"More Egg on Shell’s Face" by Bill Powers. FSO Editorial 03/15/2010

FSO Editorials

More Egg on Shell’s Face
by Bill Powers
Editor, Powers Energy Investor
March 15, 2010

Over the last ten years no company has been more prolific in writing down its reserves than Royal Dutch Shell Corporation. On January 4, 2004, the company wrote down 20% of its reserves by moving 3.9 billion barrels of equivalent from the proven category to other categories. A large portion of the reserve write down involved the movement of 2.3 billion barrels of reserves in mature fields in Nigeria and Oman from the “proven undeveloped” category to the “non-economic” category. Unbelievably, the announcement on January 4, 2004 was followed by four additional reserve reductions in 2004 that wiped out nearly a third of the company’s proven reserves. Needless to say, this episode infuriated both investors and regulators and eventually cost the company over $700 million in fines and settlements.

Shell is back to its old ways. According to a February 24, 2010 Wall Street Journal article, the Norwegian Petroleum Directorate downgraded proven reserves on Shell’s massive Ormen Lange offshore natural gas field from 423.3 million cubic meters (14.9 trillion cubic feet (tcf)) to 320.3 million cubic meters (11.3 tcf) due to dry holes drilled on the undeveloped northern end of the field. A spokesperson for the Shell, which is operator of the Ormen Lange field with a 17% ownership, was quoted in the article saying that the reserve write down would not cause the company to take a write down on its developed portion of the field and that the write down would not impact production volumes until late in the field’s life. I find the spokesperson’s explanation hard to believe. A major revision in proved reserves, which by their very definition are reserves that the company expects to produce with a 90% certainty, also calls into question future production estimates.

The major reserve revision to Ormen Lange is not only further embarrassment to Shell, but it also calls into question the sustainability of Norway’s natural gas exports since Ormen Lange is the country’s second largest field behind Troll. Should Ormen Lange experience further reserve write downs, the nearly 2.4 billion cubic feet per day (bcf/d) of natural gas that it exports to the UK via the 750-mile Langeled pipeline may begin to decline sooner than expected. Given that Norway is Europe’s largest natural gas producer and exporter, any significant drop off in production will rapidly tighten the world LNG markets. We may have seen a preview of what is to come when, earlier this year, the Langeled pipeline was down for repairs which sent the UK into a series of gas balancing alerts. While I do not expect one downgrade of reserves to lead to an immediate fall-off in production, it is something I will be watching for.

The write down by Shell may just be the first of a series of write down should history repeat itself. Only time will tell. With Norway being a vital part of Europe’s energy future, any fall off in production will accelerate the coming tightening of the world’s LNG market. Given the negativity surrounding the outlook for natural gas, contrarian investors would be well advised to position themselves into companies with significant exposure to rising natural gas prices in both Europe and North America.

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