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Storytelling In The News: #93

Shell reduces estimates--again

March 19, 2004

Royal Dutch/Shell seems to have a problem in storytelling. In January, it changed its story about its reserves and reduced them by 20%. Six weeks later the CEO was fired and multiple investigations were launched into the causes of the revised story. On Thursday, a storytelling problem emerged and it cut its oil and gas reserves yet again. The reduction was much less, but the fact of a further revision in its story is a fresh blow to investor confidence, and U.S. regulators have announced that they have stepped up legal probes into the debacle. Shell shares in London fell by about 3 percent as a result of the new story.

The cockroach theory

The new adjustment is much smaller than the January change, but it is even more problematic, because it includes reserves from Norwegian field Ormen Lange that were identified as bookable only a few weeks ago -- after the January admission. The new head of Exploration and Production (EP) said he was surprised, disappointed and embarrassed by the new problems, which occurred despite strict new booking guidance to engineers.

"This means about a quarter of what they've booked for 2003 goes into non-proven reserves," said one trader. "Terrible."

Investors fear what else might be around the corner. "You develop the cockroach theory," said James Halloran of U.S.-based National City Wealth Management Services, quoted in Reuters. "Where there's one cockroach, you're going to find more. You've now been twice bit."

Shell said the latest reserves downgrade would add $20 million to costs for last year on top of a $96 million charge for the original cut. These amounts are small for a company that makes more than $10 billion a year of net profit. Analysts want re-assurance that a big oil company still has lots of oil.

"There's a limited immediate financial effect, but the real point is what it tells you about their future potential," said Brendan Wilders, analyst at Oriel Securities.

False stories were aimed at protecting Nigeria

In an even more startling development, the New York Times reports this morning that the false stories that Shell issued about its reserves were not mistakes or accidents: the Royal Dutch/Shell Group has kept secret important details of its sharp reduction in oil and gas reserves, particularly in Nigeria, for fear of damaging its business relationship with the government there and the Nigerians' desire to produce more oil, internal company documents show.

While Shell has acknowledged that the biggest adjustments in reserves include those in Nigeria, it continues to conceal the extent of its problems. But confidential documents from late last year show Shell concluded that more than 1.5 billion barrels, or 60 percent of its Nigerian reserves, did not meet accounting standards for "proven reserves."

The scale of the revision is important because Nigeria is a significant source of oil for Shell and the country is seeking to increase markedly its production quota within the Organization of the Petroleum Exporting Countries. The size of proven reserves is a basic consideration when OPEC sets quotas for its members. At stake for Nigeria are billions of dollars in revenue annually.

Shell disclosed two months ago that it had overstated its oil and gas reserves by 20 percent, which is equivalent to 3.9 billion barrels of crude oil. On Thursday, it pared its reserves by the equivalent of 250 million barrels more, most of that involving a natural gas field off Norway. Shell also postponed the publication of its 2003 annual report for two months to complete a review of its oil and gas assets.

The oil company's executives are acutely aware of the potentially explosive political effect of their cutting the estimates of Nigerian reserves. A report dated Dec. 8, 2003, and prepared for senior executives by Walter van de Vijver, then the top official for exploration and production, recommended that the revised Nigerian reserves remain "confidential in view of host country sensitivities."

So far, Shell has not released a country breakdown of its reserve restatements, but it told analysts last month that Nigeria and Australia were the two largest. Company documents show that Shell's senior managers were told in December that 720 million barrels in Nigeria were "noncompliant" with guidelines established by the Securities and Exchange Commission, and that a further 814 million barrels were "potentially noncompliant."

Why has the story changed?

The Shell documents, including the December report, show that geology is just one part of determining whether oil or gas is a proven reserve. A producer must also have firm plans to extract the resource and be ready and able to make the investment to carry out those plans; the absence of such commitments, the documents showed, was the main reason most of the Nigerian reserves did not meet the definition of "proved."

Mr. Corrigan, the Shell spokesman, said that "government funding has been a constraint, not Shell's willingness to fund."

From Nigeria's perspective, the foreign oil companies are partly to blame for the slow pace of meeting reserve targets because they "are sitting on large tracts of undeveloped acreage," according to Shell's understanding of a growth plan prepared by Funsho Kupolukun, who functioned as an adviser to Nigeria's president and who now manages the national oil company.

There are more than financial issues behind the decline in reserves. "Community disturbances and political instability" were also to blame, according to the Shell report. Most of Nigeria's oil reserves are in the delta region in the south, where unrest forced the company to reduce production last year.

Shell faced international criticism from human rights groups after the execution in 1995 of Ken Saro-Wiwa, a Nigerian environmentalist who organized demonstrations to demand that Shell and other energy companies reduce oil spills and pollution, and hire more local people. Shell decided to pay more attention to its civic responsibilities, but challenges remain.

"It's a very challenging environment for Shell in Nigeria," said Alex Vines, head of the Africa program at the Royal Institute of International Affairs in London.

The impact of the Shell story

By reducing its estimates of reserves, the physical world hasn't changed. What has changed is the story about those reserves. It's the story that enables investors to determine how much money Shell can make over certain periods and how busy it can keep its refineries. No matter how "challenging" the environment is in Nigeria, if it is confirmed that Shell was telling stories to the world about the reserves which its executives knew to be false, Shell will have misled investors and not only reduced its market value but also exposed itself and its executives to civil and possibly criminal lawsuits. The succession of unexpectedly negative stories causes financial markets to fear that more bad news may be on the way..

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