Royal Dutch/Shell 'Oil Reserves' Controversy

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Case Details:

Case Code : BECG040
Case Length : 14 Pages
Period : 2001-2004
Pub. Date : 2004
Teaching Note :Not Available
Organization : Royal Dutch/Shell
Industry : Oil and Energy
Countries : Netherlands/UK

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This case study was compiled from published sources, and is intended to be used as a basis for class discussion. It is not intended to illustrate either effective or ineffective handling of a management situation. Nor is it a primary information source.

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"Shifting a project from proven to probable is like moving it out of a cash account to accounts receivable. It is still an asset, but not as valuable because of the lower certainty."¹

- Michael Lynch, Consultant in Strategic Energy & Economic Research.

"A reclassification of this magnitude is catching the attention of not just the investors in Shell but other watchdog groups. This is only likely to increase the pressure from investors to make sure companies are more careful and forthcoming."²

- Lysle Brinker, Energy Stock Analyst at John S. Herold.

Introduction

On January 09, 2004, after an internal review, Royal Dutch/Shell group's (Shell) management announced that it was downgrading nearly four billion (bn) barrels³ of its 'proven' oil and gas reserves to the 'probable' category. This represented about one-fifth of Shell's total 'proven' oil reserves.

The announcement from Shell which had been considered as a conservative company shocked the financial markets and the oil industry. Soon after, Shell's share price fell by 7%. (Refer Exhibit I for the stock price chart of Royal Dutch/Shell). Shell's recategorization of oil reserves raised questions among analysts about the procedures followed by oil companies to 'book' reserves. The episode led to calls for an industry-wide standardization of accounting practices. The Securities and Exchange Commission (SEC)⁴ started investigating the reasons for the controversy over Shell's oil reserves. Soon after Shell's announcement, BP⁵ announced a reduction of 2.5% in its 'proven' oil and gas reserves estimate at the end of 2003, which was equivalent to 445 million (mn) barrels of oil.

In late 2003, El Paso Corporation⁶ announced a 34% reduction in its gas reserves. Analysts believed that in Shell's case, there was no evidence of criminal wrongdoing - there was no precise legal standard or industry agreement on the method of classifying reserves.

Under the SEC guidelines for booking of proven reserves, managerial discretion and reclassifications were allowed. Robert Plummer, an analyst with Wood Mackenzie Limited, said, "They are not reducing the number of barrels in the ground, but the time when they would be developed."⁷ However, what worried analysts the most was the size of the reserves recategorization, the largest ever for any oil company in the world. Bernard Mignon, senior investment manager for the oil sector at ING Investment Management in the Hague, said, "I couldn't believe such a reclassification. It was incredible."⁸ Jon Wright, analyst at Citigroup said, "It's not uncommon for reserves to be cut, but from what we know, nothing of this magnitude has ever happened before"⁹...

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1] 'Shell Shock,' Economist, January 17, 2004.

2] 'Oil Stocks Look Like a Dry Hole,' Palmeri Christopher, Business Week Online, January 16, 2004.

3] Barrel is a unit of measure for oil and petroleum products and is equivalent to 42 US gallons.

4] SEC is a civil law enforcement agency operating in the US. SEC's mission has been to administer and enforce the federal securities laws in order to protect investors, and to maintain fair, honest, and efficient markets.

5] Headquartered in London, BP is one of the world's largest oil and petrochemicals groups. BP's businesses include exploration & production activities, refining & marketing, gas & power and petrochemicals.

6] El Paso Corporation is a global energy company whose operations extend from natural gas production and extraction to power generation. It has four primary business segments - Pipelines, Production, Field Services and Merchant Energy.

7] 'Shell: The Case of the Missing Oil,' Carey, John, Palmeri, Christopher, Reed, Stanley, BusinessWeek, January 26, 2004.

8] 'Shell's Drama Isn't Over,' Reed, Stanley, BusinessWeek, February 23, 2004.

9] 'Shell: The Case of the Missing Oil,' Carey, John, Palmeri, Christopher, Reed, Stanley, BusinessWeek, January 26, 2004.