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Business Report: The corporate pressure of performance

Business Report: The corporate pressure of performance

By Bert Chanetsa

21 June 2004

What is clear from the saga at Royal Dutch/Shell is that the practice of categorising reserves is a supreme challenge.

This is so both in the context of shareholder and market expectations as well as regulatory requirements.

For any company operating in the resources sector, reserves booked are a critical indicator of value to stakeholders.

A drama around the veracity of the method of such bookings has been playing itself out at Shell.

On January 9 this year, Shell announced that it would be recategorising some 3.9 billion barrels of oil equivalent, or 20 percent of proven reserves, previously stated as at December 31 2002.

Within the category of proven reserves, 90 percent of the change related to a reduction in the “proved to undeveloped category”, with the balance being a reduction in the “proved developed category”.

Shell claimed that several factors identified in its own reviews led to the recategorisation. During the fourth quarter last year, it had carried out a number of in-depth reserve studies, which had prompted a broad review of “previously booked reserves against current proved reserves standards”.

This carefully worded explanation seemed plausible enough. Surprisingly, this recategorisation turned out to be the first of several.

The fourth restatement occurred earlier this month, when the company raised the figure from 3.9 billion to 4.47 billion barrels of oil equivalent, roughly 25 percent of proven reserves.

Since January 9, a number of significant events have taken place at the company. Internal memos that have been made public revealed that as far back as February 2002, Shell’s executive committee was warned that the categorisation of a significant portion of its reserves did not comply with Securities and Exchange Commission (SEC) rules.

This was two years before the first recategorisation.

Walter van der Vijver, Shell’s head of exploration and production at the time, sent the following e-mail to Philip Watts, then the chairman: “I am becoming sick and tired about lying about the extent of our reserves issues and the downward revisions that need to be done because of far too aggressive/optimistic bookings.”

These disclosures have led to a number of casualties at Shell. Watts, Judy Boynton, who was the group chief financial officer, and Frank Coopman, who was the chief financial officer of exploration and production, and even Van der Vijver have all left the company.

According to John Kay of the Financial Times, Watts and others like him were the type of “corporate chiefs who want to be perceived as visionary entrepreneurs rather than dispassionate administrators”.

Davis Polk & Wardwell, the US law firm that carried out an independent investigation into the company, noted the perception in the market that Watts’ success could be partially attributed to his ability to “meet or exceed reserve expectations”.

The SEC itself has come under attack. It has been accused of employing outdated standards of judging oil companies and not keeping up with changes in oilfield technology, particularly the method of assessing reserves.

But it is not clear how far the SEC’s alleged failings can be taken as a partial defence or a practical explanation of Shell’s predicament.

It seems that where a chief executive’s ego and his reward expectations are an issue, there is a high probability that corporate governance will be breached.

Indeed, shareholders have a right to demand transparency, but the pressure they place on the chief executives for superior performance can be so intense that they feel compelled to tamper with the truth.

Bert Chanetsa, a practitioner in finance and law, is the chairman of Decathlon Continental, an investment banking advisory concern, and a director of Chanetsa Incorporated

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