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New York Times: Shell Lowers Estimate, and Investors Ask Why

By HEATHER TIMMONS

January 22, 2004

LONDON, Jan. 21 – Shell’s surprise cut in its reserve estimate this month may be a sign that the uniquely structured company needs to reconfigure itself, some investors and analysts are saying.

Attention has been focused on Sir Philip B. Watts, who led the unit in question before becoming chairman in 2001, but also on Shell’s two-headed structure. Ultimately, most investors doubt that Sir Philip, who will leave his post next year, will step down or be forced out. But the time may be right for Shell to reconsider its overall operating structure, some investors are saying.

Shell, one of the world’s top oil and gas producers, is unusual in that it is made up of two separate holding companies, the Royal Dutch Petroleum Company in the Netherlands, and the Shell Transport and Trading Company in Britain. The latter owns 40 percent of the total group, the former 60 percent. Both have separate boards, with no overlapping executives.

Groups of investors have been lobbying the company for a meeting to explain the Jan. 9 announcement of a drastic cut in estimates, which removed 3.9 billion barrels from proven reserves. So far, Shell has declined to provide any further information, citing a company quiet period before it announces its year-end results on Feb. 5.

In a note to employees posted on the company’s Web site, Sir Philip acknowledged that there was “significant concern and, in some quarters, outrage” because of the reduction in the estimate. But, he said, “there are constraints on the timing and content of our disclosures.” The company contacted the Securities and Exchange Commission before the Jan. 9 disclosure and is in ongoing talks with the regulator, the note said.

The absence of information has led investors to try to find their own answers on why the discrepancy occurred, and offer solutions to make sure it does not happen again.

Critics say that Shell’s separate boards mean less governance, not more. “We think there is a case for revisiting the high-level corporate structure of the company,” said Robert Talbut, chief investment officer at Isis Asset Management, which controls $95 billion in assets, including shares of Shell Transport. It is time to “look again as to whether there is sufficient independent oversight of executive management,” Mr. Talbut said.

Shell disputes the notion that the company’s overall structure has anything to do with the change in reserve estimates. The heads of the two operating units meet regularly to make decisions about day-to-day operations, the company said.

“The fact that it is a two-parent group does not impact on decision-making at an operational level,” said Simon Buerk, a spokesman for Shell.

But most investors agree there is little upside to Shell’s complicated structure.

“In a difficult operating environment, complex corporate structures begin to encourage incorrect decision-making,” said Louis Gargour, a managing director with RAB Capital Management in London, who recently sold short bonds of Shell subsidiaries, essentially making a bet the bonds would lose value.

The Royal Dutch/Shell Group of Companies was created in 1907. In the face of rising competition, Shell, which started in 1833 as a London seashell peddler and over time transformed itself into an import-export business focused on oil, combined with Royal Dutch, an oil drilling and transport company.

But the combination was not a true merger. The two independent companies remain, with the boards at each heavily made up of either British or Dutch executives.

Changing the dual structure could be difficult. Combining the companies would require a completely new tax structure and an overhaul or combination of both boards, among other complications.

Consideration has been given to merging the companies, one person close to the situation said, but executives have decided against it because it was too complicated.

Shell’s two-company structure is also a handicap to making acquisitions, energy bankers said. Both Royal Dutch and Shell Transport and Trading are required to issue separate bonds and equity, making it cumbersome to raise quick capital, the bankers said.

Consequently, Shell is forced to rely on cash more than its rivals do in making acquisitions – a particularly tough hurdle at a time when merger price tags carry big premiums for higher oil prices, bankers said.

The overall corporate structure may even be at the root of some of the criticism directed at Sir Philip. His performance is being judged against that of his counterpart, Lord Browne, at BP, which has posted strong results. BP has excelled in part because of a string of deals that Lord Brown undertook in recent years, including buying Amoco and investing over $6 billion in Russia.

“Lord Brown has taken certain risks, and moved in a direction that in some cases has been trend-setting,” said Fred Leuffer, an analyst with Bear Stearns in New York.

A different direction may still be in the cards for Shell, if investors have their way. Members of the Association of British Insurers hold 40 percent of Shell Transport and Trading, the British arm of the company, and the reduction in the reserves estimate has the traditionally conservative investors worried.

“Our members are very concerned,” Lucy Butler, a spokeswoman for the insurance group, said, without elaborating.

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