MarketWatch: Shell may face reserve cut risk on Sakhalin deal-Fitch

Last Update: 3:29 PM ET Dec 19, 2006

LONDON (MarketWatch) — Royal Dutch Shell PLC’s (RDSB.LN) reserves replacement may be under pressure if it cedes control to Gazprom (GSPBEX.RS) in Sakhalin-2, its largest oil and gas project, credit agency Fitch Ratings said Tuesday.

Cutting some of the Sakhalin reserves would be bad news for Shell, which has struggled to replace barrels following a reserves scandal.

Under International Financial Reporting Standards, or IFRS, it uses to report earnings, Anglo-Dutch major normally books 100% of the reserves brought from the units it operates.

But Shell won’t be allowed to book all of Sakhalin II’s reserves if it loses a majority stake – currently at 55% – in the venture, a company spokesman said. He said the reserves will then be booked in proportion of its stake, which press reports say could drop to 25%.

Fitch said in a report that “new proposals for state-run OAO Gazprom to acquire a controlling stake in Sakhalin may have an adverse impact on its reserve replacement strategy.”

Shell said earlier this year it still had a “fair prospect” of achieving 100% reserves replacement ratio for the period 2004 through 2008, based on U.S. Securities and Exchange Commission criteria. But it also warned it may not be able to respect the commitment.

The company has already struggled in recent years to replace its reserves after a serie of five oil and gas reserves restatements in 2004 and 2005. At the end of 2005, total proved reserves for Shell’s companies was 4% lower than a year earlier, according to its annual report.

Shell doesn’t disclose the reserves booked under the project but Fitch estimates Sakhalin-2 contains 1.398 billion barrels of oil equivalent.

The agency, which rates Shell a BBB minus with a positive outlook, said any “credit impact on Shell will depend on the form and amount of consideration it will receive” to make up for the reduction of its stake.

Shell has proposed ceding a controlling stake in the project to Gazprom, an official close to the situation has previously said. Gazprom said Tuesday it expects to reach an agreement this week. Investec Bruce Evers also said Tuesday that Shell’s production targets may become more “vulnerable” if its stake in the project is reduced. The company currently forecasts a production of between 3.8 million barrels a day of oil equivalent to 4 million boe/d in 2009.

But in a report last week, broker CitiGroup said it expects the target to be lowered by 100,000 boe/d, adding “we still see Shell falling well short of this target.”

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