The world’s oil companies were already double-checking their books before Royal Dutch/Shell Group sent the industry into a tizzy this month by reducing the stated amounts of its proven reserves by almost 4 billion barrels of oil and natural gas. That’s 20% of its total.
The stock market’s reaction was swift. In the week that followed, the shares of Netherlands-based Royal Dutch Petroleum Co. and Britain-based Shell Transport & Trading, which make up the world’s second-largest petroleum firm, tumbled 11%.
But the effect on the oil industry — and on the world’s pocketbook — won’t stop there.
Thanks in part to the Shell hullabaloo, regulators are stepping up their scrutiny of other companies’ oil reserves — and that may lead to more downward revisions. Because the production schedules of oil firms are directly tied to their reserves, these changes are sure to exert an upward pressure on market prices.
Simply put, every change in reserves recalibrates the supply side of the supply-demand equation. And that’s an unpleasant prospect in a world already burdened by oil that goes for more than $30 a barrel and natural gas that is fetching more than $6 per thousand cubic feet.
For petroleum firms, reserves amount to nothing less than “the value of the company,” says Ronald Harrell, chairman of Ryder Scott Co., a Houston petroleum engineering firm.
“All companies today are taking a hard look at their reserves,” Harrell notes, as much because of the requirements of the Sarbanes- Oxley corporate governance law as questions arising from Shell’s cutback.
Yet for something so important, there is a great variability in measurement.
The price of oil can raise or lower reserve levels, for example, because deposits producible at one price might not be producible at another. Like so much else in business that seems on its face to be a matter of hard data, reserves are in reality a matter of judgment.
Of all companies, Exxon Mobil Corp. has the most conservative policy on reserves, according to a report by Deutsche Bank. The Irving, Texas, giant does not list them as “proven” until funds are allocated to an oil and gas project.
ChevronTexaco Corp., which was involved in a Shell project in Australia but did not list the deposits as “proven,” also takes a more cautious approach. Since Chevron married Texaco in 2001, the San Ramon, Calif.-based company has switched some of Texaco’s reserves from proven to “probable,” indicating that timely production is less certain.
For all of Shell’s relative looseness in counting its reserves, one thing should be made clear: Its actions are not akin to those of Enron Corp. or Parmalat. No oil and gas — or billions of dollars from corporate coffers — have gone “missing.”
The reserve reduction came from a reassessment of estimates made by Shell’s regional managers dating to 1997. Their job was to figure out what the company could produce at certain costs, and in a given amount of time, from projects in Australia, Nigeria and other nations in Africa and in Asia.
Those estimates proved to be overly optimistic. But the company, with dual headquarters in The Hague and London, didn’t correct them until it consolidated operations in recent years and took a fresh look at the numbers. One impetus for its restatement was a Securities and Exchange Commission review of regulations covering oil and gas reserves.
In the end, experts say, private-sector companies such as Shell may not be the worst offenders when it comes to taking too rosy a view of oil reserves. Increasingly, questions are arising about the reserve levels claimed by government-controlled energy companies, including those in the Organization of the Petroleum Exporting Countries.
In the 1980s, “OPEC countries simply raised their reserve levels arbitrarily,” says Matthew Simmons of Simmons & Co, a Houston investment bank. Saudi Arabia, for example, raised its reserves from 175 billion barrels to 261 billion barrels.
“But I haven’t seen any rise in production,” Simmons says. “How much is really there?”
Cambridge Energy Research Associates, a consulting firm, lists Iraq with 112 billion barrels of reserves. But there are many doubts about how much can actually be developed. The country’s oil fields, damaged by years of Saddam Hussein’s misrule, are capable today of producing fewer than 1 billion barrels a year. That would reflect a reserve level of fewer than 20 billion barrels.
As one oil expert says, “Who would you trust to evaluate reserves, a major company’s petroleum engineer or Saddam Hussein?”
These days, that might actually be a tossup.