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E&Ps Smash 4Q Earnings Records, but Shell Reserves Loss Overshadows

Both independents and majors, which continued to report 4Q earnings last week, are shattering earnings records because of sustained high oil and natural gas prices. Several of the U.S.-based independents reported higher domestic production, but for the majors, the story continues to be dwindling output in North America. However, the biggest story last week was Royal Dutch Shell Group's announcement that it will once again reduce its proved reserves -- the fifth time in just about a year's time.

London-based Royal Dutch Shell Group more than doubled its 4Q earnings on soaring oil and natural gas prices, but the positive news was completely overshadowed with the company's announcement Thursday that it will reduce its proved reserves once again.

Shell, which has now completed a year-long internal and external review of its global reserves, reduced its proven reserves by 1.4 billion boe for 2003, a much higher revision than the 900 MMboe expected by analysts. Over 2004, it reduced its proven reserves numbers four times, leading to an investigation by U.S. and European regulators and a $151 million fine (see NGI, Aug. 2, 2004).

During a conference call with analysts on Thursday, CEO Jeroen van der Veer called 2004 "a year of extremes, with the reserves recategorization on one hand and record net income and cash generation on the other." He acknowledged disappointment in announcing the reserves cut, but in prefacing his discussion with analysts, he detailed how the company has revamped its internal auditing system and has begun to hire more exploration and production staff.

Shell set up its internal systems to comply with rigorous Securities and Exchange Commission guidelines, even though the oil major is headquartered in Europe. The latest proved reserves restatement was one "we did not anticipate," but van der Veer said most of the changes were "largely of a technical reporting nature. Now that we've completed the reserve review, we intend to move on. The hydrocarbons are still in the ground, and our production outlook is unchanged."

Malcolm Brinded, executive director of the Exploration and Production (E&P) business, also expressed disappointment in Shell's organic reserves replacement in 2004, which was estimated at 45-55%, excluding year-end pricing. Including year-end pricing, Shell's reserve replacement ratio was 30-40%, and including pricing and divestments, it was 15-25%.

Shell managed to hit the high end of its oil and gas production guidance in 4Q2004 of 3.8 MMboe, but the company still is not where it wants to be -- nor will it be this year. This year's production, said Brinded, "will be at the low point for production." He blamed the lack of reserve growth on projects that had not yet ramped up and noted Shell's decision to hire nearly 1,000 new E&P engineers.

Overall, all five of the reserves restatements will equal 1% of 2000-2004 earnings, according to Shell. However, to make up for the earnings and reserves shortfall, Brinded said the company is targeting 100% reserve replacement between 2004 and 2008, with stronger growth by 2009. Shell intends to "unlock 13 billion boe of resources by the end of 2009. We are now at the turning point, and we've taken all the steps to put the reserves issues behind us."

ExxonMobil Corp. reported its highest-ever fourth quarter last week, with net income of $8.42 billion ($1.30/share), including a special item of $2.23 billion to settle a long-running U.S. tax dispute. However, oil and natural gas production barely managed to break even globally, and in North America, output was substantially lower.

Revenues and other income for 4Q2004 totaled $83.3 billion, compared with $65.95 billion in 2003. Capital and exploration expenditures of $4.2 billion in the final quarter were down $127 million compared with 4Q2003. Full-year net income was $25.3 billion, up $3.8 billion over 2003.

Natural gas production worldwide decreased to 10.4 Bcf/d from 10.86 Bcf/d in 4Q2003. Worldwide, on an oil-equivalent basis, production decreased by 2% from 4Q2003. Excluding divestment and entitlement effects, production increased by 1%.

In the United States, 4Q gas production for sale fell to 1.8 Bcf/d, down from 2.038 Bcf/d in 4Q2003. For the year, gas production fell to 1.947 Bcf/d from 2.246 Bcf/d in 2003. In Canada, gas production reached 951 MMcf/d in 4Q2004, down from 994 MMcf/d in 4Q2003. For the year, Canadian gas production was actually higher at 972 MMcf/d from 943 MMcf/d.

For Unocal Corp., worldwide hydrocarbon liquids and natural gas production averaged 428,000 boe/d, slightly higher than the 420,000 boe reported in 4Q2003. However, natural gas production in the United States dropped to 470 MMcf/d from 566 MMcf/d in 4Q2003, and in Canada, output fell to 551 MMcf/d from 655 MMcf/d. Total liquids production worldwide fell to 69,000 bbl/d from 75,000 bbl/d in 4Q2003.

"Our earnings continue to be driven by strong crude oil and natural gas prices," said CEO Charles R. Williamson. "On top of that factor, we also saw an upturn in our international liquids and natural gas production that more than offset our North America declines on an oil-equivalent basis."

Williamson said, "Our primary focus in 2004 was development and moving contracts forward on previous discoveries," said Williamson. "We recorded major bookings in Bangladesh and the Caspian Sea as contracts were signed and development projects were approved. In addition, we added reserves from discoveries in Thailand, the Permian Basin and Canada."

Houston-based independent Swift Energy Co. said Tuesday that it increased its domestic oil and natural gas production 24% last year to 42 Bcfe, up from 33.8 Bcfe in 2003. The company's total production in 2004 rose 10% to 58.3 Bcfe, with 16.3 Bcfe produced in New Zealand.

Swift achieved the increases despite an announced slowdown in 2004 drilling activity in its largest domestic development at Lake Washington, LA. The slowdown was implemented to conduct a 3-D seismic survey and undertake facilities improvements.

Domestically, oil and gas production in the fourth quarter grew 28% compared with 4Q2003 and increased 11% sequentially from 3Q2004. New Zealand saw a 1% increase in production from 4Q2003, and a 23% sequential increase. Domestic reserves increased slightly to 653 Bcfe. compared with 644 Bcfe of domestic reserves in 2003, while Swift focused 63% of domestic drilling on proved undeveloped reserves.

Swift's 2004 year-end proved reserves totaled an estimated 800 Bcfe, a decrease of 3% from 2003 year-end estimate of 820 Bcfe. The reduction resulted in part from focusing the company's reduced drilling activity in Lake Washington on close-in proved undeveloped locations to optimize production in a high-price environment, but which also resulted in smaller additions to proved reserves.

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