Royal Dutch/Shell Group's disclosure that it overstated its proven reserves by 20 per cent rattled energy investors and is raising questions about whether the oil industry as a whole has inflated its prospects.
Shell, one of the world's largest publicly traded oil concerns, said on Friday that it had erroneously overbooked its proven oil and natural gas reserves by the equivalent of 3.9 billion barrels of oil.
The oil portion alone, about two-thirds of the revision, represents some $US67.5 billion in potential future revenue, assuming moderate oil prices of $US25 a barrel. Reserve calculations, though technical and arcane, drive an oil company's prospects, much like revenue growth drives a technology company's outlook.
Shell officials said engineers acted "in good faith" in booking the reserves. But the disclosure comes as the US Securities and Exchange Commission has intensified its scrutiny of oil company reserves, prompting concerns that others may follow Shell's lead.
The SEC's petroleum engineers, charged with investigating reserve calculations, have focused on how companies book properties in costly deepwater fields in the Gulf of Mexico, where some companies have used less traditional measures to assess how much oil and gas can be extracted. Deepwater fields in the Gulf and off the coast of Africa are among the world's hottest oil spots as new reserves become harder to find.
ExxonMobil, the world's largest listed oil company, said it had received routine inquiries about reserves but declined to elaborate. "Certainly the entire industry has been feeling an increased level of scrutiny when it comes to reserves," spokesman Tom Cirigliano said.
BP said it also received routine questions last year, including some concerning reserve valuation, after it filed its 2002 annual report.
But ExxonMobil and BP did not expect to reclassify reserves.
Reserves are at the heart of an oil and gas company because they represent what can be taken from the ground in the future. Since companies must replace the oil and gas they produce each year just to stay even, reserve growth is a crucial indicator of how well a company is doing. If the reserve size falls, the company is less valuable to investors and its stock price will tumble.
At the least, Shell was more aggressive in booking reserves than some of its peers. In the Gorgon field, off Western Australia, for instance, Shell is a partner in a project to produce liquefied natural gas.
Shell booked an unspecified amount of proven reserves there. But other partners didn't book reserves. For example, ChevronTexaco, was more cautious, saying it didn't book reserves even though it had already lined up customers.
Shell said it started booking Gorgon reserves in 1997 based on letters of intent for gas sales and internal development timetables, which later didn't pan out. Shell said its discovery came amid regular internal reviews.
Managers also were looking at ways to more quickly develop untapped proven reserves, said Simon Henry, Shell's head of investor relations. At the same time, Shell last spring began to centralise far-flung exploration units, which had operated with a fair degree of independence.
Shell's disclosure has larger significance for the trillion-dollar global oil industry, which has struggled for decades with the murky science of estimating reserves. Though the SEC provides some guidance, companies are required to show only "reasonable certainty" in classifying proven reserves.
Regulators cracked down on energy companies in the 1970s when it appeared they were being cavalier with their disclosures. In industry forums recently, SEC engineers have cited red flags that could prompt closer examination, such as reserves booked in nations where the government had not yet blessed the project.
But ultimately companies must make their own geological and financial assumptions in calculating reserves, giving them considerable leeway. The SEC doesn't require third-party certification of a company's reserves.
"There's still room for interpretation," said Dan Olds, a petroleum engineer with Ryder Scott Co in Houston.
Recently, Shell has fared poorly against its two closest competitors, ExxonMobil and BP, in reserve replacement, triggering sharp criticism of Philip Watts, Shell's chairman.
Because of Shell's disappointing results, Sir Philip has been under fire almost since taking the top Shell job in 2001. Investors and analysts also fault him for poor communication. He was absent from a conference call Friday explaining the reserve issue, though Shell officials said that was because the company is in a "closed," or quiet, period before releasing year-end earnings.
The reserve issue has reignited questions about Sir Philip's future, especially since he led Shell's exploration business for much of the period that it overbooked reserves.
The size of the overstatement has also raised the prospect of more regulatory scrutiny of Shell, including possible SEC enforcement action. An SEC spokesman declined to comment on the Shell reclassification or say whether it was looking at reserve issues at Shell or any other oil company.
But Lynn Turner, a former SEC chief accountant, said the revision looked like more than a mistake.
"A 20 per cent restatement of proven reserves is a humungous error," he said. "For a company like Shell to have missed its proven reserves by that much is not an oversight. It's an intentional misapplication of the SEC's rules."
A Shell spokesman said that judgement had to be used in assessing reserves and that employees believed they were working within SEC guidelines. He said it would be inappropriate to comment about further regulatory scrutiny, but said, "as you would expect, we have been in communication with the SEC".