promises lots of it. One of those changes must surely be the creation of a unified board. Yet Sir Phil's chances of presiding over it were not improved by yesterday's apology. To many in the City, he looks too much like a busted flush to survive. And if he does manage to brass neck it out, it would likely be seen as proof positive that Shell is indeed incapable of change. The City is a harsh and brutal judge of men, but a new dawn requires a new man.

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