Controversy over Shell Value Creation Teams

COMMENT ADDED ON 1 APRIL 2011

FROM IAIN PERCIVAL (RIGHT), RETIRED GLOBAL CHIEF PETROLEUM ENGINEER OF SHELL INTERNATIONAL (Iain retired from Shell in 2006 after 33 years of service.)

John – in your posting dated 31 March 2011 “You can be sure of Shell – the biggest confidence trick in history”, you wrote

when Shell so-called “value creation teams”, were already engaged in activities leading to the falsification of Shell’s oil and gas reserves and one of the biggest investor frauds in history.

I wish to correct any impression the team members were in any way conducting themselves in any other way than as competent, dedicated technical professionals conducing a root and branch examination of the huge volume of hydrocarbons in Shell’s resource portfolio categorized as “Scope for Recovery”. The aim of the exercise was to identify activities & projects which could (I emphasise the word could) lead to booking volumes of hydrocarbons as “Expectation” volumes, not proved, and only if there was a reasonable level of certainty the projects would go ahead. The outcome of the Value Creation initiative was a complete change in the way the company goes about generating hydrocarbon development concepts, designing and executing well programmes, defining and executing major engineering projects and optimizing the way facilities are operated and maintained. The current suite of E&P Global Processes, operating standards, learning & development programmes, best practice sharing / knowledge management owe their existence to the pioneering work conducted by the Shell technical professionals who worked in the Value Creation Teams.

The implication that the Value Creation work led to the falsification of hydrocarbon reserves and investor fraud is false. The work has led to value generation for investors in Shell resulting from increased efficiency in the use of capital and increased effectiveness of the technical staff in their daily work.

I remain immensely proud to have been associated with the value creation effort and the implementation of the subsequent changes to how we did our work.

Kind regards,

Iain Percival

COMMENT ENDS

REPLY BY JOHN DONOVAN

I have supplied below some information from independent sources on the issue raised by Iain Percival.

CLICK ON THIS LINK TO READ FINANCIAL SERVICES AUTHORITY REPORT ON SHELL RESERVES SCANDAL: http://www.fsa.gov.uk/pubs/final/shell_24aug04.pdf (August 2004 — £17 MILLION FINE FOR “MARKET ABUSE”)

EXTRACT

Paragraph 5.

In 1998 Shell created five Value Creation Teams (‘VCTs”) to find radical new ways to improve Shell’s Exploration and Production business (“EP”) profitability and reputation and hence aid growth in the EP business. One VCT was tasked with creating the maximum value from Shell’s hydrocarbon reserves. A paper dated May 1998 entitled “Creating value through Entrepreneurial Management of Hydrocarbon Resource Values” made a number of recommendations including changing Shell’s reserves guidelines. On 16 September 1998 the revised guidelines were issued to Shell’s operating units. These revised guidelines resulted in an overstatement of Shell’s proved reserves of 940 million boe for the two years ended 31 December 1999.

Below is a link to the “REPORT OF DAVIS POLK & WARDELL TO THE SHELL GROUP AUDIT COMMITTEE: EXECUTIVE SUMMARY” dated 31 March 2004. Every page of the 202 page report is marked “HIGHLY CONFIDENTIAL”

I invite readers to download the report and run a search on “value creation team” and read the information on the related ten pages.  I will provide a few extracts here, but recommend that the entire 10 pages are read so the information can be seen in context.

From page 32 (or Court numbering — page 52 of 202)

The Value Creation Team prepared a report for EP BusCom that was widely distributed within EP entitled “Creating Value through Entrepreneurial Management of Hydrocarbon Resource Volumes.”

From pages 45 & 46 (Using Court numbering — pages 66 and 67 of 202)

In 1998 and 1999, a diagram known as the “cascade model” developed by the Value Creation Team appeared in the Guidelines. The”cascade model” illustrated the “migration of volumes between resource categories during the development life cycle.” In the diagram, “undeveloped reserves” appeared before “final investment decision” or FID (although the diagram does not make clear whether these volumes include proved undeveloped reserves).

Beginning in 1993, the Guidelines also introduced the concept of “commercial viability” (or later,”commercial maturity”) as a counterpart to technical maturity. As explained in the 1996 Guidelines, commercial viability implied that the project would yield an expected positive net present value (NPV) based on “advised Group reference criteria for commerciality.” Such viability was adequate for the inclusion of “reserves,” even though a more robust demonstration of “economic viability” (i.e., positive NPV under a number of technical risk downside scenarios) was necessary to obtain investment approval. In other words, it appears that the Guidelines permitted the booking of reserves (whether proved or expectation) with respect to projects that would not survive the Group’s capital allocation process, again a result that appears to fall short of “reasonable certainty.”

Pages 7 & 8 (or Court numbering — 86 & 87 of 202)

C.    Revisions to the Shell Guidelines — “Volume Value Creation Team”

In each of 1997 and 1998, Shell’s RRR performance significantly exceeded 100%. During these years Shell’s proved reserves were significantly boosted, not by exploration and development activity, but rather by significant modification to Shell’s methodologies for booking proved developed reserves. This change was at least partly the result of a review that was conducted under the auspices of a “Hydrocarbon Resource Volume Value Creation Team” (the “Value Creation Team”) within EP that was, in turn, established as part of Shell’s Leadership and Performance “LEAP” Focused Results Delivery Project. Similar to the relaxation in standards for booking proved gas reserves in 1990, this initiative was driven by the perception that Shell’s approach to booking proved developed reserves was more conservative than its competitors’, and that Shell’s reserves were therefore not maximizing value.

Footnote of page 4  (or Court numbering page 83 of 202)

It should be noted that the main increases in proved reserves resulting from the Value Creation Team’s revised Guidelines in 1997/1998 (See Section II C, below) related to proved developed reserves.  Such proved developed reserves did not make up a significant portion of the reserves recategorization announced on January 9, 2004.

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