Posts Tagged ‘Securities and Exchange Commission’

However, the real answer lies six years earlier in another just as painful oil scandal that hit BP’s nearest rival, Royal Dutch Shell. This was the heated reaction to news that Shell had over-stated its oil reserves by a third in the years leading to 2004.

Downgrade after downgrade kept hitting the company’s share price until matters came to a head over an email from Shell’s head of exploration to the chief executive.

“I am becoming sick and tired of lying about the extent of our reserves issues and the downward revisions that need to be done because of far too optimistic bookings,” it said.

Chief executive Sir Phillip Watts resigned and was escorted from the premises. No further action was taken against management, with official Financial Services Authority and US Securities and Exchange Commission inquiries into their roles dropped.

For a short period, this corporate giant, on which 1m people rely for employment, was run by just three interim leaders while there was a management clear-out at the top and merger between its Dutch and British divisions with Jeroen van der Veer taking the helm.

An array of authorities started launching investigations and the company began an amnesty, where all departments could take a cold hard look at their numbers and declare any discrepancies.

By its own admission, the energy major has really only just recovered from the scarring restructuring, cultural change and executive hand-wringing that ensued.

Now powering ahead of BP with profits of $8bn in the past three months alone, Shell is the largest oil company in Europe with an enviable pipeline of new oil and gas projects due to boost production this year. Lauded by investors and analysts, these are the same City faces who were back then pressing for the company to be taken over or split up – much like for BP today.

Although BP’s accident is a completely different, more expensive problem, there are still parallels with Shell’s historic corporate scandal – most notably its probable longevity. Herein lies the tale of how Shell regrouped from one scandal, to transform itself into a company that is today worth twice as much as BP, even though the pair are often mentioned in the same breath.

Despite today’s differences, industry insiders argue that both companies began to lose their way years before their respective disasters struck.

According to former Shell executives at the time the scandal hit, the seeds of the crisis were sown when the company started to base its business around trading and becoming more “asset-light”, cutting costs aggressively and setting tough bonus-related targets. The focus had shifted away from its historical expertise in engineering and operations, in much the same way that BP has been criticised for neglecting its traditional strengths.

What’s more, one disaster followed another, much like BP stumbled out of the Gulf of Mexico straight into an almighty row with its Russian billionaire partners and Kremlin-backed oil company Rosneft.

“Do we spy another PR disaster on Shell’s horizon after Nigeria, Brent Spar and the reserves debacle?” one Sunday newspaper asked in 2005. Environmental and security problems in Nigeria followed hot on the heels of the reserves scandal in the wake of greater public scrutiny and mistrust.

Shell’s ultimate solution for regaining the trust of the market was to go back to basics – investing billions of dollars in new production of oil and gas, particularly in “unconventional” extraction. Its management repeated buzz words such as “technology” and “engineering” to reassure investors the company was going back to its dependable core strengths.

It pushed into North American deepwater, pioneering liquid gas projects in Australia and Qatar, plus development in Russia’s remote Sakhalin region. All were technically complex, some suffered delays and cost over-runs, and in total, they needed $150bn of capital, but the gamble, supported by oil prices at near record highs, is on the brink of paying off.

Insiders say investors were not always supportive, pushing for immediate improvements and near-term returns, but in the end, Shell’s new management persuaded the market to endure years of patient faith in its turnaround.

The question is now whether BP’s shareholders, bewitched by the possible £180bn break-up value of the company, will be willing to grant it such leeway. BP has promised “consolidation” and extra capital investment in exploration and production, having completed a promising $7bn deal in India.

Yet some analysts are sceptical that BP has acted quickly enough in clearing out the old management and realising the scale of its problems, which could hinder any attempts to keep the 100-year-old corporate behemoth in one piece.

“It took Shell a long time to recover, but the Shell machine went into action quickly,” says Malcolm Graham-Wood, a long-time BP watcher from VSA Capital. “They found out what was wrong and they rectified it. The depth and breadth of management within Shell sorted it out. What’s a shame is that BP have not got depth or breadth of management and they’re making a mess of it. I think it will take them years to get back to the state they were in before. The Shell story is, and has been to me for a couple of years now, about the huge projects which have come on stream in this quarter,” he adds.

“Shell has not been distracted by any of the self-inflicted grief affecting BP and has outperformed accordingly.”

Stuart Joyner, analyst at Investec, agrees that it will take years for BP to recover.

“I think we have to be patient. In fact management has been quite explicit about telling investors that at least for the remainder of this year, and possibly into next year.

“In terms of when BP will organically start to improve, I think we’re looking at a couple of years out. It could take even longer than that if you look at the two key strategic plans [CEO Bob] Dudley has made. By their very nature they are very long-term, which is not to criticise, but realistically it means that anything they do in India and Russia will probably not impact the portfolio for the best part of a decade.

“Shell has really only just – in 2011 – started to reap benefits from what it put in place after the reserve scandal. It’s taken the best part of a decade for them to change the portfolio and that’s partly because their strategy was to invest in long-lived assets like Qatar, and obviously that has taken longer for them to turn around. But they are producing an enormous amount of cash at the moment and we saw that in both quarters.”

Now that Shell has won round its critics, the challenge will be to keep up the momentum and stave off those who believe BP’s crisis has exposed cracks in the over-sized, integrated oil major.

Shell’s chief executive, Peter Voser, argues that the company has proved the worth of owning both production and refineries through projects like the Canadian oil sands and Qatari developments. These look after oil and gas from extraction to point of sale. And he claims national oil company partners value the versatility of Shell’s skills across upstream and downstream and ability to invest in both areas.

The question now for oil investors is whether BP’s depressed share price offers more of an opportunity for increasing value than Shell, which must keep up its production growth and reserve replacement.

The jury is still out in the City, with little faith in BP’s management team in evidence at this early stage in its turnaround.

BP vs Shell

2000 BP unveils its new sunflower logo to symbolise “dynamic energy” and green sympathies, after a period of acquisitions and quick profits. Shell cuts costs, makes record profits.

2002 Low oil prices and new North Sea taxes hit profits at both companies. Shell says it is “uncertain about meeting output targets”.

2004 Shell reveals that reserves have been over-stated and merges its Dutch and UK divisions, with Jeroen van der Veer taking the helm. BP buys back $5bn (£3bn) of shares after moving into Russian oil with TNK-BP partnership.

2005 BP and Shell conduct secret early merger discussions, revealed years later by former BP chief Lord Browne. BP suffers blast at Texas refinery, which kills 15 people.

2006 Russia seizes Shell’s oil assets at Sakhalin. BP suffers oil leaks in Alaska and Lord Browne fights push for his retirement.

2007 Investigation into Texas blast points to serious safety failings at BP and Lord Browne steps down after lying about how he met a lover. Shell pays $350m to settle reserve scandal cases.

2008 Shell sets new record for company profits. New BP boss Tony Hayward embarks on round of cost-cutting.

2009 Shell suffers revolt over high executive pay. Plunge in oil prices prompts job losses at both companies. BP overtakes Shell to be biggest European major.

2010 Gulf of Mexico oil spill floors BP, as share price dives and losses accrue. Shell sheds more jobs and focuses on big projects coming on stream.

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But they began to rebound after a sweeping rule change by the Securities and Exchange Commission, intended to modernize how energy companies report their gas reserves.

As part of that change, the commission acquiesced to industry pressure by giving these companies greater latitude in how they estimated reserves in areas that were not yet drilled. The new rules, which were several years in the making, were officially adopted only weeks before the S.E.C. chairman under President George W. Bush, Christopher Cox, stepped down.

Previously, companies were allowed to count gas only from areas close to their active wells as part of their “proved” reserves, the amount of gas that a company estimates to investors it will tap. This was meant to prevent companies from claiming reserves of gas based largely on guesswork.

After the rule change, companies were allowed to include gas located farther from producing wells in their reserves estimates, using modeling methods to predict how much gas could be produced from these yet-untapped areas. But the S.E.C. said that the companies, for reasons of trade secrecy, did not have to disclose precise details about the technology they used to estimate reserve sizes. Though the commission considered requiring third-party audits to verify the reserve estimates, the idea was dropped in the end.

The rule change was especially helpful to shale gas companies because it approved the use of new technology and modeling techniques that these companies rely on more heavily than traditional oil and gas companies.

Shale gas producers also especially benefited from the relaxed restrictions on how large an area companies could predict would be productive without drilling to test first. Shale formations tend to span much bigger areas than conventional oil and gas fields, and some shale gas producers say they can achieve relatively predictable results across these large areas.

Among 19 of the largest shale companies reviewed by The New York Times, at least seven increased — some by more than 200 percent — the amount of undeveloped reserves they reported in their federal filings immediately after the rule took effect, according to their S.E.C. filings. Investors cheered the rule change as it was adopted, and in the following months they sharply bid up the stocks of five of the seven companies.

The rule change also allowed these companies to reduce one of the costs that investors often rely on to compare the performance of energy companies: their finding and development costs. These costs now appeared drastically lower because they were being divided across a much larger reserve estimate. Five of the seven shale companies also reported huge decreases in their finding and development costs — by as much as 86 percent, according to a review by The Times of their federal filings. The average decrease in these costs for the oil and gas industry on the whole was about 48 percent for the year.

However, in internal e-mails and documents, many industry executives and federal officials have questioned whether some companies are overstating, perhaps intentionally, the amount of gas they can economically produce in a given period. This practice, known as overbooking, is illegal because it misleads investors trying to assess a company’s strength and banks that use reserves as collateral for loans.

“There is now plenty of production data available from the states to show that these wells are nowhere near what these guys are touting,” an official with a Texas oil and gas company who formerly worked at Enron wrote on Nov. 7, 2009, comparing the practices of shale companies to Enron’s. “I have discussed this numerous times with analysts that are friends of mine — they agree with me and then just shrug their shoulders.”

Asked about the rule change, officials at Chesapeake Energy, one of the leading shale gas companies, said its reserve numbers were accurate and comparable to those of other companies.

“We believe that the new modernized S.E.C. rules reasonably reflect the advancements in our industry’s ability to predictably produce oil and natural gas resources from unconventional formations,” Jim Gipson, a spokesman for Chesapeake, wrote in an e-mail. With advances in technology, he said, “exploration can be more accurately described as a manufacturing process because well outcomes become very predictable, substantially reducing risk.”

W. John Lee, a professor at Texas A&M University who worked for the S.E.C. as one of the main architects of the rule change, said the threat of S.E.C. action is also a powerful deterrent. “The S.E.C. is requiring more complete (transparent) disclosure in many cases,” Mr. Lee wrote in an e-mail, adding that the risk of overbooking was recognized when the rules were written. Steps were taken to minimize that risk by allowing companies to include only reserves from areas that would under most circumstances be drilled within five years, he added.

John Nester, an S.E.C. spokesman, said the new rules did not require third-party audits because there was a lack of qualified professionals available to do the work and companies themselves could do a better job checking their own reserve estimates.

Some industry experts say they think they are seeing a replay of events from last decade.

In 2004, the oil and gas industry faced one of its most embarrassing scandals. After whistle-blowers reported concerns about the size of Royal Dutch/Shell’s reserves, the company surprised investors by slashing reserve estimates. “I am becoming sick and tired about lying,” Walter van de Vijver, a senior executive at Royal Dutch/Shell, wrote in a November 2003 e-mail made public shortly after his company’s problems came to light. The episode led to the ouster of several of the company’s top executives and an investor lawsuit worth more than $350 million, and helped propel the S.E.C. rule change.

Companies could not apply the new rule until they submitted their 2009 federal filings to the S.E.C. in the early part of 2010. However, companies began describing to investors the coming increases in reserves shortly before the rule change was officially adopted in late 2008.

John E. Olson, an energy market analyst at Houston Energy Partners, says he believes shale companies have been aggressively booking their reserve estimates and playing down costs to make themselves appear more profitable.

Mr. Olson, who is famous for having been fired from Merrill Lynch in 1998 for refusing to recommend Enron stocks, compared the accounting practices of shale gas companies and the hype surrounding the industry to what he saw at Enron. Of the S.E.C. rule change, Mr. Olson said: “Welcome back to Alice in Wonderland.”