Shell Cuts Proven Oil Reserves: Some Observations

On the 9th of January 2004, The Royal/Dutch Shell Group of companies announced to a shocked world that it was reducing its estimates of proven petroleum reserves by a whopping 20%. This meant as much as 3.9 billion barrels of hydrocarbons were to be reclassified as “scope for recovery.” Of this amount two thirds (2.7 billion barrels) relates to crude oil and associated gas while the other third (1.2 billion boe or 7.2 trillion standard cubic feet) is in respect of natural gas. From the company’s statement, the reclassification covered the period from 1996-2002 and the countries most affected were Nigeria and Australia, both countries accounting for about half of the amount being reclassified.

The news was shocking and serious enough to send ripples through the energy market, bringing Shell’s share prices tumbling by as much as 7% in one day, as well as affecting the share prices of other major companies such as Exxon Mobil and Chevron. Shareholders called for the head of the Group’s Chairman Phillips Watts (who has so far survived having refused to resign), and have already filed a Shareholder Class Action against the Royal Dutch/Shell Group. There are also indications that the United States Securities and Exchange Commission (SEC) may investigate the circumstances leading to the “error” by the Shell group.

Ordinarily, errors of judgement (due to estimation problems, lack of standardized categorisation, subtleties of definitions, etc.) leading to reclassifications or re-categorisation of reserves are nothing new in the industry. However, Shell’s announcement was unique because of the scale of the cut back, especially by a company of Shell’s stature with over 100 years experience in the industry. Although there are as yet no outright accusations of wrongdoing, eyebrows are being raised as reflected by the reaction of Lynn Turner, a former SEC chief accountant who believes an error of this magnitude by Shell is a “humongous error”. For a world already worried about issues regarding security of supply of oil, concerns are being expressed about the wider question of how much more such errors exist. This concern already appears justified as another major gas pipeline company, El Paso, has also recently cut its proven natural gas reserves by a whopping 41%, (1.82 trillion cubic feet). That company has already hired a firm to examine the cause of the reduction.

It was apparent to any casual observer of trends in the oil industry, that Shell’s announcement is a considerable blow to Nigeria for very obvious reasons. It is no secret that the Nigerian economy depends almost wholly on revenue from oil exports. Being a member of OPEC, Nigeria’s production quota, which stands at about 2 million barrels per day, is closely linked to the amount of proven reserves. In order to apply for increased quota and boost its revenue from oil, Nigeria has over the years sought to increase its proven reserves, with a target of 40 billion barrels by 2010. Only in December 2003, the director of DPR, Macaulay Ofurhie proudly announced that the nation’s proven reserves stood at 34 billion barrels, well ahead of expectations and was consequently optimistic that the 40 billion barrels target by 2010 could be achieved. While not all analysts are convinced that increased production is the way to go, the new categorisation sets the government back by at least 1 billion barrels.

More pressing for today is the implications of this news for continued production at current levels. Reserves are the lifeblood of the industry as production levels can only be maintained if new reserves are found to replace dying out fields already in production. According to a 2001 British Petroleum (BP) Report, Nigeria’s crude reserves (based on an estimate of untapped proven reserves of 22 billion barrels) would be exhausted in 29 years at current levels of production. Of course with increases in proven reserves, that was no longer in issue and all things being equal, Nigeria could afford to continue depending solely on oil for several more years. Crucially however, significant increases in Nigeria’s proven reserves occurred at the same time as the period under review by Shell, with reserves leaping from 20.8 billion barrels in 1996 to 31.5 billion barrels in 2002.

In light of the above, it was not an unreasonable expectation that Nigerians deserved prompt and clear explanations from both the Nigerian government and its regulatory agency DPR on the one hand, and from Shell Nigeria on the other hand. More importantly, one expected DPR to investigate exactly what had happened.

It was therefore intriguing, to say the least, that Chris Finlayson, the General Manager Shell Petroleum Development Company, Nigeria (Shell, Nigeria) a subsidiary of the Royal/Dutch Group is reported to have declared that “the reserves volumes reported by Shell Companies in Nigeria (SCiN) to their regulator, the Department of Petroleum Resources [DPR] under the Nigerian Standard are unaffected by these changes” (Vanguard, January 20th, 2004). While there is no standardized approach for categorising proven fields, there is no question that the fields are one and the same, irrespective of whether they are filed in Nigeria or the US. Categorising a field is largely a matter of scientific judgment and Nigeria till date still has recourse to international standards as far as oilfield practice and operations are concerned. Moreover, the oil industry is an international one and it is dubious to claim that reserves which have been re-categorised by the company at the international level could still remain on Nigeria’s records. Would the world and indeed OPEC accept as proven by Nigeria, reserves which the parent company had declared not to be so? The unconvincing explanation and offhand dismissal of the issue by none other than the chief executive of Shell Nigeria, while not surprising, epitomises the attitude of Shell towards its host country, an attitude not displayed by his Chairman, Phillip Watts towards Shell’s shareholders when following shareholders’ criticism, he apologised for not being present at the announcement of the re-categorisation, an issue they felt was serious enough to warrant his presence.

Even more shocking, if true, is the statement attributed to an unnamed senior official of DPR by the same paper that nothing was being done yet by the regulatory body because “[We] have not received any information from Shell in Nigeria to the contrary and we cannot act based on news reports from the media.” It beggars belief that a senior official of a regulatory body in charge of an industry as sensitive as the oil sector is to Nigeria would treat a report of this magnitude with such callousness and await information from Shell before it can act. Should a regulatory body, no matter how inefficient or incapable, not be proactive under such circumstances?

Curious also was the government’s apparent silence over the matter. Curious because even though DPR’s capability and efficiency as far as regulating the oil industry (particularly regarding environmental issues), has always been questionable, the government has never shied away from its responsibility to do whatever is necessary to protect revenue from oil. Anyone in doubt of this merely needs to recall or pay a visit to Odi, when in order to flush out a few “restive, criminal and murderous” youths threatening oil production, an entire village was destroyed with the might of the army. Since it is not conceivable that government’s commitment is targeted only at its citizens, one expected at least a reassurance to the citizenry and setting up some form of enquiries, even if it is only one of those whose reports rarely see the light of day.

Unfolding events however indicates that there is nothing curious about all the reactions at all and that perhaps the ever present Nigeria factor could be at play yet again. First the BBC (online, 2nd February, 2004) quoting the well respected Financial Times, reports that the Nigerian government claims that it was a reassessment of its oilfields that led to Shell’s reassessment of its proven reserves and that contrary to the initial statement by the Royal/Dutch group, Nigeria alone accounts for at least a third of the cut proven reserves. In other words, Nigeria could be set back by as much as 3 billion barrels or more. It is claimed the reassessment follows a row regarding funding of the integrated gas and oil development to meet its target of no flare by 2010. Apparently the Nigerian government has failed to contribute its share of the funding of the project which is more capital intensive than an ordinary oil development project.

The official stand, according to the BBC report, is that at least half of these reserves could be placed back in the proven reserves category within five years. The question then is why only half when the chief executive of Shell says it does not affect Nigeria’s reserves? Why only half if it is merely a matter of funding? Furthermore, why is the government recovering tax breaks granted Shell during the period, especially if the cause of the reassessment is as a result of Nigeria’s fault? (FT.com February 3, 2004 reports that Royal Dutch/Shell and Nigeria are close to settling a dispute over tax breaks that the government wants leading oil multinationals to repay after they allegedly overestimated their reserves). More importantly, why were these revelations not a part of the initial Shell Group statement? After all, it is no secret that the Nigerian government routinely fails to meet its cash call obligations.

Apparently, good old mammon, not science may explain some of these curiosities. It has come to light that during the 1990s there was real competition for reserves booking by oil companies including Shell in order to receive incentive payments from the Nigerian Government in return for booking oil and gas reserves in the country, a fact that Shell had failed to inform shareholders and US regulators about. (The Independent, February 3, 2004). The paper quotes a Shell spokesperson as saying “[E]veryone got carried away in the gold rush… Some of these reserves were not only not provable, but not realisable.” Incidentally, Phillip Watts, the current Chairman of the Shell group was the chief executive of Shell Nigeria at the time. Could recollections of happenings in Nigeria at the time been a little unsettling? One wonders.

Luckily, the paper reports that the President Obasanjo administration put a stop to the incentives payment. Although from indications over reserves booked in Australia, it appears that Shell is in more of a hurry than other companies to file reserves as proven, nevertheless, there is an urgent need for the government to ensure that bookings made by other companies over the same period are safe. Moreover, this strengthens the case for more effective regulation of the oil industry as government cannot afford such horrendous gaffes in a matter as sensitive to the national economy as oil reserves.

Engobo Emeseh
eemeseh@yahoo.co.uk