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THE WALL STREET JOURNAL: Shell’s Reserve Dilemma

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02/01/08

Royal Dutch Shell has waltzed into the record books, reporting a mind-blowing $31.3 billion in net profit in 2007, the highest ever for a British or Dutch company. But, the profit party has been interrupted by an old demon: oil reserve replacement.

The Anglo-Dutch company will delay the release of data about its reserves — the raw stuff it owns in the ground — until March. Shell says it wants to report its reserve levels at the same time as its U.S. rivals. Investors might find the delay worrying nonetheless, because the memory of the company’s reserve-accounting scandal four years ago is still fresh.
 
The problem then was the way Shell accounted for new reserves. It previously had adopted a more-optimistic approach to estimating the quantity of oil and gas. That pushed up its reserve-replacement ratio, the standard measure of the sustainability of an oil company’s production. For a few years, Sir Philip Watts, Shell’s then chief executive, looked like a hydrocarbon rock star. He appeared to have found a way to replace reserves faster and cheaper than in the past.

That changed in 2004 when Shell reduced its reserves estimate 20%. Sir Philip was forced out, and Shell revamped its management structure.

Times are tough for private oil companies such as Shell. They can’t get access to choice new fields and are getting worse deals in existing ones. Shell has been badly hit. Governments have forced it to reduce operations in major projects from Kazakhstan to Nigeria.

The worst blow came last year, when Russia gave local producer Gazprom Shell’s place in the Sakhalin II project. That is expected to wipe 1.1 billion barrels of oil equivalent off Shell’s reserves. Growing nationalist sentiment in Nigeria has put a further 1.1 billion barrels in jeopardy. These problems will undoubtedly make its reserve-replacement ratio look bad. How bad? The company should do what it can to ease — or confirm — their fears sooner than March.

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