Monday, January 19, 2004

Shell’s shocking reserve

To understand the current brouhaha over Shell’s announcement of its decision to slash its estimates of proven oil reserves by 20% (which knocked 7% or $7.8Billion off its market value and has seen a clamour in the media for the resignation of Shell’s chairman Sir Philip Watts) you need to be aware of the Shell Group’s corporate culture.

One of the criticisms often levelled at the multinational oil majors (and it is certainly true of Shell) is that they desperately seek certainties to help them in their decision making. It is ironic that in an industry which at its heart has to wrestle daily with uncertainty (in the operational search for oil and gas) when it comes to looking at investment proposals they like to have the confidence that prospective capital programmes will produce adequate earning powers and clear their predetermined “hurdle rates”. Shell has sometimes been accused of being risk averse and of leaving earnings uninvested rather than allocating them to projects where uncertainties exist - and it is true that a bias towards prudent governance lies of the heart of Shell’s culture. This is characterised by a preference, in recent years, for share “buy backs” rather than capital investments or acquisitions but also by an almost Calvinistic seeking for truth and assurance rather than speculation and risk.

The announcement of the reduction in Shell’s reserves was, so Shell claims, driven primarily by its wish to comply with United States Securities and Exchange Commission (USSEC) rules rather than because the physical reality of their hydrocarbon reserves has changed. Indeed Shell’s media statement says “The recategorisation of proved reserves does not materially change the estimated total volume of hydrocarbons in place, nor the volumes that are expected ultimately to be recovered. It is anticipated that most of these reserves will be re-booked in the proved category over time as field developments mature”. In other words “We don’t really think that we have less oil and gas than we used to say we had - we just think that we have to say so to comply with USSEC rules”. Lewis Carroll would have been happy with this – it’s pure “Alice in Wonderland”!

To understand why the whole subject is so arcane and unfathomable to the layman we need to recognize what oil and gas “reserves” are – and what they are not. The proven reserves of any oil or gas field are those which can be recovered in the future under today’s economic and operating conditions. As production from a field progresses a flow of data allows a continuous re-assessment of recoverable reserves to be made. This often leads to a situation in which the declarations of the proven reserves of oil in a field trend upwards over time, in spite of the on-going extraction of oil in the production process. Historically oil companies have been extremely conservative in talking about reserves and in almost all cases the amount of hydrocarbons produced from a field or a region far exceed original estimates. This is partly because the science of forecasting is uncertain but also because, over time, both the technological and the commercial circumstances change. Technological innovation allows more oil or gas to be extracted than originally thought and also a higher world oil price may make some fields economic when they were not at a lower price. At the micro level (i.e. in respect of particular concessions) companies have been know to play down the reserve estimates deliberately to put off their competitors from bidding for adjoining concessions close to the field.

So to estimate reserves at any one time with absolute accuracy you need wholly reliable geological data (which is hard to obtain); knowledge of not just current but future technologies (which are by definition unpredictable)and confidence about economic and political changes over the lifetime of a field (often twenty years or more) which you certainly cannot have. This is not to say that you should not try to make forecasts and it is reasonable that reserve levels are seen as one of the key indicators of an oil company’s health. But the search for reserves as the principal driver of an oil company’s daily behaviour can be hazardous if it takes the eye off the ball of managing existing assets and activities profitably. In managing what you have at any one time you are largely dealing with certainty. In focussing on the pursuit of reserves to the exclusion of much else you are much more in the realms of fantasy.

Shell’s announcement is a direct consequence of their current bias towards openness and disclosure. Wounded by the criticism they received in the 1990s over the Brent Spar disposal and over their activities in Nigeria (amongst other things) Shell instituted a comprehensive programme of public consultation and greater disclosure. As Sir Philip Watts said in a speech to KPMG Global Energy Conference in Houston last year
“In Shell we believe that being trusted is essential both for securing our future and for opening new opportunities, in a world that is increasingly demanding and uncertain. We will continue working very hard to earn that trust.” The announcement over reserves can be seen at least partly in the context of this commitment. It can be contrasted with ExxonMobil’s statement that “We have never had to do anything like this [reclassifying reserves] …in the past, and we would not expect to have to do anything like this in the future.” Now you can believe that the reason for ExxonMobil saying that they are different is because their reserves estimating process is better than that of Shell however this is unlikely to be the case. The reality is that ExxonMobil is more ready to acknowledge the uncertainties associated with reserves estimation and that their management, better than Shell’s, realises that to push this issue to the front of the discussions about their company’s competence and performance would be a self destructive thing to do for no material benefit (other than, perhaps, spuriously enhancing their reputation for honesty).

The Saatchi way with words...

The Saatchi way with words

The universal rejoicing amongst Conservatives when Michael Howard assumed the leadership was almost immediately tempered, for some, when he announced that Maurice Saatchi was to be a joint Chairman of the Party. The fears that the arrival of Lord Saatchi, that most brilliant but flawed of communicators, would lead to a predilection for presentation over substance have all too soon been born out by the publication of the clearly Saatchi inspired “personal credo and core beliefs” issued by Michael Howard.

Students of the extraordinary story of how the two Saatchi brothers created and then destroyed the Saatchi and Saatchi advertising empire are referred to two authoritative works on the subject - Kevin Goldman’s “Conflicting Accounts” and Ivan Fallon’s earlier “The Brothers”. It is difficult to imagine how anyone who has read these books would want either of the Saatchis anywhere near any organisation which purports to be ruled by principle or moral values - but the Tories are not the first to succumb to Maurice Saatchi’s persuasive power.

In the 1990s I was working for the international oil company Shell at a time when there was growing internal concern about how the company was perceived around the world. There was criticism on many fronts of Shell’s apparently uncaring approach to business – not least to the environment with the Brent Spar disposal saga in the headlines. At the same time there was fierce criticism of Shell’s policies in Nigeria prompted by the then Nigerian’s regime’s execution of Ken Saro-Wiwa and by suggestions that Shell had been in some way an accomplice in shoring up that offensive regime. Many of us working in the company at the time thought that the way forward was to institute a properly funded and factual communications campaign (including corporate advertising) which would redress some of the criticism. We knew that (although some of this criticism was justified) Shell, in the main, ran its business in a proper and morally defensible way and that we should say so. But there seemed then little appetite amongst the technocrats who ran the Group for such a campaign and initially nothing happened.

In the autumn of 1997 I was working in the Middle East when I was asked, along with others in the advertising and communications business in Shell, to attend a meeting at which a new communications initiative would be revealed to us. None of those attending this meeting had been in any way involved in this initiative despite the fact that we were part of the relatively small group of communications professionals in Shell around the world. At the meeting we were presented as a fait accompli the basics of a corporate campaign that would be launched internationally early in 1998. This campaign theme was that Shell had a “Core purpose” and that this purpose was to “Help people build a better world”. The presented rational was that history teaches us that things get better over time and so “the future is a better place” and because of this Shell invests – the then Shell capital budget was more then any other company (not just oil company) in the world. This theme was supported by a three minute film featuring a baby (the “future”) against a film montage which depicted the changes of the twentieth century. As this presentation unfolded it became clear that not only had none of us who were Shell communications managers around the world been involved but also that Shell’s global advertising agency J. Walter Thompson (JWT) was also out of the loop. The film and the assorted ragbag of pretentious, boastful and implausible slogans and claims had been developed at the very top of Shell under its head Cor Herkstroter, a sensitive and rather Calvinist Dutchman, aided and abetted by Maurice Saatchi!

After his removal from Saatchi and Saatchi, Maurice had wasted little time in founding a new advertising agency called M&C Saatchi - and it was this agency which had found its way through to Herkstroter and the top management of Shell. Where Herkstroter met Maurice Saatchi (newly ennobled by John Major as “Lord Saatchi of Staplefield”) is not known – they would hardly normally move in the same circles. What is clear, however, is that Saatchi swiftly got himself into a position of influence which allowed him to bypass the established Shell communications structure (and JWT the established advertising agency) and get an assignment to develop a communications position for the Shell brand. This was the “core purpose” positioning referred to above and which was supported by the “baby” film.

Fortunately when Shell’s communications professionals saw the Saatchi campaign proposals a storm of protest gathered force not only because of its preposterous content but also because it had been put together completely separated from Shell’s other advertising and communications initiatives. Although it took a while the campaign was eventually dispensed with – as were M&C Saatchi - and Maurice Saatchi had no further involvement with Shell.

The learning point from the Shell story is that the new joint Chairman of the Conservative Party is one of the most skilled salesmen of the modern era. He and his brother built the world’s largest advertising agency based on their undoubted ability to sell to and for their clients. Their fall from these heights can be traced back to 1987 when the Saatchis decided that they wanted to buy a bank and launched an initiative to acquire the Midland Bank. Suddenly they were out of their depth and potentially in a business that they did not know. They failed in their then wish to be bankers, but in failing they seriously wounded their advertising agency whose shares collapsed. The Saatchis never really recovered form this debacle. The Shell story shows that for Maurice Saatchi the message is everything – even if that message lacks credibility or substance. To suggest that Shell’s core purpose was to “help people build a better world” was as facile as it was patently untrue. But Lord Saatchi was such a persuasive advocate of this positioning that he not only persuaded the top management of Shell but got them in principle to agree to spend hundreds of millions of dollars to promulgate this message.

When I read the Saatchi inspired list of “beliefs” that he has clearly convinced Michael Howard to sign up to, I saw that this list was absolutely consistent with the style of messaging that Saatchi had wanted to force on Shell. If in Shell we had followed Saatchi’s recommendations we would have been a laughing stock - fortunately we just avoided this. Unfortunately for him the Leader of the Conservative Party has fallen into the trap that Shell avoided and he will no doubt spend months deep in the mire of these superficial, anodyne and bland statements that will be rightly derided as all gloss and no substance. No doubt following months of derision Mr. Howard will see that he can do without the shallow “ad speak” that Saatchi has persuaded him to espouse and he might then be forced to go back to the basics of policies rather than the gloss of words.