Royal Dutch/Shell Group’s share price tumbled Friday after announcing it would recategorize nearly 20% of its proved hydrocarbon reserves — about 3.9 billion boe. More than 90% of the total comes from a reduction in proved undeveloped reserves; the remainder in proved developed. The changes would trim proved reserves to 15.6 billion boe from the 19.5 billion boe the major estimated in December 2002.

Of the reclassification, about 66%, or 2.7 billion bbl, is in its crude oil and natural gas liquids numbers. Nearly 33%, which amounts to 1.2 billion boe or 7.2 Tcf, will be recategorized in Shell’s natural gas reserves.

Several of its “heartland” regions, which is how Shell refers to its core production areas, are impacted by the changes, including the Gulf of Mexico. However, the biggest drops will be within its reserve numbers in Nigeria and Australia, Shell said. Based on current production, J.P. Morgan analysts estimate that Shell’s reserve life will drop to 10.6 years from 13.4 years.

In a prepared statement, Shell also warned that it will replace only 70% to 90% of its 2003 oil and gas with new reserves, which is below market expectations of 100%. The disclosure would mean that Shell has failed to replace all of its production for the third straight year.

To soften the blow, Shell said the changes would not have a material effect on financial statements for any year up to and including 2003. Also, Shell said that it anticipates that “most of these reserves will be re-booked in the proved category over time as field developments mature.” The company reports its fourth quarter production and earnings results Feb. 5.

Shell has been hinting in recent months that its production gains have been disappointing. In its third quarter report last October, Shell warned it would probably miss its year-end oil and gas production target of 4.1 MMboe/d by 1% because of asset sales and a change in the terms of a major production contract (see Daily GPI, Oct. 24, 2003). Production averaged 3.9 MMboe/d in the third quarter, which was below analysts’ expectations.

During a conference call to discuss the impact of the changes, Simon Henry, the head of Group Investor Relations, said several factors identified by a regular internal review had led to the recategorization. During the fourth quarter of 2003, several in-depth reserve studies were completed,which prompted a broad review of previously booked reserves against current proved reserves standards. Reserves affected were mainly booked in the period 1996 to 2002.

None of Shell’s exploration and production managers were part of the conference call; Henry was joined by Mary Jo Jacobi, vice president of external affairs.

When asked whether the news would lead to “resignation issues” for any of Shell’s top management, Henry discounted the rumors. He said that when the reserves were first classified, the engineers involved were using the best information available.

“We have an issue of categorization of reserves,” said Henry. “We identified it. We are fixing it.” He also dismissed questions about whether the changes had been prompted by the U.S. Securities and Exchange Commission.

Most of the recategorization relates to the current status of project maturity, said Henry. The recategorization, he said, would bring the global reserve base up to a common standard of definition, consistent with the globalization of processes within the new Exploration & Production business model. Most of the overall recategorization will be reported in Shell’s “Other Eastern Hemisphere” numbers in the next quarterly report.

“We have worked very hard in a very short period of time to communicate and clarify the impact” of this news, said Jacobi. “Although we have certain data available, some data still needs to be analyzed.”

Shell’s financial performance is unlikely to be affected by Friday’s announcement, analysts said. But it does shake confidence in the solid company. J. J. Traynor, an analyst with Deutsche Bank, said the news “will erode confidence in the company’s senior management.”

The drop in reserves also raises an “industry-wide question,” Traynor said. Most of the reserves to be downgraded are in Nigeria and Australia. In Nigeria, other majors holding substantial reserves include ExxonMobil Corp., ChevronTexaco Corp., France’s Total SA and Italy’s ENI SpA. In Australia, other majors include ExxonMobil and ChevronTexaco.

Henry said the reserves adjustment included the Gorgon gas venture in Australia, where Shell is a major player. “The original decision to book the reserves reflected letters of intent on gas sales and an expected development timetable. That has not panned out,” Henry said. Gorgon’s proven reserves had previously been assessed at 12.9 Tcf.

Gorgon is operated by ChevronTexaco, which plans to build a plant off the northwest coast of Australia to produce liquefied natural gas (LNG). ChevronTexaco had no comment on Shell’s news.

“Among the events that have not unfolded as were expected at the time are the Asia crisis, the impact that has had on demand for LNG and subsequent development of LNG supply,” Henry said.

Standard & Poor’s Ratings Service (S&P) and Moody’s Investors Service both announced they would place the oil major on review for a downgrade.

Moody’s analyst John Diaz said the “substantial reduction in Shell’s proved reserves and consequent diminution in its future discounted revenue values affect the company’s reserves to debt-based ratios materially and raise uncertainty over the group’s reserves position.”

Diaz said that “the restatement of reserves has no impact on the companies’ historical financial statements or near-term cash flow expectations, but … a medium-term impact may be expected as these reserves are re-booked. The restatement may also have longer term implications for the group’s production growth and per unit development and production costs.”

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