Altered Picture for Big Oil Reserves Three Years After Shell



HOUSTON Apr 13, 2007 Dow Jones Newswires

As a crystal ball into the energy industry's prospects, proved crude-oil and natural-gas reserves aren't as clear as they used to be, at least not for the biggest oil companies.

While energy investors still look to the annual computation of these hydrocarbons in the ground for all energy companies, Wall Street's assessment of Exxon Mobil Corp. (XOM), BP PLC (BP) and other oil giants increasingly rests on other qualities, such as the market's perception of executive competence, or a company's proficiency in managing mega-projects that take years to develop.

By comparison, the reserves benchmark - an estimate of the quantity of oil and gas a company controls and will produce - is viewed as a somewhat more telling gauge of the future profitability for U.S. exploration and production companies, which extract oil and gas mostly from relatively simple, short-lived operations.

On Wednesday, Royal Dutch Shell PLC (RDSA) said it would pay investors outside the U.S. $352.6 million, plus administrative costs, related to a significant downward revision of its reserves in 2004. The company said it expects to settle with U.S. investors for around $80 million related to the matter.

But three years after the Shell scandal broke, it's become clear that reserves carry a different meaning for Big Oil and for its smaller and simpler cousins.

Reserves are "still a valid measure, but they are harder to get a handle on than what they have been in the past," said Bruce Lanni, an analyst at A.G. Edwards who covers the largest oil companies. "It's a very important number, but you have to look beyond that."

Taking Its Lumps

Big oil companies and the analysts who follow them point to a variety of reasons that reserves have become somewhat less relevant for these companies, whose operations extend into far-flung locales that necessitate complex relations with national oil companies.

In a conference call in January, ConocoPhillips Chief Executive Jim Mulva said that the company expects reserve replacement to be "somewhat uneven" on a yearly basis, as major development projects take time to develop and resources become harder to access. The company downgraded its 2006 reserves by 260 million barrels of oil equivalent due to technical difficulties in a Caspian oil field and North Sea fields. Conoco's 2006 reserve replacement was 300%, but that included the $35 billion acquisition of Burlington Resources. Discounting the Burlington deal, Conoco's 2006 reserve replacement would have been just 10%-15%

Analysts are willing to overlook a bad reserve replacement year if a company has enough promising prospects in the pipeline through a successful exploration program.

For example, Chevron Corp.'s (CVX) recent drilling successes in the Gulf of Mexico and elsewhere - along with record profits lifted by high commodity prices - helped offset the negatives associated with the company's difficulty in replacing reserves in recent years. Chevron replaced 101% of its reserves in 2006 after replacing just 18% in 2004. Like Conoco, Chevron's reserve replacement has been bolstered by a large acquisition - its $18 billion acquisition of Unocal Corp in 2005.

As the biggest companies have undertaken more massive projects like the Sakhalin ventures, Canadian oilsands mining operations or cross-continent liquefied natural gas ventures, project management has become essential. Companies like Exxon, which also has a strong record on reserves replacement, have established a good reputation at executing projects on cost and on time.

"As a project manager, I don't think Exxon Mobil has got a peer," said Mark Gilman, an analyst with The Benchmark Company. "Project management is exceedingly important."

Rising economic nationalism is also a factor that can distort a company's reserves.

Further downgrades by Conoco, Exxon, Chevron, Total S.A. (TOT) and Statoil ASA (STO) are expected, reflecting their reduced ownership in Venezuela's Orinoco belt heavy oil projects, in which state-owned Petroleos de Venezuela S.A. will gain a majority stake on May 1. In January 2006, Spanish-Argentine giant Repsol-YPF (REP) cut 25% of its proved reserves due to changes in Bolivia's hydrocarbons law. Most companies maintain that these changes don't affect their operations' profitability.

In late March, Bolivian officials reminded foreign operators to keep local reserves off their books.

"Can companies register reserves at stock exchanges? I clearly tell them, 'No,' because the owner is the Bolivian state," energy minister Carlos Villegas told the Senate, according to local press reports.

Analysts doubt that this virulent sort of economic nationalism will spread beyond Latin America, at least as far as reserves are concerned. Countries like Libya and the former Soviet republics are more focused on recouping a greater share of profits than on whether Western companies book reserves, A.G. Edward's Lanni said.

Reserves "shouldn't matter," Occidental Petroleum Corp.'s (OXY) Chief Financial Officer Steve Chazen told Dow Jones Newswires. "If you move to a service contract, nothing really happens. You get the same cash flow that presumably you'd have gotten otherwise, it's just cosmetic."

Copyright (c) 2007 Dow Jones & Company, Inc.

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