Royal Dutch/Shell Group has dropped its position that it acted in “good faith” with the Securities and Exchange Commission (SEC) following news that the former chairman may have known about the overbooking of oil and gas reserves as long as two years ago.
A Shell spokesman said the company now says that “judgments were made in the past that would not be made today.”
The statement followed the resignation last week of Sir Philip Watts, chairman of the joint Shell Group’s managing directors, who was ousted along with the exploration and production (E&P) chief amid an ongoing SEC investigation and investor pressure (see Daily GPI, March 4).
According to a report in Monday’s Wall Street Journal, Watts was warned of possible overstatements to Shell’s reserves up to two years ago. The newspaper said that a memo, circulated to Watts and other senior executives in 2002 by an undisclosed employee, warned that Shell’s method of booking reserves appeared to be inconsistent with SEC guidelines. Sources said that the memo indicated then that Shell might have to revise downward its reserves by about 1 billion boe. In January, Shell cut its reserve total by 20%, or about 3.9 billion boe.
According to the Journal, Shell’s audit committee briefed directors recently about preliminary findings concerning the reserve revisions. The committee found a “trail of communications” that indicate Watts may have known about “longstanding internal questions over the validity of its reserves bookings.”
The committee apparently also found fault with Walter van de Vijver, who had headed Shell’s E&P unit who also resigned last week. According to the committee, internal communications in early 2002 and “throughout last year” indicated van de Vijver brought the reserve problem to the attention of Watts to figure out how to correct it. “He didn’t bring it to the attention of the right people,” sources told the Journal.
If the sources are correct, the audit findings would contradict Shell’s assertions that it acted quickly to disclose problems and that the company acted in “good faith,” as Watts maintained in correspondence with the SEC and employees (see Daily GPI, Jan. 22; Jan. 12).
In a letter to Shell employees in mid-January, Watts said, “The scope and timing of our announcement were determined by compliance with regulatory requirements on disclosure. We released the information at the earliest possible time after the recategorized reserves had been quantified with some certainty.”
He wrote that during the fourth quarter of 2003, “in-depth reserves studies were completed that triggered a broad review of our previously booked proved reserves. These studies and reviews indicated that the proved reserves disclosed did not in all cases properly reflect the maturity of the development projects concerned, accounting for a significant proportion of the recategorization. Hence the need for immediate action.”
Last year, Shell centralized its global E&P operations, consolidating about 35 upstream businesses into five geographic centers (see Daily GPI, March 27, 2003). Each of the units has a senior technical manager who is responsible for booking reserve additions, which then are reviewed by directors of the E&P unit. Annual reserve statements are reviewed and approved by Shell’s audit committee, followed by the group’s committee of managing directors. Its outside financial auditors, KPMG and PricewaterhouseCoopers are not required to sign off on the reserve statements.
The SEC provides specific guidance on booking reserves, and the rules only require “reasonable certainty,” which allows companies to use some assumptions. The SEC also does not require third-party verification, and most of the majors use internal staff to audit reserves.
According to the Journal, some Shell executives had a small incentive to boost reserves. The newspaper said some senior Shell managers are awarded year-end bonuses based on a companywide “scorecard” system, which rates the company’s performance on several metrics, including financial targets. Nearly 2% of the review is directly related to reserve additions, according to Shell.
Shell has hired New York-based Debevoise & Plimpton, a securities law firm, to represent it before the SEC. Shell representatives also have met with SEC investigators in Fort Worth to discuss the probe, but the SEC would not comment on the investigation.
In another action, Houston-based El Paso Corp. apparently is exchanging information with the Securities and Exchange Commission (SEC) about its 41% reserves reduction, which was announced in February. El Paso reduced its reserve base as of the end of 2003 to 2.64 Tcfe from 4.46 Tcfe following an independent audit (see Daily GPI, Feb. 18). It also warned last month that the changes would result in a write-down of at least $1 billion as a non-cash charge against 4Q2003 earnings. No formal investigation has been announced, and the SEC had no comment.
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