Paula Dittrick
Senior Staff Writer
HOUSTON, Jan. 13 -- Royal Dutch/Shell Group's recent announcement that it overestimated its proved oil and natural gas reserves by 3.9 billion boe is apt to prompt investors to call for greater transparency in reserves reporting, according to accounting analyst Wood Mackenzie Ltd.
The US Securities and Exchange Commission already was reviewing its reserves definitions and contemplating increased surveillance of oil companies' reserve calculations (OGJ, June 23, 2003, p. 58). Meanwhile, Canada's stock exchanges implemented a requirement for third-party certification of reserve figures for public companies. No such requirement exists in the US.
"[Shell's] revision highlights the challenges regarding reliance on SEC figures to analyze true exploration performance. While there will undoubtedly be calls to tighten the guidelines attached to booking proved reserves, this is only part of the story," said WoodMac consultant Derek Butter.
"To give a clearer picture of a company's exploration performance, investors may call for greater disclosure of 2P [proven and probable] reserves to supplement the current information together with a more detailed breakdown of the reserves booked," he said.
Butter also said there was apt "to be a call for third-party certification of reserves given the importance of this area as a proxy for a company's exploration performance."
Overestimates
Shell said the recategorization involved 2.7 billion bbl of crude oil and natural gas liquids and 1.2 billion boe, or 7.2 tscf, of natural gas (OGJ Online, Jan. 9, 2003). About half of the total involved the Gorgon gas fields development off Western Australia and Nigeria operations. Gorgon is linked to a proposed LNG export project.
WoodMac said that questions "undoubtedly would have been raised at the time concerning [Shell's] booking of Gorgon reserves had a more detailed breakdown of reserve bookings been available."
Gorgon operator ChevronTexaco Corp. issued a news release stating that Shell's announcement would not affect how ChevronTexaco's worldwide reserves are categorized, including in Nigeria and Australia.
John Gass, president of ChevronTexaco Global Gas, confirmed that the company has yet not recognized any proved reserves for its interest in the Gorgon joint venture.
"Our Gorgon project continues its steady progress toward commercialization, having received in-principle approval in 2003 from the Western Australia state government for the restricted use of Barrow Island for a foundation development in 2003, and strong market support, including a memorandum of understanding with China National Offshore Oil Corp. [CNOOC] to import Gorgon LNG into China," Gass said.
The Western Australian government last year authorized construction of an LNG liquefaction plant on Barrow Island, which lies between the Gorgon gas fields and the Australian mainland (OGJ Online, Sept. 9, 2003).
China's CNOOC Ltd. has agreed to become a partner with the Gorgon joint venture participants. Its parent, CNOOC, was to purchase an undisclosed but "significant" volume of LNG directly from Gorgon for use in China (OGJ Online, Oct. 31, 2003).
Before the equity purchase agreement, Chevron Australia Pty. Ltd. held a 4/7 interest in the Gorgon development; Shell Development (Australia) Pty. Ltd., 2/7, and ExxonMobil Corp. unit Mobil Australia Resources Co. Pty. Ltd., 1/7. CNOOC Ltd.'s equity interest was not disclosed.
SEC regulations
Ryder Scott Co. LP Chairman and CEO D. Ronald Harrell said Shell's revision illustrates growing concerns with SEC reserve reporting regulations, which were established 26 years ago.
"Since that time, the technology that we use to evaluate reserves has increased dramatically beyond the tools and techniques that we had in 1978. The way oil and gas is marketed today is drastically different than in 1978. . .. So trying to incorporate the business world and the technology world of today with requirements that were written a long time ago just brings about problems of interpretation," Harrell said.
Annual reserve reports are either prepared by companies themselves or by hired third-party engineers. Many companies also request midyear or quarterly reserve estimate updates to help monitor reserves, he said.
Project partners frequently have different reserve estimates for the same field. Harrell said this is because reserve reporting depends on the quality and quantity of available data, and figures also will vary depending upon the individual making the estimate.
"There is no way to take out the effects of professional interpretation on the data that we have," he said. "It is highly interpretative so that is why we use the term 'estimate.'"
Revision impact
Spokespeople for ExxonMobil and BP PLC have indicated that neither company expects to reclassify its reserves.
ExxonMobil spokeswoman Sandy Duhe said that ExxonMobil had not booked Gorgon reserves as proved reserves.
"We are very confident in our proved reserves number, and we stand behind it," Duhe said. "We've always taken a very conservative and rigorous, structured approach to booking proved reserves. While we may be in joint projects with Shell and other companies, it doesn't mean that we all book reserves the same way."
Butter said, "There is no indication that a widespread problem exists among other oil and gas companies. . .. We believe the major investor groups will be the ones calling for greater transparency, and that the companies are quite likely to comply to reassure investors that there are no similar problems to the one that has affected Shell."
He expects that the initial impetus could help push tightened definitions of proved reserves for SEC purposes.
"While this should provide more comfort and protection for shareholders in that they will be more confident that companies are compared on a like-for-like basis, this does little to provide them with a more detailed knowledge of reserve potential," Butter said.
Harrell said the Sarbanes-Oxley Act, passed by the US Congress in 2002 to deter corporate fraud in financial reporting, already had prompted renewed interest in more third-party intervention in reserve reporting (OGJ, Oct. 13, 2003, p. 22).
"I think Sarbanes itself probably will advance that cause a little more than the Shell event will, but if there is another Shell and another Shell, then all bets are off. I wouldn't anticipate that, but I wouldn't rule out the possibility. If it's happened once, it could happen again, but I have no specific expectation of any one company," Harrell said.
Accounting for Shell's reserve downgrade, Butter said Shell's reserve replacement performance for 1997-2002 drops to 57% from 105%, compared with ExxonMobil's 116% and BP's 152%.
Correspondingly, Shell's finding and development costs for the same period have risen to $7.90/bbl from $4.27/bbl. That compares with $3.93/bbl for ExxonMobil and $3.73/bbl for BP, Butter said.
The reserve reclassification itself will not affect Shell's operational performance or future growth prospects, but "the fact that both reserve replacement and finding and development costs are widely used to benchmark the relative performance of oil and gas companies, and the fact that these have now changed so markedly, will cause concern," among investors and analysts, Butter said.
Reserve statistics represent the assets underlying a company's stock price. Shell's stock dropped $4.15/share on Jan. 9 (the day the announcement was made), while ChevronTexaco shares dropped 93¢, ExxonMobil shares dropped 61¢, and ConocoPhillips dropped 37¢. Meanwhile, BP shares gained a penny that day. All those companies trade on the New York Stock Exchange.
Shell's management credibility is likely to suffer, said Michael Mayer of Prudential Equity Group Inc.
"This is expected to reduce investor confidence, and thus, the price paid for future earnings and cash flow," Mayer said.
Butter said he believes the vast majority of the unbooked reserves still will prove to be commercial, adding that the issue is the timing of booking those reserves.
"Shell's announcement has highlighted the problem of relying solely on reported oil and gas metrics in assessing a company's underlying exploration performance. The control of reserve reporting is largely regulated by the companies themselves, and there is little transparency as to which discoveries are being included in the proved category," Butter said.
Contact Paula Dittrick at [email protected].
