Shell Oil Reserves Revision - Sloppiness or Fraud?
Shell Oil Reserves Revision - Sloppiness or Fraud?
I have been following with a deep level of interest, and not a little
trepidation, the unfolding saga of re-categorizations by multibillion-dollar
Royal Dutch/Shell Group of Companies ("Shell") of its international oil and
gas reserves - petroleum that the company expects to extract commercially.
The saga has already resulted in the toppling (on March 3, 2004) of its
Chairman, Sir Phillip Watts and its Group Managing Director, Mr. Walter van
de Vijver; a tumbling of its stocks, and the filing of a $1 billion dollar
lawsuit in the US. Also in the United States, the powerful Securities &
Exchange Commission (SEC) has since upgraded its informal inquiry of Shell
to a formal non-public investigation. Other regulatory authorities such as
Autoriteit Financiele Markten (AFM) and Euronext of the Netherlands, and
Financial Services Authority (FSA) in the UK are also asking formal
questions of Shell over the affair.
Pardoning the pun, in a nutshell - and bomb-shell - it all began on Jan. 9,
2004, when, following an internal review of its reserves late last year,
Shell announced a 20 percent reduction in its recoverable hydrocarbon
reserves worldwide (see Figure 1), with the company assuring investors and
regulators that there is no difference in the volume of oil and gas in
place.
Naturally, that is assured by God Almighty Himself.
In fact, Shell re-categorized approximately 3.9 billion barrels of oil and
the natural gas equivalent, comprised of two thirds (2.7 billion barrels)
related to crude oil and natural gas liquids, and one third (1.2 billion boe
or roughly 7.2 trillion standard cubic feet ) related to natural gas, the
company's largest such step ever. More than 90 percent of the
re-categorization is a reduction in the "proved undeveloped" category, with
the remaining 10 percent in the "proved developed" category. The company
said in a press release that "most of these reserves will be re-booked in
the proved category over time as field developments mature."
To make matters worse, in the last few days, further cuts of 250 million
barrels for 2002 and of 220 million barrels planned for 2003 have been
announced, all when the review is only 40 per cent complete.
The catch in all of this is that much of the earlier re-categorized reserves
were in Australia and Nigeria; the latest round were in Norway. In fact,
confidential documents from late last year show Shell concluded that more
than 1.5 billion barrels - almost 40% of the re-categorization, and 67
percent of its 2.2 billion barrels of Nigerian reserves booked for the year
2002 alone (see further discussion on this one-year booking below) - did not
meet accounting standards for "proven reserves."
Yes, our dear Nigeria again, always in the news.
Nigeria is the world's seventh-largest oil exporter, and produces about two
million barrels a day, earning us over 80% of all government revenues,
90-95% of our export revenues, and over 90% of our foreign exchange
earnings. At the same time, it constitutes roughly 40% of our GDP. Nigeria
ships 40 percent of its oil exports to the United States, which constitutes
about 10% of U.S. oil imports, its fifth largest importer (after Saudi
Arabia, Mexico, Canada and Venezuela.) It has been clamoring for an increase
in its OPEC quota, which is partly based on reserve estimates. In fact, it
hopes to double its daily output to 4 million barrels by 2010.
So all of this news could be pretty serious stuff, if not properly
investigated.
Some "reserves" lingo
Taking a look at Figure 2, which outlines the terminologies used by the
Energy Information Administration (EIA) in the US for reserves, one will
find that all of this is a combination of technology and economics of oil
and gas.
Let us begin at the top of the figure, and assume that there is absolutely
no production yet, of either oil or gas. Only God knows the total oil and
gas resource base of the world and of any given country, and it is left for
Man in his adventuresome-ness and within the limits of technology and
economic feasibility - some will say greed - to try to find that out. In the
interim, only some of this oil and gas has been discovered in place, of
which only a fraction is ultimately economically feasible to recover.
It is this ultimately economically recoverable portion of the in-place
already-discovered oil and gas that is classified as either other unproved
reserves (with two subclasses: possible reserves, probable reserves) or
proven reserves (with two subclasses: cumulative production (by depletion of
proven reserves to date) and , the three categories being jointly called
"ultimate proved reserves." According to the Society of Petroleum Engineers
(SPE), World Petroleum Congress (WPC) and the American Association of
Petroleum Geologists (AAPG) "proved" reserves are the amount of oil and gas
believed to be recoverable with "reasonable certainty" (90 percent
probability), based on current economic conditions and technology;
"Probable" reserves indicate additional resources more likely to be
recovered than not (50 percent probability), while "possible" reserves are
less certain to be recovered (10 percent probability).
When geology/technology and economics jam probability and international
politics - with relatively scarce and critical commodities such as oil and
gas - uncertainty galore creeps in. In fact the EIA states that: "Reserve
estimates for crude oil and natural gas are very difficult to develop. As a
convenience to the public, EIA makes available these crude oil and natural
gas reserve estimates from other sources, but it does not certify these
data. Please carefully note the sources of the data when using and citing
estimates of crude oil and natural gas reserves."
Ironically, according to one Professor Kovarik of Radford University, the US
Department of Energy (DOE) does not use the US Geological Survey (USGS)
numbers for oil reserves, and when the former was asked, it had no comment.
The latter, a technical agency simply stated that it was not a "political
department!"
Summary so far: at one level of discussion, the total oil and gas resource
base of the world or any given country can be divided into undiscovered
resources, unproven reserves and proven ultimate reserves, with geology,
technology, and economics - as well as politics - determining which is which
at any given time.
Shell and Nigeria: Distilling the Figures
The temptation to divert here into the history of $hell in Nigeria and
elsewhere - the Brent Spar saga, conflicts in the Niger-Delta, particularly
with respect to the Ogoni and the death of Saro-Wiwa, etc. - is very strong,
but I shall resist it.
But let us calm down and try to estimate what all of this might really mean
to Nigeria.
According to the Oil and Gas Journal (published by Penwell Corporation), as
of January 1, 2003. Nigeria has 24 billion barrels of oil in "reserves," and
124 trillion cubic feet of gas (roughly 21.4 bbls of oil equivalent, at 5.8
tcf of gas per 1 bbl of oil). However, according to World Gas (Gulf
Publishing), those numbers are 32 bbls of oil and 178.5 tcf. of gas (roughly
30.8 bbls of oil equivalent). See for example these various quotes in
http://www.eia.doe.gov/emeu/iea/table81.html. Some 1993 estimates for the
various categories outlined in Figure 2 for Nigeria and several other
countries are given in a USGS table:
http://energy.er.usgs.gov/products/papers/WPC/14/table1.htm.
These estimates are significantly different from each other to question the
legitimacy of any of the numbers.
Now Shell reportedly has half of these proven reserves, whichever figure is
"correct." Let us use, for definiteness, 24 bbls of oil and 124 tcf of gas
(21.4 billion boe). Even though Shell has not disclosed the full
recategorization data for Nigeria - purportedly fearing ongoing litigation
and potential damage to Nigeria's request for increased quota from OPEC, not
to talk of risk of losing some of the reported $385 million bonus to Shell
for finding new reserves (!?) - let us assume that for Nigeria's
re-categorized 1.5 billion barrels:
(i) All were oil. This would amount to a 6.25% downgrade in oil reserves for
Nigeria - or 12.5% of Shell's oil reserves for Nigeria. (ii) All were gas.
That would amount to a 7.0% downgrade in gas reserves for Nigeria - or 14%
of Shell's total gas reserves for Nigeria. (iii) All were two-third oil and
one-third gas, to follow the international trend of Shell's
re-categorization. This would amount to 4.2% downgrade in proven oil
reserves and and 4.7% downgrade in proven gas reserves for Nigeria. (iv) An
undefined re-categorization: 1.5 barrels out of 45.4 boe corresponds to a
3.3% downgrade of total Nigerian reserves and 6.6% of Shell's.
In short, however way we dice it, we are talking about a 3.3 - 7.0%
downgrading in our total proven reserves - or 6.6 - 12.5% of Shell's proven
reserves in Nigeria
By themselves, these figures for downgrades would be serious, but they are
made more serious because they are for the year 2002 ALONE and for just one
company, if my reading of the rather difficult-to-read news is correct. Note
in particular the following passage from Friday March 19, 2004 International
Herald Tribune report on the matter (note the emboldened portions): "But the
company continues to conceal the extent of its problems in Nigeria, the
country with the largest reserve restatement, to avoid endangering its
partnership. Shell operates the largest joint venture with the Nigerian
government. Confidential company documents late last year show that more
than 1.5 billion barrels, or 60 percent of Shell's earlier estimate of
proven Nigerian reserves, were not fully compliant with accounting rules and
company guidelines...
"So far Shell has not released a country breakdown of its reserve
restatements, but it told oil industry analysts last month that Nigeria and
Australia were the two largest. Company documents show that Shell's senior
managers were told in December that 720 million barrels in Nigeria were
non-compliant with SEC guidelines and an additional 814 million barrels were
potentially noncompliant. At the end of 2002 Shell booked 2.524 billion
barrels of proven reserves for Nigeria, but after internal reviews and a
tightening of company guidelines, the December report said only 990 million
barrels fully complies with current Shell guidelines.
"Reserves are a key input in quota discussions, the report says, and since
Shell's portion of Nigeria's reserves constitutes about 50 percent of total
country reserves, an external disclosure indicating that estimates have been
overstated could negatively impact the government's position. An OPEC
spokesman said Thursday that a team from OPEC's secretariat visited Nigeria
last month and that the organization would discuss a new formula for
determining quotas this year. Proven reserves, the spokesman said, were part
of the quota calculation. Oil yields 90 percent of Nigeria's export revenue,
and a doubling of its production could mean tens of billion dollars in extra
annual income."
Thus except one reads the news very carefully, it would appear that the 1.5
billion barrels were re-categorizations of ALL proven Shell reserves, rather
than for just the one year 2002. That is not so, after noting that 720 + 814
million barrels = 1.5214 billion, which is 60% of 2.524 billion of 2002's
booked reserves; which reserves is quite much less than the 50% of Nigeria's
total reserve which Shell is reported to have above.
There you have it.
The Bottom Line
In the oil and gas business - and one would say in general mining industry,
there are standard cautions for reserves which are widely known, namely:
"Proved reserves can be found as the 'on the books' reserves in operational
and financial data of natural gas exploration and production companies,
carrying with them economic implications for the company. These companies
have economic incentives to not overstate these 'on the books' estimations
of their reserves as this classification carries with it a high degree of
certainty. In order to not overstate the actual amount of natural gas (and
suffer the potential financial side effects of such an overstatement or
miscalculation), many companies list a high percentage of their reserves as
unproven. It follows then that most of the natural gas that exists in the
United States does not fall under the proven reserves classification. It may
be misleading, then, to look only at levels of proved reserves as an
indication of how much natural gas there really is. Instead, the entire
supply picture should be examined, including conventional and unconventional
natural gas, discovered and undiscovered, and economically recoverable or
unrecoverable".
Bearing in mind that there are different ways of defining and calculating
reserves and resources, which vary between companies, between countries and
even within organizations of a given country, one does not know whether this
Shell re-categorization was one of genuine technological uncertainty,
administrative sloppiness or outright fraud.
The bottom line here is that we in Nigeria do not know what the full
re-categorization figures might be for 2003, 2002, 2001, 2000, etc., bearing
in mind that only 40% check has been done so far. We do not know whether or
when any or all of them will be ultimately re-booked. We do not know how
this will affect Nigeria's aim to increase its OPEC quota - or whether it is
even wise to do so at this time and thereby possibly mortgage future
generations' access to the oil, bearing in mind the danger of
over-production from a reduced proven reserve.
What we do know are that: (1) all agents here must come clean - the Nigerian
government, and not only Shell, but ChevronTexaco, MobilExxon, Agip,
TotalFinaElf, BP, and other oil companies - about this particular
re-categorization and possibly others, for the country to determine the true
extent of its impact. No ands, ifs or buts, no hiding behind fingers, no
denials before facts are in. If the regulatory authorities SEC of the US,
AFM and Euronext of the Netherlands, and FSA in the UK are all asking formal
questions of Shell over this affair, who is doing so in Nigeria? NNPC? NSA?
NSO? SSS? MOF? OBJ? Rather what we have read so far is either silence or one
brazen statement from a state apparatchik that our reserves remain exactly
as Shell quoted them - prior to re-categorizations!
The use of a battery of independent auditors - some indigenous, hopefully
patriotic to Nigeria, with unimpeachable integrity - is strongly recommended
here. This recommendation definitely in line with the recent Extractive
Industries Transparency Initiative (EITI), which enjoins companies to
increase transparency over payments to governments and government-linked
entities, as well as transparency over revenues by those host country
governments. For example, what figures were used to determine Joint Venture
(JV) and Production Sharing Contracts (PSC) demands made by Shell and other
companies, and paid by the Nigerian government? What about the "finders"
bonuses reportedly paid out to Shell and possibly other oil companies to
encourage them over reported new reserves?
(2) there is a serious need to quickly come to agreement about common
international standards for defining reserves, as being currently canvassed
by the United Nations Framework Classification for World Petroleum
Resources.
(3) while Nigeria continues with its monoculture of oil and gas - roughly
40% of our GDP, 80% of all government revenues, 90-95% of our export
revenues, and over 90% of our foreign exchange earnings - our country will
continue to be haunted by upheavals like this one, over which it has
absolutely no control. Not only is our financial situation impacted, already
Shell is announcing a possible 1,000-employee cut in Nigeria - 20% of its
workforce - which may or may not be related.
Even under our civilian democracy, bromides apart, our government has not
come to grips with these realities, and if it has, its policies do not
indicate an appreciation of its effects. In fact, ongoing 2004 budgetary
machinations, already three months late into the new year, center around
what price of oil to base revenue calculations on: $23 or $25 per barrel.
