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Oil sector governance

Financial Times: Oil sector governance

“Royal Dutch/Shell’s reserves downgrade was a dramatic failure of corporate oversight.”

“Good reputations take time to build, but are quickly lost.”

Jul 26, 2004

Do oil sector investors care about corporate governance standards? Royal Dutch/Shell’s reserves downgrade was a dramatic failure of corporate oversight. But, with oil prices close to record highs, Shell’s share price has already regained the ground lost after the debacle, even though the outcome of its governance review is unknown.

Deutsche Bank, however, has found evidence of a link between governance standards and performance. It ranked 11 large oil companies on governance criteria – board independence, for example – with further weightings for more specific oil industry metrics such as reserves disclosure. On both rankings Shell, Repsol and ChevronTexaco achieved the lowest scores. Over the last three years, these bottom three delivered 15-20 per cent lower total shareholder returns than the top three.

The data is backward looking – governance ratings will partly reflect past mistakes that can be expected to have affected performance. But governance standards are part of the assessment investors make. They are more of an issue when a company has a reputation for poor governance – part of the reason to avoid a stock, but featuring lower when considering buying. Good reputations take time to build, but are quickly lost.

A company with lousy performance and lousy governance will be viewed more favourably for changing strategy than board structure. This is sensible – without a credible strategy any board will struggle. But too narrow a focus on short-term performance can obscure potential benefits. Effective governance is more than mere box-ticking. It can help reduce execution risks and should ultimately improve performance.

Yukos provides a stark example of emerging market political risks, but also of the benefit of western-style governance in attracting investors. With the oil majors looking increasingly to the developing world for new reserves, country risk is increasing. Effective governance has a role to play in managing those risks.

© Copyright The Financial Times Ltd

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