by Tom Bower
Walter van de Vijver, the director of Shell’s exploration and production, sought to understand the background of the revised rules. Ron Winfrey and James Murphy, both former petroleum engineers based at the SEC’s office in Fort Worth, Texas, had noticed before 2000 that during the previous 20 years all the oil companies had practically doubled their reserves. They questioned whether the increase represented real growth, or was merely a maneuver to maintain the companies’ share prices. Only one fifth of the oil Shell was selling was drawn from its reserves; the remainder was resold after purchase for the full market price. Shareholders, Winfrey and Murphy believed, were being misled. In an attempt to remove “confusion” from the companies’ filings because of improved technology and their operations in uncertain environments like Kazakhstan, the two officials announced that since universal classification had become “difficult, if not impossible,” the rules were “in urgent need of modernisation.” Rather than the “reasonable certainty” defined in Rule 4-10, the SEC would in future restrict the oil companies to announcing reserves only when there was “absolute certainty” of production.
The SEC believed there were good reasons for doubting some bookings. Shell had booked reserves in 1999 after drilling only two exploration wells at the Ormen Lange field off Norway. While no one doubted that at least 109 million barrels of oil and gas could eventually be produced there, Shell’s partners — BP, Exxon and Statoil — had not booked the reserves, because complicated technical problems remained unresolved. Studies showed that 8,000 years earlier a giant slide of sediment, equivalent to the size of Iceland, had been dumped onto the seabed. Settlers on Norway’s coast had been drowned by colossal waves, which had reached as far as England. To check that another disaster would not be triggered by drilling through the sediment, the consortium had commissioned a $1 billion study that would not be completed before mid-2003. After the safety issues had been dealt with, the partners would still need to lay the longest pipeline in the world, 747 miles across the seabed to England, and would finally have to confirm that the gas could be marketed. Only then, five years after Shell, would the other companies, abiding by the SEC’s rules, book the reserves. On that basis, Shell’s booking in 1999 was premature. Winfrey and Murphy noted that the oil majors had also booked reserves in Kashagan, an unstable region, where the start of production had been repeatedly delayed from 2005 until 2014. To officials in Texas, the notion of relying on the verbal promise of an African or Kazakh dictator to formally book reserves influencing the price of shares in New York was risible.
The two officials wrote to the major oil companies stipulating that reserves could only be booked under the new conditions. They could no longer be booked in anticipation of the renewal of a license to produce oil in the future, but only if the company was in possession of completed legal documents. The sale of natural gas had to be contractually watertight, and signed government approvals in “frontier areas” would be required before any reserves could be booked. The SEC’s new regulations challenged the oil companies to radically reduce their values. “Prove it to us or take it out,” Murphy would tell a meeting of petroleum engineers. The industry was alarmed by the new rules’ apparent arbitrariness. No one had anticipated back in 1973 that the SEC would become a global regulator. Too many officials in America’s regulatory agencies, fed by distrust and even envy of big business, had become a dangerous cancer. Lawyers at ExxonMobil, BP, Shell and other companies protested. It was folly, they argued, to demand that oil companies prematurely sign a contract for the sale of natural gas from the North Sea, because prices would inevitably rise, and the eventual sale of the gas in Britain was certain. Similarly, valuing their oil and natural gas reserves according to the price on the last day of the year was distorting. ExxonMobil’s booking and valuing of its reserves, protested the company’s lawyers, had always been based upon the “conservative, disciplined” management of the entire business. Politely, the SEC officials were warned that their interference with Exxon’s “certainty and consistency” was unlawful. Rule 4-10 could only be changed after formal consultation. Winfrey and Murphy were unmoved. Discomfiting Big Oil, they knew, would attract public applause, as the oil companies understood only too well. Nevertheless, Winfrey and Murphy were not immune to persuasion. By deft legal arguments, stubborn lawyers employed by ExxonMobil, BP, Chevron and Total either accommodated the SEC’s new strictures or successfully opposed them. Only Walter van de Vijver remained alarmed.
Van de Vijver had become head of Shell’s exploration and production after Mark Moody-Stuart had reorganized the 35 upstream businesses into five regional centers. The five new technology managers had been asked to reexamine their reserves. Their reports unnerved van de Vijver. “I have a gut feeling there are problems in Oman, Brunei and Nigeria,” he told his deputy. “Production is not rising and I want to know why.” In Oman, he knew, Shell’s relations with the government had been fractured after Philip Watts’s optimistic promises to produce more oil had not materialized, and production had actually fallen. Irritated, Sultan Qaboos bin Said, the ruler, had invited other oil companies to compete with Shell. In Brunei, the government was empowered to declare its own reserves regardless of accuracy. The situation at the Gorgon field in Western Australia was ominous. In October 2000, Shell’s local expert had recommended that the reserve be debooked, but Anton Bylondrecht, a reservoir engineer appointed in 1999 as the group reserves auditor, ignored the suggestion after Shell’s group reserves coordinator declared that debooking was “too big to swallow.” At Sakhalin the reserves had been booked although the development was delayed by problems; and in Nigeria, to avoid blame for any wrongdoing, Shell had sought to satisfy successive bankrupt dictators’ demands and overbook the reserves, although the regimes were unwilling to pay for the development of the oilfields. Nigeria’s anticipated reserves, van de Vijver suspected, could not be exploited, although the company expected that new discoveries would compensate for any losses. But even that was uncertain. The Shell team in Nigeria was constantly asking for money to finance development, and, considering that the company should be self-financed from profits, van de Vijver was puzzled. He asked questions but received either unsatisfactory answers or assurances that “Everything’s fine.” To some extent he was reaping the whirlwind of the changes that had encouraged engineers to refuse uncomfortable jobs in the oilfields, preferring to PowerPoint their engineering from Houston, London or The Hague. Frustrated, he dug deeper, and found only ignorance or embarrassment. He suspected the worst. Under pressure to maintain targets, he believed that Watts had exaggerated the reserves in order to enhance his bid for the chairmanship. Van de Vijver feared that his own promotion would be jeopardized by any shortfall. His salvation would be to discover the truth. Ordering a “top-down investigation,” he dispatched Frank “the Tank” Coopman, Shell’s chief financial controller, to Nigeria.
On February 11, 2002, van de Vijver distributed a Note for Information to the committee of managing directors, the most senior group of executives, warning that Shell’s reserves were possibly overstated by 2.3 billion barrels of oil equivalent (boe). According to the SEC’s latest guidelines, he explained, one billion were overbooked and a further 1.3 billion in Oman, Abu Dhabi and Nigeria were dubious because there was no “reasonable certainty” that the licenses would be renewed. Unmentioned was Anton Bylondrecht’s assessment. He would subsequently admit that some of Shell’s bookings in January 2002 had been “too lenient,” and that greater honesty on his part “would probably have cost me my job.” Van de Vijver could rely on the fact that neither Price Waterhouse nor KPMG, the company’s auditors, had expressed any doubts about Bylondrecht’s reports. Both firms would assert that certifying oil reserves was not their task, yet Shell’s executives would assume that both had passed the reserves statements. In any event, the implications of van de Vijver’s report should have been clearly understood by all Shell’s managing directors. They all knew that Shell applied its own interpretation of the r
ules. Some would say that estimating the reserves was a “black art” that had plunged Texaco into costly controversy for “stretching,” but Shell’s directors basked in the public perception that their company could be trusted. All the managers simply assumed that the reserve numbers were immune to challenge by the SEC. None questioned van de Vijver’s reaction to the SEC’s changes, or queried the fact that Anton Bylondrecht, now part-time and officially retired, was the company’s sole auditor. None knew that, by contrast, Exxon employed eight full-time reservoir engineers, advised by a former SEC lawyer, to manage its bookings. Hindered by isolation and fragmentation, the directors assumed that Watts would resolve any problem and ignored van de Vijver’s warnings.
Over the following months, the problems festered. Van de Vijver received hazy reports about the reserves, while his relationship with Watts deteriorated. In the chairman’s opinion, van de Vijver lacked the ability to energetically manage Shell’s global portfolio. For his part, van de Vijver repeatedly complained that his prospective inheritance was in a far worse state than he had imagined, and considerably worse than was portrayed by Watts to the board of directors. Watts, he felt, had been “aggressive” and “premature” in his bookings between 1997 and 2001. Believing that he was being misled about the reserves, van de Vijver became frustrated by Watts’s directive that the SEC’s new guidelines were van de Vijver’s problem, but that legitimate juggling could resolve the issue. Van de Vijver decided to mention his unease again to the conference of managing directors. Besides his interest in protecting his own reputation, he was prompted by an instinctive suspicion of Watts. The Dutchman disliked the replacement of Shell’s technical vigor by entrepreneurial priorities. He also disliked Watts’s disdain for the internal politics in The Hague’s headquarters, and blamed the British for giving the country managers an incentive to exaggerate their reserves. By failing to obey the SEC’s new guidelines, he believed, Shell was losing the plot.
Van de Vijver was due to make his second presentation to the managing directors on July 22, 2002. Seven weeks before then, Watts sent him a memo urging that while “leaving no stone unturned,” he should ensure that, if possible, the existing reserves were maintained. In his assertive manner, Watts placed the onus on van de Vijver: “It’s Walter’s plan,” he said, fixing the responsibility. He would later appear to contradict his own memo by claiming that he had commissioned van de Vijver’s review six months previously. “Do we need to debook?” he had asked van de Vijver. The reply, according to Watts, was “No.” Van de Vijver had obliged his chairman, who “didn’t want to hear the bad news.” Conveniently, van de Vijver agreed to play for time at the July presentation by suggesting that any problems would be resolved. He could do little else, because the facts remained elusive. None of the managing directors urged him to hasten his review. All assumed that reserves were “Walter’s problem,” and the solution was simple.
During the summer of 2002, van de Vijver became noticeably agitated. On September 2, he wrote a memo blaming “aggressive booking in 1997–2000” for giving outsiders a false impression of Shell’s reserves, which according to the SEC’s new guidelines, he concluded, had been overstated by at least 20 percent. “We are struggling on all key criteria,” he wrote. While Shell’s credibility remained “high,” there were “dilemmas,” and “the market can only be ‘fooled’ if… positive trends” could be shown. Out of Watts’s hearing, he described the “inflation” of the statistics to several senior Dutch directors, and protected himself by recording in a note marked “strictly confidential” that the information about the problem had been “obviously ‘transmitted’ in a careful fashion so as not to compromise/undermine the previous leadership.” In other words, the message was obscured. “The severity and magnitude of the EP [Exploration and Production] legacy issues,” he added, “may therefore not have been fully appreciated.”
Finally Watts realized there was a problem, but he blamed van de Vijver. The Dutchman, he was certain, was diverting attention from his own unsatisfactory performance by repeating his doubts about the reserves — a view with which van de Vijver strongly disagreed. Nevertheless, to placate van de Vijver, Watts invited him for dinner. The atmosphere was not harmonious. The chairman did not conceal his irritation that van de Vijver was disparaging his inheritance and failing to control his department. He also scorned the aspersions about his honesty, and the idea that he had personally booked the reserves. They disagreed over whether to limit any announcement to merely noncompliance, or to disclose the true extent of the overbooking. Remarkably, the decision could not be made by Watts. Although he was the company’s chairman, he was employed by Shell, and was unable to issue direct orders to van de Vijver, who was employed by Royal Dutch. Frustration, mutual suspicion and allegations of deception meant that the meal ended acrimoniously. Watts blamed the argument on van de Vijver’s depression over his father’s recent death and problems with the funeral. Van de Vijver resented that suggestion. On October 22, 2002, he wrote to Watts, “I must admit that I have become sick and tired about arguing the hard facts and also cannot perform miracles given where we are today.” He continued, “If I was interpreting the disclosure requirements literally… we would have a real problem.” In effect, van de Vijver accused Watts of a cover-up toward the SEC and Shell’s directors, especially about the Nigerian reserves, which were said to be overstated by 220 million barrels — which outraged Watts. With conflicting reports about the reserves’ accuracy, relations between the two men over the following months became poisonous.
On August 25, 2003, van de Vijver wrote another memorandum implicitly blaming Watts for Shell’s “shrinking opportunity” to find new oil, which had been “exacerbated by… too aggressive reserves bookings in the past.” Watts ignored the allegations. None of those whom he respected doubted his integrity. Just because he had adopted less conservative guidelines to reporting the reserves did not amount to fiddling the books. “Walter,” he commented, “is playing his own game.” Disunited and squabbling, Watts and van de Vijver failed, unlike the rival oil companies, to vigorously resist the SEC’s new guidelines. Instead, Watts mismanaged Shell’s official response. The company’s audit of its reserves was repeatedly delayed, and in April 2003, undirected by van de Vijver, the formal reply to the SEC composed by Cravath, Swain, Shell’s lawyers in New York, was tepid. “We think your guidelines go counter to the spirit of 4-10,” Cravath’s wrote, and nothing more. Shell was meekly unwilling to challenge the American government, and its protests to the SEC officials, unlike those from other oil companies, failed to elicit any concessions. Throughout those weeks, Watts behaved in a self-destructive assertive manner, while van de Vijver, having failed to meet and micromanage the problem with Anton Bylondrecht, the part-time reserves auditor, relied on Frank Coopman, Shell’s financial controller.
Coopman had been identified as a troublemaker by the company’s British executives. Mischievously, he ignored Judy Boynton, the newly appointed chief financial officer. The American Boynton had been nominated by John Hofmeister, Shell’s human resources director, in an effort to break the incestuous culture of internal appointments, an initiative that was unwelcome to many of the Dutch. Van de Vijver showed his disrespect for Boynton by failing to mention the reserves issue to her. Coopman showed the same insubordination. “He’s poison in the soup,” Hofmeister told Boynton, but, reluctant to exert her power, she failed to remove him. Her inaction encouraged Coopman to assume measurable control of the reserves investigation, leaving Boynton unaware of the problem.
In May 2003, Coopman delivered an unpleasant report to van de Vijver about Shell’s operations in Nigeria. Pipelines and equipment from wellheads were being stolen on an industrial scale. Repairs and replacements costing vast sums were not covered by production profits. Shell’s operation in Nigeria was running at a loss, prompting demands for money from Holland. Van de Vijver dispatched Coopman back to Nigeria to compose a definitive report. Coopman’s new discoveries were start
ling. Shell’s reserves in Nigeria, he revealed, were massively overstated. Instead of the original assessment that the overstatement was 220 million barrels, the true amount was 1.2 billion. On his return to Holland, Coopman did not reveal his findings to van de Vijver, but instead consulted Michel Braundjes, a company lawyer. Alarmed, Braundjes sent Coopman’s report to Cravath’s in New York.
Unaware that Shell’s most sensitive issue had been disclosed to outsiders, van de Vijver was disturbed by Coopman’s perfunctory report in September 2003 that the reserves in Nigeria had been “overstated” and were “unsatisfactory,” especially after the SEC had further tightened the rules in the wake of the Enron fraud. Even van de Vijver was still unsure about the precise facts. In that atmosphere of discontent, Watts was due to write his annual review of van de Vijver’s performance. With production failing in Nigeria and the Gulf of Mexico, and the new estimate of costs at Sakhalin expected to exceed the $9.6 billion budget, Watts’s report was outspokenly critical. Van de Vijver regarded the written reprimand as a step too far. The business plan was, he believed, flawed because of Watts’s exaggerated assertions. No extra production existed to replace the depleted reserves, and he resented taking the blame for that humiliation. “I am becoming sick and tired,” he wrote to Watts on November 9, “about lying about the extent of our reserves issues and the downward revisions that need to be done because of far too aggressive-optimistic bookings.” Shell’s directors, he added, were concerned that the market would continue to be “fooled.” In reply, Watts expressed his surprise at van de Vijver’s allegation of “lying.” The problem, Watts convinced himself, had been addressed by the management conference in mid-2003, and everyone had been reassured. Van de Vijver’s written allegation, he said, “blew up out of the blue,” but he decided not to mention its contents to anyone. “I had to scream at him to stop ignoring the problems,” van de Vijver would later say. “The Shell board were also at fault for trying to shove the problem aside as a row between two men.” Critical reports about the overstated reserves were submitted to Shell’s audit committee, and managing directors were briefed about it, yet those same directors would subsequently claim to have been unaware of the full extent of the problem until December 2003. The culture of secrecy and the lack of mutual candor within Shell was fracturing relationships as events spun beyond the control of the company’s chiefs.
