The Sunday Times: Ready to blow

April 18, 2004

Shell’s reserves crisis is being blamed on just two chiefs, a move that could set off a bout of fatal infighting, writes Lucinda Kemeny

Walter van de Vijver was furious. Tuesday morning’s newspapers had confirmed his worst suspicions. He, the former second-in-command of Royal/Dutch Shell, was going to be made the scapegoat for the biggest crisis in the Anglo-Dutch oil company’s 100-year history.

Van de Vijver and his boss, Shell chairman Sir Philip Watts, had been sacked a month earlier after it emerged that the company had seriously overstated its reserves, a revelation that caused its share price to plunge. It had instituted an internal inquiry, whose outcome was eagerly awaited by the City and Wall Street.  

But the newspaper reports — which appeared to be uncannily well-sourced — were now pointing to only one conclusion. The report was to be a whitewash, with all the blame heaped on the shoulders of Van de Vijver and Watts.

It was time for a pre-emptive strike. Van de Vijver, well known for his quick temper and a penchant for plain-speaking, reached for the phone and called his lawyers, the aggressive Washington firm Akin Gump Strauss Hauer Feld. After a hurried consultation, the Van de Vijver camp fired its own salvo — a statement that made it clear that, in his opinion, he had told everybody that counted at Shell about his own concerns over the state of the company’s reserves.

But if last week’s leaks made Van de Vijver angry, this week might send him into orbit.

The 200-page Shell report, compiled by the American law firm Davis Polk & Wardwell and entitled “The facts and circumstances surrounding the reserves recategorisation”, will be released early this week. It will point the finger at Van de Vijver and Watts — and specifically at the pair’s antagonistic relationship.

Like a corporate version of the Hutton inquiry, the Davis Polk inquiry is understood to have looked through the pair’s e-mails and found evidence that the tension between the two men exacerbated, and may have even helped to cause, the reserves debacle.

It is an extraordinary conclusion. Watts and Van de Vijver had, at least on the surface, been Shell’s unstoppable double act, with the latter steadily following the former’s path to the top of the company.

Last year they indulged in a classic spate of shuttle diplomacy, endlessly flying to Russia — singly and together — to convince President Vladimir Putin of the merits of the company’s planned expansion into his country.

Their combined charms, the mercurial Dutch executive and the steady, cerebral English engineer, won the day, giving Shell its vital entree into the world’s next big oil province.

But under the surface, Davis Polk is understood to have found, the situation was anything but harmonious.

It will not make comfortable reading for the pair — but despite the painfulness of its revelations, it is unlikely to satisfy the company’s critics, who want one thing: the injection of some senior, big-hitting, independent directors who will be able to take an unjaundiced view of Shell’s predicament.

The next few days will also be a severe test for Jeroen van der Veer, the new chief executive. Not only will he have to contend with the “warts-and-all” reading from Davis Polk, but Ryder Scott, the American oil consultant, is expected to finalise its probe into the true state of Shell’s oil reserves.

Van der Veer and his management team know that they must not put a foot wrong. The internal inquiries are in some ways the least of their worries.

Led by America’s Securities and Exchange Commission (SEC), regulators on both sides of the Atlantic are probing Shell’s affairs, and hot on their heels is likely to come a blizzard of lawsuits from disgruntled American shareholders. Shell is being dragged down into a corporate nightmare.

THE explosive revelations about the company’s reserves, and the sorry state of its internal communications, have left many former executives bemused. Shell’s internal processes for checking the state of its reserves were thought to be as safe as Fort Knox.

Each year in an anonymous meeting room in the Hague, up to 30 of the company’s most senior staff, including Watts, would hear evidence from the exploration and production people in the field. The annual “programme discussions” could take three hours, starting with technicalities before moving on to detailed explanations by staff about their reserves numbers.

It was not an easy process. One former Shell exploration manager said that getting any changes made to reserves figures was “formidable”.

The process started in the field. Teams of technical staff would regularly scour data coming from the wells. If they found any information that could mean reserves under the ground were greater or lower than expected, it had to be reported immediately to the Hague, the head office of Shell’s Dutch business.

“If the adjustment was in any way significant — more than 5% — that would result in a visit from a team from head office,” he said.

They would go over the numbers again, giving local staff a severe debriefing to test their belief in the revised figures. It was nothing to do with trying to inflate the numbers, but the complete opposite. “It was not a grilling that was sponsored by the Hague to get the figures up. We always had a battle against the sceptics,” he said.

Then there was the annual meeting — and another mauling by senior management about the numbers.

But at some stage in the past three years, something started to go wrong. According to leaked internal documents, Shell’s management realised as early as 2002 that the company was not finding enough oil to replace production — a key measure of any oil company’s future profitability.

Years of scattergun investments had left Shell with a legacy of small fields that were immaterial in production terms. Something had to be done.

It is alleged that a decision was made to relax the rules by which the company accounted for proven reserves — a measure used by the SEC to categorise whether oil and gas can be produced with “reasonable certainty” using current technology.

Shell’s decentralised management — often cited as a strength — became in this case a weakness. Units were run as mini-fiefdoms, with different practices adopted in different parts of the company.

The tidal wave broke in January, when Shell admitted the 20% overstatement of reserves. It had to axe 3.9 billion barrels of oil from its proven reserves, a decision that wiped almost 8% off the share price. The reclassification was blamed in large part on overbooking in developments in Nigeria and at Ormen Lange, a gasfield off the Norwegian coast.

At issue now is who knew what, and when. Company documents from late last year, which have been leaked to The New York Times, said Shell had concluded that 1.5 billion barrels, 60% of its Nigerian reserves, did not meet accounting standards for proven reserves. Management advised against changing the figures, however, for fear of damaging Shell’s relationship with the Nigerian government.

Watts and Van de Vijver may have been made to carry the can, but the Dutchman has already come out fighting against any allegations that Shell’s problems were all down to the two men.

In a statement issued last week, he rebuffed any suggestion that senior management knew nothing about the company’s reserves position.

“From the inception of my tenure as head of E&P, I worked diligently to diagnose and improve the health of the business. I regularly communicated to the committee of managing directors regarding the nature and quantity of the potentially non-compliant reserves and our efforts to assess the magnitude of the problem, prevent recurrence, and implement offsetting measures,” he said.

This may be too late to save his career at Shell, but it calls into question Shell’s attempt to blame the problem on just two people.  

THIS WEEK the crisis could come to a head. The internal report into the reserves categorisation, as well as the Ryder Scott probe are both due.

Analysts and investors hope the report will not merely blame the two ousted leaders but will offer some constructive comments for the future.

JJ Traynor, an analyst with Deutsche Bank, said: “Blaming Watts and Van de Vijver looks like scapegoating and it could open the door for legal action.”

He added that it would also lead to new questions over the role of the board which could undermine market confidence again.

Many investors believe the management structure is a problem. It is split between the boards of Royal Dutch and Shell and the top executives come together as the committee of managing directors (CMD). Royal Dutch owns 60% of the company.

Eric Knight, who runs the fund manager Knight Finke and represents Calpers, the largest pension fund in the world, said: “The question is who is running the group and who is responsible when there is a problem. The truth of the matter is that it is everybody and nobody.”

Van der Veer has said he might put potential changes before shareholders at the annual meeting next year, but investors say this is unacceptable.

The best outcome for this week would be a plan of decisive action for the future. Shell already has a string of lawsuits looming, and the last thing it needs is former directors joining in.

But huge hurdles remain. Shell’s joint auditors, KPMG and Price Waterhouse Coopers, are still battling to meet the April 29 deadline for publication of the first-quarter results. Investigations by the SEC and Britain’s Financial Services Authority have made it hard to get the documentation together to sign off the accounts. As of Friday, it still looked like a remote possibility.

DIARY OF A FIASCO

January 9: Shell announces a 20% cut in its proven reserves — equivalent to 3.9 billion barrels — causing its share price to fall 7.5%. Sir Philip Watts, Shell chairman, is criticised for failing to explain the move in person.

February 19: The US Securities and Exchange Commission announces a formal investigation into the downgrading of Shell’s reserves, giving investigators the right to subpoena witnesses and documents.

March 3: Sir Philip Watts and Walter van de Vijver, the company’s head of exploration and production, resign. Shell’s board initially says the decision came by “mutual consent”, but later changes tack, saying the two were asked to resign. Shell’s market value rises by £1 billion.

March 18: £1.5 billion is wiped off Shell’s market value as the company delays publication of its audited financial results for 2003 until the end of May and admits that another 500m barrels of reserves are not proven.

After criticism of its internal audit on its oil reserves, Shell commissions Ryder Scott, one of the biggest reservoir-evaluation consultants, to provide a credible estimate. Davis Polk & Wardwell, an American law firm, is asked to make a full report on the reclassification.

April 16: Shell announces that the Davis Polk review will be published by the end of April. The Ryder Scott report is expected at the same time.

April 29: Financial results for Shell’s first quarter expected to be published.

June 28: Revised date for Shell’s annual meeting. The meeting was postponed from April 23 after the company’s second downgrade of its proven reserves.

Copyright 2004 Times Newspapers Ltd.