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Shell: still too sure of itself?

The Observer: Shell: still too sure of itself?

Sunday 26 June 2005

Worries linger, but the oil giant has at least listened to investors, writes Oliver Morgan

Sunday June 26, 2005

The Observer

On Tuesday, the directors of Royal Dutch Shell, the dual-listed oil group, head for annual meetings in London and the Hague, expecting a smoother ride than they got this time last year.

Then they faced their owners sure of only one thing: a tongue lashing. The company was in the midst of a crisis triggered by the downgrading of oil and gas reserves by 4.5 billion barrels, or 23 per cent (there have since been further cuts of 1.4 billion). Anger grew as details emerged about directors covering up the problems. There was outrage that Shell’s former senior executive, Sir Phil Watts, got a £1 million payoff. There was concern at the clumsy company structure, and irritation at the apparent resistance to change. Lord Oxburgh looked shell shocked as he was barracked from the floor.

This time round, he and his Dutch counterpart, Aad Jacobs, will be more confident. Alongside the AGMs, Shell is to hold extraordinary general meetings to approve arrangements finalising an overhaul that will see the cumbersome dual structure abolished.

The two operating subsidiaries, Royal Dutch and Shell Transport and Trading, each with their own boards, will be replaced by a single company, Royal Dutch Shell, with one set of shareholders – albeit holding two classes of shares – with Dutchman Jeroen van der Veer as chief executive of a single board, and Jacobs the chairman. Oxburgh will be stepping down.

At the same time, the company will aim to draw a line under the rebooking fiasco, pointing to the fact that the company has carried out its own extensive audit, which means that everyone can be confident that when it says it has 12.95 billion barrels of proved reserves it does have them. It can also say that the team in charge at the time of the catastrophe – Watts, Walter van de Vijver, head of exploration and production, and Judy Boynton, finance director, have all left.

One influential investor says: ‘The merger plan solves the governance issues. The problem last year was that the reserves disaster indicated there were deeper governance problems, and the company appeared slow to recognise this. They have now, and I think that is the reason why there is a confident mood.’

The view is warmer among analysts, too. In an influential January note, Morgan Stanley’s Neil Perry remarked that ‘By the third quarter of 2004 … perceptions of Shell have probably never been lower,’ before adding: ‘It has not had the time or opportunity to set out its view of the future … this is likely to happen through 2005, leading to a recovery. So is it all plain sailing now? Hardly.’

When it was backed into a corner, Shell may have listened to investors. But there is still a concern that its culture is to disdain the opinions of short-term investors, that it may revert to a ‘we know best’ attitude, and, worst of all, that it remains introspective, bureaucratic and more concerned with internal politics than communication with the outside world.

One example is the process of choosing an eventual replacement for Jacobs as chairman. Van der Veer said last week that it was unlikely to be a Dutchman. However, senior City figures – the sort that would expect to get a call from head hunter Egon Zehnder – say that not only Dutch, but British and American candidates have been ruled out, for political reasons. ‘This is a leading European company, and it needs a European at the head, but it can’t be a Brit or a Dutchman,’ says one. The company says no further news will be given at the AGM but early speculation has centred on former Seimens head Heinrich von Pierer.

This sort of thing does not impress investors. One senior fund manager says: ‘The candidate should be selected on merit, not nationality per se. If the board has decided to rule out certain nationalities I would be concerned. I would not want it to be the long-term script at Shell. I think you get on to a slippery slope.’ Another said: ‘A group of this size needs a man or woman of quality, regardless of nationality.’

Meanwhile, at the AGM, the shareholder activist group Pirc is unhappy with the bonus plans for directors, known as long term incentive plans (LTIPs). It says that the performance targets are set against four other companies: BP, Chevron Texaco, Exxon and Total. While this may represent the obvious (Shell says only) comparator group, a second separate measure of performance should be used alongside it. Otherwise, Pirc says: ‘There is the potential for large rewards for only median performance.’

Compared with the governance issues that arose last year, Shell may see these as trifling. However, on the operational front there remain clear reasons to worry. On the major statistical benchmarks used to compare oil companies, Shell is at the bottom.

While BP has a reserve replacement ratio (the amount of oil it adds to its reserves compared with the amount it takes out of the ground) of 160 per cent between now and 2003, Shell’s is 71 per cent – in other words, it is shrinking. Shell spends $10 a barrel on finding oil and developing fields (bearable at current oil prices) while TotalfinaElf and BP spend about $4.5.

Citibank analyst Clay Smith says: ‘If you look at the key numbers, they are at the bottom of the league on all of them.’

Van der Veer last week tried to tackle this issue, saying that Shell would ‘flatline’ until 2008-09, when it would start to benefit from rebooking the fields that were downgraded last year. He added that the company would concentrate on making multi-billion-dollar investments in 10 new fields, and hinted that it might be on the acquisition trail.

Meanwhile, some experts point out that by the end of the decade Shell will be better-placed than BP. Morgan Stanley says that by then, thanks to investment in liquefied petroleum gas, technology to convert gas to liquid oil products and exploration of unconventional reserves such as heavy tar sands, it will have long-term reserves stretching out 10 years or more.

Wood MacKenzie’s Tom Ellacott points to LPG positions in Qatar and progress in Norway and Libya. ‘The E&P [exploration and production] position looks strong,’ he says.

But Smith says: ‘The question to ask is: “what are you going to do about the short-term gap, and how quickly are you going to rebook the reserves that you downgraded?” ‘ He adds that there are only two ways to do this: find more oil and win the right to drill it, or buy it.

Past experience of both gives investors reason to be nervous. Watts was widely criticised for overpaying for Enterprise Oil, which Shell bought for £4.3bn in 2002, although criticism has waned as the oil price has nearly doubled since.

One investor says: ‘What we really want to avoid at this point is an expensive medium or large acquisition. This should be time for consolidation after what it has been through.’

Meanwhile, Shell has been pipped to the post in recent attempts to develop existing fields such as in Oman, where it was outbid by Occidental Petroleum of the US. And Smith reiterates that the big projects Shell is focusing on – for example, the Sakhalin gas field in Russia – are years away. ‘Shell’s record in development has not been good,’ Smith says.

‘There are management questions here,’ adds another investor. ‘Malcolm Brinded [head of E&P] was seen as a steady hand last year, but Oman and the speed of development elsewhere has led to muttering about him.’ About other directors too? ‘No, and certainly not Van der Veer. Losing him is the last thing I want.’

Last week, the Dutchman said changes to retirement law meant that he could stay for another eight years. He had ‘a lot of energy to go for it’. He will need that on Tuesday, but it seems his shareholders are likely to give him a bit more time.,,1514501,00.html

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