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Sunday Telegraph: Shell in Hell

Sunday Telegraph: Shell in Hell

29 August 2004

The oil giant has been heavily fined for overstating its reserves, but now looms the prospect of law suits against the individuals involved. Sylvia Pfeifer reports

The great and the good of the North Sea oil industry descended on the town of Stavanger in Norway last week for one of the sector’s annual get-togethers. But among the chief executives, politicians and royalty attending – Norway’s King Harald V opened the conference – there was only one man everyone wanted to see: Jeroen van der Veer.

As chairman of the committee of managing directors of Royal Dutch/Shell, the Anglo-Dutch oil giant, and the keynote speaker, van der Veer was the star attraction.

But while van der Veer was being feted in Norway, regulators in the UK and the US were preparing to publish the results of their investigations into the shock overbooking of reserves at the oil giant.

The revelation in January that Shell had overbooked its reserves by 25 per cent – following revisions, that overstatement has now risen to 29 per cent – led to the departure of the oil giant’s two top executives, Sir Philip Watts and Walter van de Vijver, and has left it battling to restore its reputation.

The damning reports – by the US Securities and Exchange Commission and the Financial Services Authority, the UK regulator – will have made uncomfortable reading for van der Veer, a long-term Shell executive who took over after Watts was ousted, and his management team.

They make clear that Shell ignored internal warnings for several years that it was overstating reserves in a bid to maintain the appearance of having a strong oil and gas reserves base.

In addition, the regulators found that Shell’s group reserves auditor (GRA), Anton Barendregt, had warned the company as early as January 2000 that its reserves figures may have been overstated – two years earlier than previously reported by the company’s own internal investigation, carried out by Davis Polk & Wardwell, the US law firm, parts of which were published in April.

“The conclusion of the FSA’s and the SEC’s investigations into Shell represents another significant step for Shell in putting its reserves issues behind us,” said van der Veer last week.

The company may have settled its case with the FSA and the SEC – Shell has neither admitted nor denied the findings but has agreed to pay penalties of £17m and $120m (£67m) to the FSA and the SEC respectively.

But the investigations are set to continue. Regulators on both sides of the Atlantic have now turned their attention to the individuals involved in the reserves debacle.

“While the focus was initially mainly on the company, the emphasis is now going to come onto the individuals,” says Harold Degenhardt, administrator of the SEC’s Fort Worth office in Texas.

The SEC is casting its net as wide as possible, he adds. It is in the process of interviewing not just current and former employees of the oil giant. “We’re looking at all individuals or entities that might be responsible for the violations,” he says.

Given the information that the SEC has been able to put together in recent months, Degenhardt says he is convinced those responsible will be held to account. “Based on what we have now, we are confident we will be able to connect the dots to the people responsible. I have every confidence of that,” he says.

While the Davis Polk report painted a graphic picture of conflict between Watts and van de Vijver, the SEC and the FSA lay out in detail systemic problems with the company’s reserves reporting procedures as far back as 1997.

The regulators’ reports also attack Shell’s internal audit function as intrinsically flawed.

As early as 1997, Shell implemented new guidelines in some countries to maximise oil reserves bookings. These were issued to Shell operating units in 1998.

“These revised guidelines resulted in an overstatement of Shell’s proved reserves of 940m barrels per day for the two years ended 31 December 1999,” the FSA report says.

Perhaps the most startling revision came in 2000. In January of that year an internal presentation showed that Shell had a reserves replacement ratio (RRR) – a key measure of the rate at which used oil and gas is replaced by new finds – of only 37 per cent in 1999. This figure, however, was “robustly rejected” by the company and in April Shell announced a ratio of 56 per cent.

A central figure in the report is Barendregt, Shell’s group reserves auditor. Barendregt, a retired petroleum engineer, had huge responsibility. But incredibly he was employed only on a part-time basis and provided with limited resources and no staff to audit Shell’s vast worldwide operations, the reports say.

Barendregt is said to have highlighted problems with the reserves reporting procedures and repeated concerns about reserves in three of his internal annual reports from 2000. Nevertheless, the SEC says, he was sometimes more upbeat about reserves than local management.

“At other times, solely to support booking proved reserves for otherwise uneconomic projects, he advised local management to submit development plans unlikely ever to be executed.”

The reports also note that “critically, the position of group reserves auditor was not an independent role. The GRA reported to the management of Shell’s Exploration and Production business, meaning he was answerable to the same people he audited”.

Last week, long-term industry watchers cautioned that it was not a foregone conclusion that individuals involved in the reserves debacle will be successfully prosecuted.

So far no individual has been accused of wrongdoing. Nevertheless, the possible repercussions from the regulators’ investigations should not be underestimated.

In the UK, individuals found guilty of making a regulatory statement which they know to be misleading or false, can be fined or even face imprisonment for a number of years under the FSA’s market abuse rules.

In the US, the SEC has only civil powers, but can impose huge punishments, including swingeing fines, as well as disbarring individuals from becoming directors.

The US criminal probe by the Justice Department may also still lead to charges being brought, although legal experts in the US said last week that they thought it unlikely Shell would have settled with the SEC if it thought the DoJ might prosecute the company as a whole.

In addition, Shell and former and current executives are still facing multi-billion dollar class action lawsuits in the US. The cases include as defendants a quartet of former and present Shell executives who are FTSE100 chairmen: Sir Mark Moody-Stuart, of the mining giant Anglo American, Paul Skinner, of its rival Rio Tinto, Maarten van den Bergh, of Lloyds TSB, and van der Veer.

“The damages claim will be in the billions of dollars,” says Stanley Bernstein, a senior partner with Bernstein Liebhard & Lifshitz, the lead plaintiff in the class action suits which claims to represent investors who bought shares in the past five years.

Bernstein says the company intends to file an amended complaint next month which could include a number of new individuals and entities. These could include Shell’s auditors, KPMG and PwC.

“We are aggressively looking at their role,” says Bernstein. “It [whether to bring them into the class action suits] is something we are investigating.”

For Shell and its thousands of employees, last week’s reports are only another stage in the long haul back to credibility – and the coming months will be critical.

Shell’s annual strategy presentation next month is already being seen as one of the most important ones in its almost century-long history. Meanwhile, van der Veer is expected to report back on Shell’s review of its corporate governance structure in November.

The company, which has come under intense pressure from shareholders to reform its complex structure and corporate governance practices, is understood still to be reviewing all possibilities.

These include a full merger of the two operating companies, Royal Dutch/Shell and Shell Transport & Trading. But given the potential tax liabilities, which could be several billions of dollars according to some analysts, the most likely outcome is a merger of the two boards.

Whether Shell has weathered this particular storm – and will be able to recover from a devastating operational setback – will not become clear for another few years. On a personal level, long-term Shell watchers are still coming to terms with the damaging revelations. “We are all grieving. It’s a great family tragedy,” says one long-term Shell watcher.

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