Royal/Dutch Shell Group hopes that by sacking three senior executives and publishing a summary of an investigation by an outside law firm, it can pull the curtain down on the scandal over the downgrading of its reserves. But senior management and the board of the world's third-largest oil company may be engaging in wishful thinking. So many questions remain that it is difficult to see how a reshuffled management team will be able to improve Shell's lackluster performance.
The Apr. 19 report by New York law firm Davis, Polk & Wardwell paints a devastating portrait of Shell as a dysfunctional company where the top two executives, Chairman Philip Watts and head of exploration and production Walter van de Vijyer, were on increasingly hostile terms. Excerpts from e-mails and memos, mostly from van de Vijyer, also show that Shell failed to come clean with investors despite internal discussion for a year or more that oil reserves, a crucial measure for valuation, had been overstated. Shell has now announced three downgrades of its reserves by 4.45 billion barrels, almost 24%. The Securities & Exchange Commission is investigating the circumstances of the changes in reserves.
The antagonism between Watts and van de Vijyer must have been hard to ignore. "I am becoming sick and tired of lying about the extent of our reserves issues and the downward revisions that need to be done," van de Vijyer wrote to Watts in November, 2003, after a critical performance review. Yet, Davis, Polk surmises, van de Vijyer's team chose to "play for time," hoping that Shell could discover its way out of the reserves shortfall, rather than take these concerns to the board.
Van de Vijyer's anguished memos make clear just why Shell was motivated to overstate reserves: The company was much less proficient at finding and developing new oil and gas fields than the outside world realized. "We are struggling on all key criteria," he wrote in September, 2002. He was right. Shell's production is beginning to decline, and its key reserve replacement ratios trail other majors such as Exxon Mobil (XOM) and BP (BP). Competitors say a key reason Shell has come up short in finding oil is it has spread too wide a net. "Their returns are not as high as they would have been if they had focused," says an oil executive.
The company has certainly learned some lessons. The previously lax system of booking reserves has been tightened up. Along with van de Vijyer, Watts is gone, and Chief Financial Officer Judy Boynton, whose area Davis, Polk criticized as "not effective" in terms of "compliance," has been removed from her post -- although she remains on the staff. But Shell has so far given investors meager reason to think that major changes are on the way. Watts's successor, Jeroen van der Veer, who was president of the Dutch arm, Royal Dutch Petroleum, is respected inside Shell, but may not be a strong enough personality to shake up the company. As a chemicals specialist, he may also lack the knowhow to energize the exploration and production business, Shell's major trouble spot.
Investors hope that the recent changes are just the beginning of a thorough company overhaul. Both senior management and nonexecutive directors appear to have failed to do their jobs. Some investors blame the company's dual Anglo Dutch ownership and board structure, which is widely viewed as hampering decision-making and accountability. "In our view the overall failure of the reserves reporting control system implicates more than those who have already departed, particularly the nonexecutives whose role is to protect shareholders' interests," Lehman Brothers Inc. (LEH) says in a recent report. Huge doubts in the industry also remain about whether Shell's corporate culture can deliver results in exploration.
Finding new oil will take years. But there are a few things Shell could do right now to improve performance. The exploration division should bring in new blood from outside. The two boards should move quickly to find a successor to the 56-year-old van der Veer, who looks like a caretaker. Finally, the boards need to take a harsh look at their own performance. A review of Shell's ownership structure is already underway. Let's hope it leads to replacement of the sleepy current boards with one slimmed-down group prepared to take responsibility for reviving this once-great company. By Stanley Reed