At Shell, New Accounting and Rosier Oil Outlook

Friday, March 12, 2004
By Stephen Labaton & Jeff Gerth

New York Times Writers

The problems at Royal Dutch/Shell can be traced to the first half of the 1990's, when executives and investors began to grow concerned that the group's reserves were not keeping pace with production. Their concern led them in 1997 to instruct the leadership and performance group, known within the company as LEAP, to "create value through entrepreneurial management of hydrocarbon resource volumes," according to one company document. Royal Dutch/Shell created the LEAP program in the mid-1990's to find ways to improve business practices, reduce expenses and increase income by intensively studying particular issues and by consulting experts inside and outside the company. Other companies have used similar management programs, but industry executives say they do not know of any instances of such a program's being used to overhaul a company's accounting guidelines.

NYT
rriving on stage in a spaceship and an astronaut suit, Philip Watts, then the senior executive in charge of exploration and production for the Royal Dutch/Shell Group, glowed as he delivered a message of optimism to a conference of 600 company executives in the Dutch city of Maastricht in June 1998.

"I have seen the future and it was great," he declared.

He was talking about the success of a special management program that had recently addressed a fundamental problem at the company — that it was pumping oil and gas out of the ground faster than it was finding new supplies. Internal documents show, however, that the program allowed Royal Dutch/Shell to increase its oil and gas reserves not by discovering major new sources, but by changing its accounting to add reserves that it was not sure could ever be tapped.

At the conference, executives wore yellow T-shirts that said "15 percent growth" and affirmed their faith in Shell's "transformation process" by singing "Ode to Joy," according to a company employee and a brief account in The Times of London.

Royal Dutch/Shell's future does not look as great now as it did then. The company, a storied oil giant that traces its roots to a Dutch oil company and an English seashell importer in the 1890's, ousted Sir Philip as chairman last week. He had risen to the top of the company three years ago in part because of his ability to increase reported reserves and had been knighted by Queen Elizabeth in 2003 for his service to Britain.

His departure followed almost two months of investor unrest over the company's decision to cut estimates of its proven reserves by 20 percent, or 3.9 billion barrels. The Securities and Exchange Commission, seeking to protect American investors who bought Royal Dutch/Shell stock and bonds, is now investigating whether he or the company broke the law with the way they accounted for reserves.

Internal corporate documents and interviews with oil executives and industry analysts describe a company that in the go-go 1990's tried to manage its reserve figures much the way other companies managed their earnings — to satisfy investors.

The documents show that worried executives felt compelled to increase the reserves, which throughout the first half of the 1990's were declining because discoveries did not keep pace with production.

The fall in the so-called reserve replacement ratio troubled analysts and investors because it is an important measure of an oil company's prospects.

"Following a sustained period of proven reserves decline in the early 1990's, there was considerable pressure, both external and internal, to correct performance," according to a confidential internal review code-named Project Rockford. The origin of the name is not clear.

Along with other company documents, that review, which was completed in December in anticipation of the restatement of reserves on Jan. 9, shows that senior company executives ignored warnings over several years of the possible inflation of reserves.

Most of the misstated reserves were recorded from 1997 to 2000, when Sir Philip was in charge of exploration and production. He could not be reached for comment. His home phone number in a suburb of London is not listed and a spokesman for Shell said the company could not reach him. "As he is no longer an employee, we do not have a way to reach him," said the spokesman, Andy Corrigan.

The misstated reserves came during a decade of significant upheaval for Royal Dutch/Shell, at a time when low oil prices were increasing competitive pressures throughout the industry. And the unwieldy corporate structure of the oil conglomerate may have made the problems worse, some large institutional investors said.

Since the merger that created it nearly a century ago, Royal Dutch/Shell has been overseen by separate Dutch and English boards, though decisions are made by a third group, made up of executives from the boards and known informally as "the conference." Investors and others criticize the structure as too cumbersome.

"The conference has no formal decision-making power and is currently made up of some 20-odd people," said Robert Talbut, chief investment officer with Isis Asset Management. "Our view is that with any organization with 20 people, it doesn't take a genius to tell you that that is considerably suboptimal."

(More: NYTimes.com / Business)

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Dan