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Fortune.com: Now If Only Shell Could Find Some Oil

Fortune.com: Now If Only Shell Could Find Some Oil

Forget the reserve drama: At the current rate, Shell will run out of oil in a decade: “Shell will be a no-growth company at least for the next few years.”

By Janet Guyon

Posted 27 July 2004

Now that Royal Dutch/Shell has come clean about the games it was playing with its oil reserves, can it get out of the hole it’s in? That’s what investors want to know, and the prospects aren’t good. At least not in the short term.

Sure, the company is still selling lots of oil, and at high prices. But it’s only replacing 60% of the oil it is pumping, giving it the shortest reserve life—10.2 years—of any oil major. At current production rates, Shell will run out of oil in a decade.

To boost reserves to the level of its competitors, Shell needs either a big discovery or a big acquisition. But neither of those scenarios is likely, because most big basins in the world have been explored, and oil prices are too high to make an acquisition attractive.

That means Shell will be a no-growth company at least for the next few years. Executives say production will be flat this year, fall next year by 3%, and show slight growth in 2006. Not until 2007 will gas and oil projects in Norway, Russia, Kazakhstan, Canada, and Qatar begin to pay off. “There’s a limit to what we can do today to affect production in the next two to three years,” says Simon Henry, Shell’s head of finance in exploration and production.

As those projects start producing, Shell will rebook some of the 4.4 billion barrels it moved into the unproved category in recent months. “There’s no question that the barrels are there,” Henry says. “We just didn’t have plans to commercialize them.” SEC rules dictate that only barrels in the ground that can be produced in the next few years should be declared as proven.

To further boost its reserves, Shell is increasing spending on exploration to $1.4 billion this year and next, up from $1.3 billion last year. That’s nearly twice what some of its competitors are spending. Half that money is targeted on big wells with the potential to boost reserves by 100 million barrels each. “We’ve stopped doing a lot of the little bitty stuff,” says Henry. The company also hopes that negotiations for access to oil and gas in Saudi Arabia, Libya, and Russia will eventually succeed. While Exxon, Total, and BP were boosting their reserves through acquisitions in the late 1990s when oil prices were low, Shell cut its exploration budget and focused on negotiating access to countries with large oil reserves. But getting agreements to explore and develop has taken longer than expected. “We maybe took our eye off the ball on exploration and made a strategic shift to negotiate for reserves,” says Henry.

All that talking may some day pay off. But to get its reserve life up to Exxon and BP levels, Shell would have to boost its replacement ratio from 60% to 130% over the next five years, says Peter Nicol, ABN Amro’s oil analyst in London. And that looks like a long shot.

From the May. 17, 2004 Issue

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