Arabies Trends:
the crisis at shell:
May 2004
Decline and fall
The mighty Royal
Dutch/Shell Group is facing an unprecedented crisis of
confidence. A special report on the scandal that is shaking up
the energy giant.
By
ED BLANCHE
BEIRUT
 |
Philip Watts, then chief
of Royal Dutch/Shell’s exploration and production department,
was a big hit when he appeared on stage at a gathering of the
international oil giant’s top executives in Maastricht in June
1998. Making a grand entrance wearing a silver astronaut suit
and riding a mock spaceship, he declared to rapturous applause:
“I have seen the future, and it’s great.” For a company that was
regularly posting net profits of more than $10 billion a year,
that meant fat checks for executives and investors alike.
Six years later, on March
3, 2004, Watts, by then chairman of the board, was
unceremoniously booted out, along with Walter van de Vivjer, who
had Watts’s old job as head of exploration and production, amid
intense pressure from angry shareholders. It was the corporate
world’s most serious management
upheaval and the worst
scandal to hit the straight-laced, politically correct
Anglo-Dutch company. Watts, 58, aloof and distant, had never
been a favorite with institutional investors and his dismissal
showed all the signs of an old-fashioned boardroom coup.
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Head hunting. “On the
face of it,” wrote financial analyst Oliver Morgan in the
Observer, “the City’s corporate assassins . . . got their
biggest scalp – and in double-quick time . . . Sir Philip
Watts’s unseating is spectacular because of Shell’s reputation
for haughty disdain toward outside pressure.” All this caused a
grievous loss of confidence in the world’s third-largest
publicly traded oil company, wiped $1.5 billion-plus off its
stock market value and turned the energy industry on its head.
On January 9th, Shell
confessed that it had overestimated its reserves of crude oil
and natural gas by more than one-fifth – the equivalent of 3.9
billion barrels. That included 1.5 billion barrels that
comprised 60 percent of the company’s Nigerian reserves and
others in the offshore Gorgon gas field in Australian waters.
The impact of that shock
disclosure, the first of its kind involving one of the world’s
oil majors, was catastrophic. The company’s shares
tumbled and investors went ballistic, howling for Watts’s head.
On March 18th, Royal
Dutch/Shell slashed its oil and gas reserves for the second time
in as many months, cutting its end of 2002 reserves by 250
million barrels and wiping a further 220 million off 2003. Most
of that was in the Norwegian sector of the North Sea. That
raised the total loss of reserves to more than 4 billion
barrels, well and truly bringing into question its accounting
standards.
Then, in April, reports
began to surface about Shell’s estimates of Omani oil reserves
and, in particular, the success of the company’s horizontal
drilling techniques in the sultanate. It appears that, in 2000,
Shell dramatically overstated the figure for proven reserves
and, perhaps even more ominously, raising the question asked by
the New York Times: “whether new technology can extend the life
of huge but mature fields.”
Before the Oman scandal
broke, van de Vivjer’s successor as head of exploration and
production, Malcolm Brinded, declared that his department was
determined that the group “cannot stumble again in such a
manner.” But he warned that there could be further reserve
shortfalls since a “fast-track review” that resulted in the
second downgrade had only covered 40 percent of Royal
Dutch/Shell’s assets at that point in mid-March. The company
delayed publication of its annual report, due on March 18th,
until late May, supposedly to give independent auditors time to
complete a review of all the company’s reserves. It also took
the unprecedented step of postponing its annual meeting from
April to June 28th, putting off a public confrontation with its
outraged shareholders.
For energy companies, oil
and natural gas reserves constitute a central asset and are a
primary indicator of economic health. But companies have every
incentive to boost reserve estimates – the more they can claim,
the more competitive and attractive they are to investors, who
along with industry analysts, see the figures as an indication
of future profitability. Despite all the technological advances
over the years, estimating proven reserves remains as much an
art as a science, although there are extensive industry and
government regulations that seek to ensure that these estimates
are measured as precisely as possible.
Open and shut. The scandal over reserves has a particular resonance in the Middle East as countries there are increasingly opening up to foreign oil companies once more. It has also highlighted the oil companies’ practice of listing millions of barrels in oil reserves in states where they have hold no rights to oil and gas deposits.
Saudi Arabia recently
signed exploration agreements with ENI of Italy, Repsol of
Spain, Sinopec of China and Lukoil of Russia in a groundbreaking
move nearly 30 years after nationalization. Kuwait is expected
to follow suit and Libya, newly rehabilitated in the world
community, is throwing open its doors to Western oil companies
again.
The Royal Dutch/Shell
scandal broke as the United States and Europe grappled with a
plague of corporate corruption: Enron and Tyco International of
the United States; Parmalat of Italy; France’s oil giant Elf;
Norway’s Statoil; Halliburton, the US oil services company once
run by Vice President Dick Cheney; and the $11 billion
accounting fraud by WorldCom.
But the Shell scandal
was notable because it broke new ground and has reverberated
internationally in the strategic field of energy. The
Anglo-Dutch oil giant may not be the only energy company that
has misrepresented its reserves. On February 17th, the
Houston-based El Paso Co. lowered its listed gas reserves by 51
billion cubic meters, slicing as much as $1 billion off the book
value of its reserves. Other companies could follow suit as the
Royal Dutch/Shell scandal swells. ExxonMobil, for instance, also
has a stake in the Norway’s Orme Lange gas field, as does
Norway’s state-owned Petoro and BP, and they may have to
reevaluate their reserves there.
Criminal charges. Royal
Dutch/Shell faces an investigation by the US Securities and
Exchange Commission (SEC) that could result in civil charges.
The US Department of Justice is investigating whether
shareholders were intentionally misled and whether the company
is criminally liable for failing to disclose a significant
shortfall in its reserves.
Royal Dutch/Shell, with
corporate headquarters in London and The Hague, could also face
investigations for possible insider trading by the Autoriteit
Financiele Markten, the Dutch financial regulatory body,
although there does not appear to have been any such
irregularities in that regard. Britain’s Financial Services
Authority, which regulates publicly traded companies, is also
conducting an investigation.
Watts is expected to be
questioned in a lawsuit brought by a Philadelphia law firm,
Berger & Montague, claiming unspecified monetary damages on
behalf of the Ongoni tribe in Nigeria’s southern delta region
for alleged human rights abuses by a Shell development company
in the early 1990s. Watts was head of that subsidiary at the
time.
The lawsuit alleges that
Shell engaged in militarized commerce in a conspiracy with the
former military government of Nigeria. It accused the company
of “purchasing ammunition and using its helicopters and boats
and providing logistical support for . . . a military foray into
Ogoniland designed to terrorize the civilian population into
ending peaceful protests against Shell’s environmentally unsound
oil exploration.”
Shell’s London office
said the allegations are “without foundation.” ChevronTexaco is
accused of similar actions in 1998-99 in Nigeria, while Unocal
and ExxonMobil of the United States face similar suits in other
countries in Africa, Asia and Latin America. And as if all that
were not enough, Shell is also looking at as many as seven
class-action lawsuits in the United States from shareholders who
allege it deliberately violated accounting regulations by
misreporting its reserves in filings to the SEC.
Class action. One suit
is being brought by one of America’s leading class-action law
firms, Milberg Weiss Bershad Hynes and Lerach of New York, which
said that Shell, by dropping its claim that the 3.9 billion
barrels were registered as reserves in good faith – a position
fiercely defended by Watts before his ouster – the company
greatly strengthened the investors’ case.
In many ways, investors’
ire was directed as much against the oil giant’s arcane
corporate structure, a relic of its imperial origins that date
back to the 1890s. The ownership structure is highly unusual: 60
percent held by the Royal Dutch Petroleum Co., which is listed
on the Dutch Stock Exchange, and 40 percent by Shell Transport &
Trading, listed and based in London. Both have their own boards.
Investors have been critical of this for years. Watts was
chairman of a key central committee whose lack of accountability
has long disturbed institutional investors. Executives and
non-executives of the two boards meet together only rarely.
In the late 1990s,
shareholders blamed this loose arrangement for Shell’s failure
to act on takeover opportunities that followed a slump in oil
prices and which BP and Exxon, the company’s great rivals, used
to expand through acquisition. But despite the baying of
investors and the slew of investigations into the company’s
inner workings, few in corporate circles expect any major
reforms that would sweep away the unwieldy dual structure in
favor of a more streamlined American model. The stolid Dutch are
considered to be seriously opposed to any significant changes,
since that could endanger the delicate 60:40 balance of
shareholdings in their favor.
Still, the pressure for
reform is going to increase as the scandal grows and grows, and
which has touched the Dutch side as well. Watts, who had been
head of exploration and production from 1996-2001, when the
mistakes were made, was replaced as chairman by Jeroen van der
Veer, the group’s former vice chairman and the president of
Royal Dutch Petroleum.
Now there are allegations that van der Veer, a chemical engineer
with such a modest public profile he is known in some quarters
as “the low-flying Dutchman,” and the company’s chief financial
officer, Judith Boynton, had known about the huge shortfalls in
proven oil and gas reserves since February 2002, two years
before they were publicly disclosed.
The New York Times quoted
a company memorandum from that date as saying 1 billion barrels
of reserves “are no longer fully aligned” with guidelines laid
down by the SEC because the agency had clarified those
regulations.
The memorandum, according
to the Times, noted that a further 1.3 billion barrels of
reserves were in jeopardy because it was no longer certain,
under the clarified SEC regulations, that they could be
extracted during the time remaining under the licenses between
Anglo Dutch/Shell and three countries where it was operating.
The newspaper, citing
internal corporate memoranda, indicated that van der Veer and
Boynton had received information about the shortfalls when they
were members of a small committee of senior Shell executives
headed by Watts. The documents in question are now in the hands
of lawyers investigating the company.
The Times said that
rather than disclose the problems to investors, senior
executives, according to a July 2002 memorandum, came up with –
and later carried out – what was described as an
“external storyline” and “investor relations script” that
tried to “highlight major projects fueling growth,” “stress the
strength” of existing resources and “minimize the significance
of reserves as a measure of growth.”
Shell officials have
repeatedly pledged more openness to investors, but have still
kept secret details of its reduction of reserves in Nigeria
for fear of damaging its already strained ties with the
government there. That could jeopardize efforts by Nigeria, the
world s seventh largest oil producer, to persuade OPEC to
significantly increase its oil production quota, and thus its
revenues. Its current quota is 2 million barrels a day (b/pd),
but it has a production capacity of 2.5 million b/pd and hopes
to raise that to 4 million b/pd by 2010.
Nigeria’s oil exports
account for 90 percent its revenues. Full disclosure by Shell
would endanger Shell’s partnership with the Nigerian government,
which is facing rising unrest in several regions, particularly
in the Niger Delta, where most of Nigeria’s oil reserves are
located. Political and ethnic violence resulted in a sharp
reduction in production recently. Cutting costs. On March
22nd, Royal Dutch/Shell, reeling from the reserves scandal,
announced a “strategic transformation” of its Nigerian
operation. Company sources said that its 5,000-strong workforce
could be cut by one-third in a cost-cutting drive, a development
that could be explosive because Nigeria’s labor unions, old foes
of Shell, are well organized and highly politicized. As it is,
provincial authorities in Delta state have warned Shell they
could shut down the company’s production there if it goes ahead
with the plan.
The company’s
embarrassment deepened on March 10th, when the small
Scotland-based Cairn Energy announced a spectacular oil strike
in a concession in India that the oil giant had sold it 18
months earlier for a meager $7 million. Royal
Dutch/Shell may be able to reverse some of its setbacks with its
March 25th announcement of a “long-term strategic relationship”
with Libya, now reforging links with the West after decades of
estrangement. The deal – involving exploration of new energy
reserves and developing existing natural gas facilities – could
be worth $200 million over the next five to seven years. Shell
was active in Libya from the 1950s to 1974, producing around
300,000 barrels of oil a day. But it gradually reduced its
presence and finally pulled out in 1992 when the United Nations
Security Council imposed sanctions over the Pan Am Lockerbie
bombing.
But the massive Shell accounting scandal is likely to reverberate for some time, and possibly spread further. That could strengthen the claim by a growing number of geologists and former oil company officials that global oil reserves may be dangerously exaggerated.