Royal Dutch Shell plc and its oil reserves
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Royal Dutch Shell plc and its oil reserves
Prepared by:
G€ler Aras, Yildiz Technical University, Turkey & David Crowther, De Montfort
University, UK
2007
Background information
The Royal Dutch / Shell Group of companies was created in February 1907 when the Royal
Dutch Petroleum Company and the Shell Transport and Trading Company Ltd of the UK
merged their operations - a move largely driven by the need to compete globally with the then
monopolistic American oil company, Standard Oil. The terms of the merger gave 60% of the
new Group to the Dutch arm and 40% to the British. Since that time (until 2005), the group
was a dual listed company. The two holding companies were the Royal Dutch Petroleum
Company of the Netherlands and the Shell Transport and Trading Company plc of the UK.
These two companies jointly owned all the operating companies in the group, although some
also have local shareholders and are traded on local stock markets. The Shell interest in
subsidiaries was always divided 60/40 in favour of Royal Dutch. In many cases, subsidiary
companies are held in partnership with other companies or governments. The company's
shares are divided into two classes, A and B, representing the former Royal Dutch and Shell
shares respectively. This arrangement is probably for tax reasons. Although to meet company
law in all countries, there were executive and non-executive nominated directors of both
Royal Dutch and Shell Transport and Trading, the Group was actually run by an executive
body called the "Committee of Managing Directors" (CMD), whose members were the
(executive) Managing Directors of the two parent companies.
Corporate social responsibility
The risks attached to much of the business operations of Energy/Oil companies, such as Shell,
are such that their operations are subject to particular scrutiny by stakeholders - especially
environmental and human rights groups and local communities. Over the years Shell has been
criticised in respect of a number of its operations. These have included its businesses in
Nigeria (especially in relation to the public unrest of the Ogoni and the execution of Ken
Saro-Wiwa) as well as its attitude to the environment (e.g. the disposal of the Brent Spar
production platform in Britain).
Shell as a company,is deeply unpopular among Nigerians due to its environmental records in
the Ogoni area of the Niger Delta. In a landmark ruling in a Nigerian court,the company was
ordered to pay about €2bn in compensation to the Ogoni people.However welcoming the
news might have been at the time of the ruling,it seems unlikely to be achieved as the
Nigerian press have cited corruption, injustice and brutality (by the government),as major
barriers that may ultimately prevent this compensation from being actually paid. As the Niger
Delta saga seems to continue without end (even after the death of Ken Saro-Wiwa), Shell is
also unpopular in other areas of the globe eg Rossport-Ireland,British Columbia-Canada as
well as a host of other areas.
Brent Spar was an oil storage and tanker loading facility located in the Brent oilfield in the
North Sea (off the coast of the UK) and operated by Shell. With the completion of a pipeline2 connection to the oil terminal in Shetland, the storage facility had continued in use but was considered to be of no further value as of 1991. Brent Spar became an issue of public concern in 1995, when the British Government announced its support for Shell’s application for its disposal in deep Atlantic waters at North Fenni Ridge (approximately 250 km from the west coast of Scotland, at a depth of around 2.5 km). Greenpeace organised a worldwide, high- profile media campaign against this plan. Although Greenpeace never called for a boycott of Shell service stations thousands of people stopped buying their petrol at Shell. Greenpeace activists occupied the Brent Spar for more than three weeks. In the face of public and political opposition in northern Europe (including some physical attacks - eg an arson attack on a petrol station in Germany), Shell abandoned its plans to dispose of Brent Spar at sea – whilst continuing to stand by its claim that this was the safest option, both from an environmental and an industrial health and safety perspective. Greenpeace’s own reputation also suffered during the campaign, when it had to acknowledge that sampling errors had led to an over- estimate of more than one hundredfold of the oil remaining in Brent Spar’s storage tanks. Following Shell’s decision to pursue only on-shore disposal options - as favoured by Greenpeace and its supporters - Brent Spar was towed to a Norwegian fjord and given temporary moorings. It was subsequently dismantled. Shell’s response to problems such as Brent Spar and Nigeria was to launch an internal review of processes and an external communications campaign to persuade stakeholders of their commitment to corprate social responsibility. In response to criticism of its track record on environmental matters Shell published its unequivocal commitment to sustainable development, supported by executive speeches reinforcing this commitment. At the same time Shell was one of the first companies to leave the Global Climate Coalition. The Shell Chairman, Philip Watts, gave a speech in Houston in 2003 calling for skeptics to get off the fence and take action before it is too late. Shell was also a founding member of the World Busines Council for Sustainable Development. When delivering the annual business lecture hosted by Greenpeace in 2005, Shell chairman Lord Oxburgh said that we must act now on global warming or face a disaster, and he encouraged governments to provide a regulatory framework to encourage the reduction of greenhouse gas emissions. He stated that ‘our job is to respond in a positive way to a regulatory environment that has to be determined by government ... given the urgency, we have to start now.’ Shell's commitment to CSR also includes its well-respected LiveWIRE Programme. This programme has over 20 years experience of encouraging young people to start and develop their own businesses in the UK and elsewhere in the world (26 countries). Shell has said that it is committed to listening to stakeholders: ‘Your opinions are important to us and we want to listen and respond as best we can to your comments and concerns’. This included the setting up of a global internet based facility for whistleblowers to report alleged violations of the law or of Shell General Business Principles (the SGBP); a voluntary code of ethics which promised transparency, integrity and honesty in all of Shell’s business dealings. Whistleblowers are asked to provide identity details but anonymous reports are also accepted. The Helpline is available to ‘customers, suppliers, partners, advisers and employees of Shell’. Much of Shell's reputation-building advertising has concentrated on the embryonic renewables business despite the fact that this remains a very small business compared to the core hydrocarbon extraction, processing and marketing operations. The corporate advertising campaign was (like a similar campaign by BP) has been described as greenwash by some NGO critics, but praised by other commentators. In response to questions which focused on the small percentage of its capital investment programme that was directed towards
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alternative energy solutions Shell said that it would be pointless to say exactly how much of
capital expenditure was going into renewable energy schemes. CEO Jeroen van der Veer
indicated that the investment in renewables was small, saying it would be ‘throwing money
away’ to invest in alternative energy projects that were noncommercial and people could not
afford to buy.
Introduction – the news breaks
On Friday 9 January 2004 a small items of news was issued alongside the plethora of other
news concerning corporate activity and its possible effect upon company performance and
consequently share price. It was a typical minor announcement on that day and finished with a
statement that a teleconference would be held on that day and hosted by Simon Henry, Head
of Group Investor Relations, Mary Jo Jacobi, Vice President of Group External Affairs and
John Darley, Exploration and Production Technical Director. The announcement stated that
‘The Royal Dutch/Shell Group of Companies (‘Shell’) announced today that,
following internal reviews, some proved hydrocarbon reserves will be
recategorised. The total non recurring recategorisation, relative to the proved
reserves as stated at December 31st 2002, represents 3.9 billion barrels of oil
equivalent (‘boe’) of proved reserves, or 20% of proved reserves at that date’.
It also stated that
‘Reserves affected were mainly booked in the period 1996 to 2002. A significant
proportion of the recategorisation relates to the current status of project
maturity. The recategorisation brings the global reserve base up to a common
standard of definition, consistent with the globalisation of processes within the
new Exploration & Production business model.’
As a standard news release of course it also sought to reassure investors by stating that
‘There is no material effect on financial statements for any year up to and
including 2003. The recategorisation of proved reserves does not materially
change the estimated total volume of hydrocarbons in place, nor the volumes that
are expected ultimately to be recovered. It is anticipated that most of these
reserves will be re-booked in the proved category over time as field developments
mature.’
Less than a month later the company announced its results for the last year, 2003. Highlighted
by the Chairman were the following aspects of performance1:
‘Reported net income of $12.7 billion in 2003 was 35% higher than in 2002.
The Group’s earnings on an estimated current cost of supplies (CCS) basis for
the full year were a record at $13.0 billion (46% higher than last year).
Final dividends proposed of €1.02 per share for Royal Dutch and of 9.65p per
share for Shell Transport, increasing above inflation. The increase in US
dollar terms, at current exchange rates, exceeds 10%, and over the past 3
years has risen by 28%.’
With regard to reserves and their reclassification the following statement was made:
1
See press release 5 February 2004.4
‘The Group is continuing to discuss the implementation of the recategorisation
with the staff of the SEC. The staff has advised that it appears that the 2002 Form
20-F should be amended to correct the reserve information previously reported.
With regard to the financial statements, as previously advised, the Group does not
believe that the recategorisation has a material impact for any year, because only
a small portion affects proved developed reserves.’
Within 3 months of this minor announcement2 the after tax income of the corporation for the
preceding 4 years had been recalculated and reduced by almost $450million and the
Chairman, Sir Philip Watts, had resigned. Since that time the recategorisation / recalculations
have continued but without the newsworthiness of the original episodes.
Rewarding managerial behaviour
According to the Cautionary Note to investors that the Shell group includes in all its
documents available in its web site:
‘The United States Securities and Exchange Commission permits oil and gas
companies, in their filings with the SEC, to disclose only proved reserves that a
company has demonstrated by actual production or conclusive formation tests to
be economically and legally producible under existing economic and operating
conditions.’
It is apparent that this requirement was ignored and that the company overstated its oil
reserves over an extended period. According to the US-SEC the company overstated proved
reserves reported in its 2002 Form 20-F by 4.47 billion barrels of oil equivalent (boe), or
approximately 23%. They also overstated the standardized measure of future cash flows
reported in this filing by approximately $6.6 billion. Shell corrected these overstatements in
an amended filing on July 2, 2004 which reflected the degree of Shell’s overstatements for the
years 1997 to 2002. These amendments are included in the Table 1. From these figures it is
important to point out that to modify billions barrels of oil equivalent (boe) in percentages
ranging from 16% to 25% is a significant variation.
Table 1. Shell„s overstatements
Year Proved % Standardized %
Reserves Overstatement Measure Overstatement
Overstatement Overstatement
1997 3.13 boe 16% N/A N/A
1998 3.78 boe 18% N/A N/A
1999 4.58 boe 23% $7.0 billion 11%
2000 4.84 boe 25% $7.2 billion 10%
2001 4.53 boe 24% $6.5 billion 13%
2002 4.47 boe 23% $6.6 billion 9%
Source: http://www.accountingeducation.com/news/news5371.html
Over this period it was also admitted that Shell had materially misstated its reserves
replacement ratio (RRR), a key performance indicator in the oil and gas industry. If Shell had
2
See report to Group Audit Committee and reserves recalculation review issued on 19 April 2004.5
properly reported proved reserves, its RRR would have been 80% rather than the 100%3 for
the five-year period (1998-2002). The differences between the original RRR and the restated
are included in Table 2. In this case the differences are even greater than in the case of the
reserves measured in boe.
Table 2. Shell’s reserves replacement ratio (RRR)
1-Year RRR 3-Year RRR
Year Original Restated Original Restated
1998 182% 134% N/A N/A
1999 56% -5% N/A N/A
2000 69% 50% 102% 60%
2001 74% 97% 66% 48%
2002 117% 121% 87% 90%
2003 N/A 63% N/A 94%
Source: http://www.accountingeducation.com/news/news5371.html
As the US-SEC„s order outlined, Shell’s overstatement of proved reserves, and its delay in
correcting the overstatement, arguably resulted from its desire to create and maintain the
appearance of a strong RRR, the failure of its internal reserves estimation and reporting
guidelines to conform to SEC requirements, and the lack of effective internal controls over
the reserves estimation and reporting process. These failures led Shell to record and maintain
proved reserves and to report for certain years a stronger RRR than it actually had achieved.
Although Shell was warned on several occasions prior to the fall of 2003, the company
rejected the warnings as immaterial or unduly pessimistic. According to Cummins & Beasant
(2005) there was an ongoing culture of arrogance amongst the senior managers of the
company which made this kind of contempt for regulation unsurprising.
Bearing in mind the previously described framework we can analyse Shell’s key financial
data, share price and dividends paid, because it is taken for granted that an overestimated
figure of reserves should become reflected in a prudent reward policy. Despite this fact, over
the period 1998-2002 Shell„s Return on Equity ratio increased from 0.6 to 16.2, which means
it went up by 2600%.4 And for example, the evolution of the earnings per share (Net Income
per Share) of Royal Dutch valued in € per ordinary share was similar to the increase of the
ROE ratio, 2500%, from a ratio of 0.11€ in 1998 to 2.86€ in 2002. These form the basis for
performance-based compensation and therefore motivate managers to use aggressive
techniques (such as the overestimation of reserves) to support these earnings. Admittedly,
such strategies are short-sighted, because the market eventually finds out that these figures
have been distorted by whatever reason.
It is necessary to highlight the different markets where Royal Dutch is listed. As it is included
at Shell’s web site in the link Company statistics, the company is listed on three different
primary exchanges, as shown in Table 3, and as the common practice of foreign private
issuers listed on the New York Stock Exchange (NYSE), Royal Dutch is listed on the NYSE
through American Depositary Receipts (ADR).
3
A 100% RRR means that the company is discovering as much new oil as it is pumping so any lesser figure
raises questions regarding long term sustainability.
4
All data has been taken from the Shell web site6
Table 3. Shell’s Company Statistics
Royal Dutch Shell plc Royal Dutch Shell plc Royal Dutch Shell plc
Amsterdam London New York (ADR)
Primary Exchange Amsterdam London New York
Ticker Codes RDSA RDSA RDS.A
RDSB RDSB RDS.B
Currency EUR GBP USD
Source: http://www.shell.com/investorcentre-companystatistics.htm
In Table 4 are included the Shell’s share prices during the period of overstated reserves. The
initial prices and the prices after amending the reserves figures are just the same, even the
later are smaller than the earlier prices, what can be understood as over these seven years the
market has adjusted the prices, because in the end the market finds out that there is something
wrong. The highest share prices are reached in the domestic markets later than in the New
York Stock Exchange, although there is only a one year difference. Nevertheless, the penalty
imposed on Shell group by the market is not very severe, and there have been significant
increases in the prices, that can have allowed managers (who changed the reserves figures) to
sell their shares before the stock price drops. As shown in Note 24 to the Shell Financial
Statements 1998, 1999, 2000, and 2001:
‘The Senior Executive Stock Option Scheme has been in operation for over 30
years providing stock options to the most senior executives of the Group from time
to time. Beginning in 1995, options were granted to a larger group of over 900
managers. This enlargement of an otherwise unchanged scheme was part of a
move to performance-related pay for the wider management cadre of the Group
which, by aligning remuneration with shareholder interest, is intended to support
the drive for improved business performance.’
So, the requiring a company to disclose more meaningful information in their financial
statements of the cost to shareholders of employee options would also be helpful, because in
this case, Shell group highlights in its 2001 Form 20-F that ‘beginning in 1995, options were
granted to a larger group of over 1100 managers, and in 2001, selectively to an additional
6000 employees’. Only after the 2002 Financial Statement did the group increase its
information adding a Remuneration point in the Notes to the Financial Statements, in which is
described the remuneration policy applied to Group Managing Directors. Thus we have not
been able to manage this information referred to the analysed period.
Table 4. Shell’s share price
Royal Dutch Shell Transport
Euronext New York Stock London New York Stock
Amsterdam (€) Exchange ($) (Pounds) Exchange ($)
High Low High Low High Low High Low
1997 56.13 33.49 59.44 42.00 4.85 3.31 47.31 33.25
1998 56.95 36.57 60.38 39.75 4.64 3.16 46.50 31.00
1999 64.10 34.90 67.38 39.56 5.41 3.04 52.56 30.50
2000 75.90 51.51 65.69 50.44 6.27 4.12 54.06 40.00
2001 73.48 43.72 64.15 39.75 6.38 4.30 53.65 38.72
2002 63.20 39.21 57.30 38.60 5.41 3.70 47.03 34.59
2003 44.58 33.35 52.70 36.69 4.40 3.32 45.19 32.28
Source: Shell Form 20-F 2000, Shell Form 20-F (Amendment No. 2) 2002 and Shell Form 20-F (Amendment
No.2)7
Shell’s dividend policy has not suffered any interruption during a long period of time, as
shown in the company’s own web site5 the total payment of dividend (the sum of interim and
final dividend) has continuously increased from 1993 to 2003: Royal Dutch has increased the
payment of dividend by 79.6% in the local market (Amsterdam) and by 74.6% in the foreign
market (New York) and Shell Transport by 96.9% in the local market (London) and 80% in
New York.
During the critical period (1997-2002) the Shell group dividend policy in the local markets
did not change, and the company went on paying dividends with an important overstatement
in its figure of reserves. Only there were some minimal reductions in the foreign dividend
payments to the American investors, although the quantitative variation is insignificant.
Table 5. Shell„s payments of dividend
Royal Dutch Shell Transport
Amsterdam New York London New York
(€ per share) (US $ per share) (Pence per share) (US $ per share)
1993 0.98 1.18 8.00 0.90
1994 1.00 1.33 9.00 1.08
1995 1.08 1.40 11.10 1.28
1996 1.20 1.45 12.30 1.52
1997 1.41 1.55 13.10 1.42
1998 1.45 1.60 13.50 1.33
1999 1.51 1.47 14.00 1.31
2000 1.59 1.40 14.60 1.24
2001 1.66 1.50 14.80 1.29
2002 1.72 1.80 15.25 1.45
2003 1.76 2.06 15.75 1.62
Source: http://www.shell.com/investorcentre-dividendpayment.htm
What is clear is that after their recent experience the Group is taking greater interest in
disclosing and filling in all the requirements about reserves; dated 09 June 2005 the News and
Media Releases at the web site tells that “Shell publishes technical report on Proved Reserves
Requirements” to assure compliance with rules set by the US SEC in relation to proved
reserves.
Critiquing Agency Theory
At this point it is necessary to remark on two different important strands related to
shareholders that have been present in company shareholding in recent years. The first one is
that, generally, the proportion of shares held by individuals, has been on a downward trend
while institutional holders have increased their representation. The second stream has to be
with shares owned by company directors and employees. This kind of remuneration has been
extending worldwide and has become even more popular in the last years.
In the analysis of the report of ownership of shares as at 31st December 2004, issued by the
British Office for National Statistics, are included as two of the main findings the following
ones:
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information that we have included in Table 58
“Institutional shareholders accounted for 48.8 per cent of the UK ordinary shares
at 31st December 2004, with a combined value of 721.7 billion pounds. Of these,
the largest holders were insurance companies (254.2 billion pounds) and pension
funds (232.6 billion pounds).
At end-2004, individuals‚ holdings amounted to 208.4 billion pounds, or 14.1 per
cent. This excluded individuals‚ ownership through mutual funds, which also
represented substantial amounts of shares”.
Thus, in international capital markets the figure of the shareholders as an individual is
vanishing, and the trend is deeper in the Anglo-Saxon world. Now is emerging another
concept, the figure of the group of shareholders who invest, for example, in a fund, and do not
worry about anything else, even about the companies of which it is supposed they are
owners… thus, these shareholders own shares that are only commodities and not a tool to be
owners of a company.
The simplest model of Agency Theory assumes one principle and one agent and a modernist
view of the world merely assumes that the addition of more principles and more agents makes
for a more complex model without negating any of the assumptions. In the corporate world
this is problematic as the theory depends upon a relationship between the parties and a shared
understanding of the context in which agreements are made. With one principle and one agent
this is not a problem as the two parties know each other. In the corporate world however the
principles are equated to the shareholders of the company. For any large corporation however
those shareholders are an amorphous mass of people who are unknown to the managers of the
business. Indeed there is no requirement, or even expectation, that anyone will remain a
shareholder for an extended period of time. Thus there can be no relationship between
shareholders – as principles – and managers – as agents – as the principles are merely those
holding the shares – as property being invested in – at a particular point in time. So
shareholders do not invest in a company and in the future of that company; rather they invest
for capital growth and / or a future dividend stream and shares are just one way of doing this
which can be moved into or out of at will. This problem is exacerbated, particularly in the
UK, by the fact that a significant proportion of shares are actually bought and sold by fund
managers of financial institutions acting on behalf of their investors. These fund managers are
rewarded according to the growth (or otherwise) of the value of the fund. Thus shares are
bought and sold as commodities rather than as part ownership of a business enterprise.
The other side is the trend to reward managers and directors with shares and options. Also in
the case of the Shell Group and during the period of “hidden oil reserves”, because they were
borne in mind although they did not exist, the number of shares under option increases from
year to year, as is included in Table 6. This number increases by 188 % from 1998 to 2001 in
the case of Royal Dutch, and 60% in the case of Shell Transport. If there is an association
between oil reserves and company image in the market, and so share prices, thus, it is an
important reward to the share’s and option’s owners to continue issuing this kind of
performance related remuneration, and also a bit dangerous practice, providing a motivation
towards the maintenance of share price by any means available – ethical or otherwise.
Table 6. Shell number of shares under option at the end of the year granted to executives and
other employees
(Thousands of ordinary Royal Dutch Shell Transport
shares)
1998 7078450 407412249
1999 6063190 34434024
2000 10214460 41936904
2001 20401000 65012000
Source: Shell Form 20-F 1998, Shell Form 20-F 1999, Shell Form 20-F 2000, Shell Form 20-F 2001You can also read
