Moody’s Investors Service on Wednesday downgraded the long-term debt ratings of the Royal Dutch/Shell Group of companies to “Aa1” from “Aaa,” following a review that began when the oil giant announced a 20% cut to its proven oil and gas reserves.

“The downgrades reflect the diminished prospects and positioning of Royal Dutch/Shell’s key upstream oil and gas operations relative to its highly rated peer group, as well as the organizational and cultural challenges manifested by the serious breaches in executive level oversight and governance,” said Moody’s analysts.

“A weaker fundamental upstream position is evidenced by the series of large petroleum reserve re-categorizations announced since January 2004. Since that time, some 4.35 billion boe in reserves, or more than 22% of the group’s proved reserves, have been ‘de-booked’ to bring its reporting practices in line with industry convention and, importantly, in compliance with Securities and Exchange Commission standards for proved reserves, which address the certainty and timing in which reserves will be developed and produced.”

Analysts said that Shell’s immediate cash flow impacts “are not substantial” in relation to its asset base and financial position. “However, the competitive pressures that drove senior management to book and report the hydrocarbons as proved reserves over an extended period of reflect more serious trends in declining reserve replacement, a shortening reserve life index, and understated costs, than had been readily apparent in the Group’s internal exploration and development efforts.”

The report noted that “while the entire petroleum industry faces similar reserve replacement and cost structure challenges, the results of the independent investigation to the Group Audit Committee (GAC) show that Royal Dutch/Shell took a more aggressive tack than its peers to demonstrate reserve growth and the potential for rising production in the face of large embedded production declines.”

Equally important, it said, the committee’s report “indicates a range of reporting and oversight flaws inconsistent with a highly rated entity, and raises major questions about Royal Dutch/Shell’s controls, reporting standards and corporate governance. Royal Dutch/Shell is taking significant and necessary remedial actions to address these reporting and governance shortcomings. While these efforts could be effective, considerable time and effort will be necessary to absorb the changes given the Group’s dual corporate and board structures and global operations, and to enhance its credibility in the financial community. Moreover, efficient, low-cost replacement of large volumes of oil and natural gas production will remain the Group’s central challenge.”

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