THE SUNDAY TELEGRAPH (UK): Shell needs to be more radical to save itself: “…severe crisis for much of the past year”: “Shell's reserve replacement ratio is a pitiful 45 per cent to 55 per cent”: “…to fix its operational woes the oil giant may need a new, more radical boss, one who is brave enough to slim down the business and rebuild Shell from the bottom up.” (ShellNews.net) 13 Feb 05

City comment

By Grant Ringshaw, Deputy Sunday City Editor

(Filed: 013/02/2005)

Here's a paradox. Royal Dutch/Shell, the oil giant which has been in a severe crisis for much of the past year, produces bumper full-year profits – a whopping $18.5bn (£9.8bn) and a record for British company. BP, its rival and one of the world's most respected companies, trailed in second last week in the battle of the UK oil majors with a hefty $16.2bn (£8.7bn) profit.

So Shell is in rude health? Not a bit of it – though it may seem curious that a group that has been so badly managed can be generating such huge returns.

To understand the fortunes of the two giants you only have to look at the comments of the respective bosses. Lord Browne at BP declares confidently that "the best is yet to come" after the 26 per cent rise in profits, a dividend hike of a similar magnitude and a promise to pay a mammoth $23bn in dividends and share buybacks to investors by the end of next year.

Meanwhile, Jeroen van der Veer, the Shell chief executive, has admitted that senior executives' heads are "on the block" if the Anglo-Dutch oil titan does not sort its problems out fast.

Underpinning BP is a healthy reserve replacement ratio – a key measure of the rate at which oil companies replace their output by new finds – of 106 per cent.

For Shell the problem is simple: the company desperately needs to find more oil. The results contained yet another shock – a fifth downgrade of its proven oil reserves by a further 1.4bn barrels.

That means in the past year the group's proven reserves have fallen by an astonishing one third to 12.5bn barrels of oil and gas. Shell's reserve replacement ratio is a pitiful 45 per cent to 55 per cent – even less than guidance last year of 60 to 80 per cent. So Shell faces a huge task to hit its target of a 100 per cent rate on average over the next five years.

But the more fundamental point is this: is Shell prepared to take a more radical approach to solving its problems? In simple terms, this would mean shrinking the business, selling off underperforming assets and quitting areas where it is weak. Rather than being obsessed by pumping out as many barrels as possible, it should focus on its most profitable fields.

There is a lesson to be learned from BP's revival after its debt-induced crisis of the early 1990s. Browne and his predecessor Lord Simon took an axe to BP's underperforming exploration and production units, flogging off assets worth billions and adopting a radical approach to partnerships and other operational issues. It was a potent strategy and it worked.

It takes a special kind of CEO to shrink any business, but in a macho industry like oil where small has never been beautiful and size is an obsession, it is particularly tricky. I am not convinced van der Veer is ready to be quite so radical.

But here is why he should be. There are strong arguments why now is a good time to sell. As the recent auction of energy reserves in Libya showed, the price of oil assets is sky high. One suggestion is that the price paid in winning bids only makes sense if you believe the oil price, currently $44, can remain above $40 a barrel. That may happen, but it's a big gamble.

To be fair, van der Veer has pledged to ditch assets worth between $12bn and $15bn, including Basell, the petrochemicals joint venture, and Intergen, the power generation business.

Shell's response so far to its dire problems has been to bow to shareholder pressure and ditch its historic dual structure and create one UK-listed group. It has also pledged to throw an even bigger mountain of cash at exploration and production – $10bn, against $8.8bn last year. It hopes to unlock 13bn barrels from its underlying resource base of 60bn.

Meanwhile, it could also boost reserves by demonstrating to regulators that the reserves that were de-booked are viable. But that is hardly the sign of a strong company.

Shell has also shifted it focus onto drilling "big cat" wells, aimed at making discoveries of 100m barrels of oil or more. Now this makes sense, but it highlights just how far behind Shell is – BP was doing this a decade ago with its "elephant fields".

The problem is that none of this is going to put Shell back on the growth path it needs to catch up with rivals such as BP and ExxonMobil.

A recent report by Sanford Bernstein estimated that even the world's largest oil companies need a reserve replacement ratio of 137 per cent to ensure even modest annual production. Such a target is pure fantasy for Shell at the moment.

The idea that it can "find" its way out of trouble just looks dubious – given that the oil industry has struggled for exploration success recently.

So what are the other options? Well, Shell could go on a buying spree, and snap up US independents such as Unocal and Amerada, and BG Group of the UK. Of course, Shell does not have the huge debts BP was saddled with in the early 1990s – but it also does not have the chance to buy on the cheap. Incredibly, BP's $67bn takeover of Amoco came when oil was hovering below $13 a barrel.

Shell's current management has gained credit for ditching its arcane structure and reforming its corporate governance. But to fix its operational woes the oil giant may need a new, more radical boss, one who is brave enough to slim down the business and rebuild Shell from the bottom up.

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2005/02/13/ccom13.xml