The Sunday Telegraph: When will Watts come out of his shell?

(Filed: 18/01/2004)

The oil giant's chairman needs to get out and do some serious communicating if he is to win round a stunned City, says Sylvia Pfeifer

Like one of the giant oil tankers it routinely sends over the oceans, it takes quite a storm to blow Royal Dutch/Shell off course. But events of the past two weeks have set the alarms wailing at the Shell Centre, its headquarters on London's South Bank. 

Just over a week ago, this oil giant disclosed that it had overbooked reserves - a vital measure of assets and pointer to future production - by 25 per cent. The City was stunned, so predictably investors are now pressing for change.

Most of them are not quite calling for the head of Sir Philip Watts, Shell's chairman. But some say they might yet - and in the meantime, they want the oil giant's cumbersome and bureaucratic management structure to be consigned to the dustbin of history.

"They got themselves into this mess in spite of their myriad management layers, so they must recognise it's time to streamline," says a representative of one of the group's largest shareholders.

Anyway, this week Lord Oxburgh, the academic who is Shell's senior non-executive director, is expected to respond to a letter from a group of shareholders - under the umbrella of the Association of British Insurers - demanding a meeting. On the agenda would be "what went wrong?" and "where was Watts when the bad news was being delivered?".

The point is that when the announcement about the restatement of reserves was made, both Watts and his finance director, Judy Boynton, failed to talk with investors directly about what had gone wrong.

Since then, Shell executives have been locked in meetings at the Shell Centre to agree a plan of action ahead of the company's results presentation on February 5. Watts, whose relationship with the City has never been warm ever since he took the top job in 2001, knows that he and his team need a credible story to tell on the day, or he could be heading for the waste pipe.

The company has insisted that the original reserves calculations were made in good faith. But that does not seem to weigh heavily with shareholders.

According to some investors, the debacle is evidence of two of Shell's salient traits: an inability or even unwillingness to communicate properly with the City and a lack of effective governance.

The company's cumbersome structure - it brings together two separate companies, Royal Dutch Petroleum and Shell Transport & Trading, which share interests in the companies in which they invest, topped by a committee of managing directors, chaired by Watts - is once again coming in for criticism.

Ruben Mikkers of the Dutch-based fund management house Robeco Group is just one who has lost faith in Shell. According to Mikkers, "this company was always perceived to be very conservative rather than aggressive in its bookings . . . It undermines the credibility of the management team".

"To regain credibility, I guess Shell would be helped by one or two changes in the management team. It's not the first time they have disappointed. The financial world has lost confidence in the top management," he says.

One of the questions being asked by investors is just how much blame to apportion to Watts directly and whether pushing for his departure ahead of his official retirement in June 2005 would make sense.

The omens for the 58-year-old physicist from Leicestershire are not good.

His tenure at the top of the company had already been marked by poor communication. Just one month after taking the helm from Sir Mark Moody-Stuart in July 2001, he was forced to reduce the oil-production targets set by his predecessor, cutting them from 5 per cent to 3.5 per cent. The City was unimpressed with his performance on the day - as was the market, which knocked £4bn off the group's market value.

Shell executives say that the incident brought home to Watts that he needed to improve his communication skills. But his intensely private nature seems to mitigate against this (his reclusive style has contrasted sharply with the flamboyance of his oppo at BP, Lord Browne).

"Watts comes across very poorly and this is from a company that has a history of not being very good with the City," says one shareholder. "Shell really don't care about shareholders. We don't matter to how they run their company, not least because they have not had to come to the market [to raise cash] for over 50 years."

Nor has Watts' management performance in the round won him many fans. Last week some analysts said that as Shell's head of exploration from 1997 to 2001, he should have had a firmer grasp of the quality and quantity of its reserves.

One investor says: "Watts should have been aware of what was going on at Gorgon [where oil reserves were reclassified]. He should have been aware that the operator of the field, ChevronTexaco, had not booked any reserves, nor had ExxonMobil.

"To a large extent Watts used the apparent success of the exploration and production business to get him the top job. He was in charge and I would say he is responsible."

On a wider scale, one of the main challenges Shell has faced over the past few years is that its rivals have simply caught up with it in terms of amassing an international portfolio of production assets.

"In the 1980s and early 1990s Shell had a very good exploration track record, especially compared with the European majors," says Paul Spedding of Dresdner Kleinwort Wasserstein.

"The company had a very international and diversified portfolio. But in the mid-1990s other majors started to discover other countries."

A string of mega-mergers by rivals in the late 1990s only piled on the pressure. When Shell did finally hit the acquisition trail, the results were mixed. Investors still feel sore about the aborted £3.1bn bid for Australia's Woodside Petroleum in June 2000, and its failure to win the £1.5bn battle for America's Barrett Resources in March 2001.

But it was Watts' decision to pay top dollar for Enterprise Oil and Pennzoil-Quaker State in 2002 that comes in for the largest dose of criticism.

There are some, however, who argue that getting rid of Watts would not solve more endemic problems within the company, notably its decentralised corporate structure and its dual board.

"Getting rid of Watts would be like getting rid of Saddam Hussein. You get rid of Hussein but if you still have the Baath Party you don't change very much," said one leading shareholder. "What the company really needs is an influx of outsiders, not just the removal of one or two people."

That said, Watts is not utterly without City support. One analyst says that the fundamental problem at Shell has been one of underinvestment; the company spent just $6bn a year on finding new reserves between 1996 and 2000, when it should have been spending closer to $9bn. However, under Watts, from 2000 to 2003, Shell's exploration and production expenditure rose to $9bn, closer to the level at BP.

So what happens next? For now, Shell board members are standing by Watts, although he might still agree to retire early. But apart from management changes the pressure is now on the company to find more reserves.

One obvious route would be via a takeover. But once again BP has stolen a march on Shell, having formed a joint venture with TNK, the Russian oil giant.

Industry bankers last week said Shell might take a look at Sibneft - which is probably available, having unwound its merger with Yukos, another Russian group - but this could lead to Shell losing its cherished AAA credit rating. For Watts and his conservative board, that might be too high a price.

But if Watts is to regain the confidence of Shell's owners, he has to break the habits of a lifetime and become bold and outgoing. And he has just three weeks to execute this metamorphosis.

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