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Sunday Business: Royal Dutch Shell encounters a sticky patch in its oil field prospects

Published: Feb 03, 2007 

Most of the world’s leading oil companies were founded on an oil gusher; Royal Dutch Shell started with a ship. Marcus Samuel, a London trader, built the Murex, the world’s first oil tanker, to ferry Caspian oil to Europe, breaking John D Rockefeller’s stranglehold on the oil market. More than a century later, Shell’s heart is still in trading and refining, while finding oil and gas has never been more of a struggle. 

The oil conglomerate was forced to restate reserves in 2004, after it was found they had been over-reported for several years. The clock has been ticking loudly since: Shell wrote down a third of its oil and gas reserves, leaving it with 11.5bn barrels of proven oil and gas reserves, enough to last just over nine years at present production levels. On average, its peers have enough reserves to last between 12 and 14 years. 

Shell’s oil refining and petrol retailing operations have made it Britain’s most profitable company, as its earnings on Thursday will confirm. It has beaten investors expectations for five quarterly statements in a row and its market value has regained the lead it briefly lost to rival BP, Britain’s second biggest oil company. Shell is worth GBP111bn ($218bn, E168bn) compared with BP’s GBP104.8bn. 

Despite these stellar figures, the company is shrinking. Oil companies aim to book in reserves and discoveries at least as many barrels a year as they produce, to grow or at least not to shrink. In 2004, Shell only replaced 49% of what it produced; in 2005, the figure was less than 70%. Ahead of this week’s fourth-quarter results, none of the City analysts that follow Shell expected the company to achieve the 100% reserves replacement it needs just to stand still. 

In May 2006, Jeroen van der Veer, Shell’s chief executive, quietly sidelined its target of an average 100% reserves replacement rate between 2004 and 2008. He made a convincing case that the soaring costs of hiring contractors and equipment meant that it made financial sense to delay projects until the market had cooled off. 

Shell has signed off projects this year which could potentially be included in its reserves. These range from processing plants in Qatar to oilfields in the Gulf of Mexico and Brazil. Even so, the oil company gives every appearance of losing booked barrels as fast as its teams of engineers, exploration geologists and project managers can find them. 

The sale under duress of half of Shell’s stake in the Sakhalin-2 project in Russia’s far east to Gazprom, the country’s gas export monopoly, is expected to have cost Shell between 600m and 1bn barrels of reserves n reducing its reserves life by as much as a year. 

Worse may come. Chaos in Nigeria, one of Shell’s core countries, has shut down 477,000 barrels per day of output operated by Shell, closing its Forcados and EA oilfields for close to a year. The Nigerian election in April could bring even bleaker news: rival presidential candidates are openly floating the idea of renationalising Shell’s onshore fields, potentially losing it another substantial chunk of reserves. 

At the same time, one of the key planks of the oil giant’s planned revival, its decision to begin hunting out what it calls “big-cat” oil exploration opportunities, each of which has the potential to deliver 100m barrels of oil reserves, looks like it may be running aground. Out of 12 big-cat wells drilled in 2005, seven struck oil. Flushed by this success, Shell stepped up the programme, planning to drill between 15 and 20 potentially large discoveries. What little news there has been of this campaign has been disappointing. Investors fear the worst. 

The risk is that Shell’s struggle to find the opportunities it needs to grow forces it to invest in riskier and less profitable ventures. Last year, it increased its planned investment in an oil sands project in Alberta, Canada, saying it aimed eventually to produce 770,000 barrels of bitumen a day, up from its previous target of 550,000 barrels. 

The sheer quantity of oil locked in Alberta’s sands rivals Saudi Arabia; but extracting and refining it into usable crude costs $40 per barrel compared with perhaps well under $10 in the Gulf, making the economics vulnerable to a collapse in the oil price. 

Shell’s newly-signed deal with the Iranian government to develop a $10bn liquefied natural gas project looks even more desperate. A month after being burnt by the Russian government, Shell is willing to do a deal with a global pariah. 

Iran’s dogged pursuit of nuclear weapons presents a very real risk of a conflict with America, Israel or both before Shell and its partner, Repsol, a Spanish oil company, finally sign off on the project in a year’s time. 

The American government has deterred the Japanese from investing in one major Iranian field and is applying similar pressure on China and India. 

For the time being, however, Shell is trying to keep investors on side with healthy profits and the promise that, at some point in the next decade, the 60bn barrels of potential resources it claims can finally be transformed into growth. 

It has spent more than $10bn on share buybacks in the past two years and could use its burgeoning cash pile from asset disposals (including Sakhalin-2) to return more money to shareholders or fund acquisitions to make up for lost output and reserves. 

Investors will not hang on indefinitely. Shell’s management needs to start turning vague promises into hard numbers fast. Shell might think that its vast size makes it unassailable; it could not be more wrong. It is a lesson that its rival BP has discovered to its cost. and its sister websites,,,,, and are all owned by John Donovan. There is also a Wikipedia article.

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