Royal Dutch Shell Evaluation of Oil Reserves — страница 10

fluctuations and speculations nowadays and in many cases, the price on December 31st may not reflect fully the actual average market price for oil. The problem is that the FASB standard was issued in 1981, year before the trading of oil begun on NYMEX. Before that, prices were partly regulated by national governments and were normally posted by buyers, so that not much of the volatility was experienced (CERA, 2005, p 20). Although, deregulation of oil markets made it another tradable commodity with highly volatile prices, yet the rules remained unchanged. The inconsistencies in the SMOG approach are well recognized and explained by the FASB itself. It is admitted that this measure cannot provide the investors with the present value of the oil reserves, but rather is aimed on

providing the standardized measurement. This measure should be a compromise between the need to give a complete information to the investors and the industry constrains that would have to put too much time and effort into the SMOG calculation if any estimations were involved in the measurement (FASB Standard 69, 1981). Indeed, the fact that SMOG does not give companies’ management too many degrees of freedom in the calculation process enables the investors to make their own calculation and compare among different companies in the industry. In this study, SMOG would be functional for the calculations in Chapter 4, where the estimation of future operational and exploration expenditures as well as the estimation of future income taxes will be required. At December 31st 2003,

the standardized measure of net cash flow of Royal Dutch Shell Group of Companies was $53.8 billion and the future inflow from oil and gas sales were $281.9 billion that is based on the year-end oil price of $26.66/bbl and natural gas prices of 17.30/boe. Full statement of Standardized Discounted Future Net Cash Flow can be found in Exhibit 2.1. The above-mentioned figures clearly cannot be seen as a meaningful estimate of the value of company’s oil reserves for several reasons. First, it is impossible to determine the production schedule of the company. Second, as it is required by FASB the oil prices are set to the value in the end of 2003. Third, the discounting is made with 10% rate, which should represent the weighted average cost of capital at Royal Dutch Shell. It

will be shown in Chapter 4 that this measure is inappropriate and that Rwacc for RDS should be set at about 7.2%. Although the figures themselves are hardly reliable, one can take it as a starting point for the further calculations. Also, in the Chapter 4 SMOG report will be used in order to determine the tax rate and operational margins for oil and gas production in different regions. Now, after the picture of how the reporting is conducted is more or less clear, let us move further and see what role did the complication of the reporting played in the recent oil resources scandal by RDS. 2.3 Mis-presentation and Restatement of Oil Reserves by Shell Management As it was shown in the previous sections, the way in which company reports quantity and value of its oil reserves is

rather complex and hardly provides the investors with the information that is to any extend close to the reality. Eventually, this should have resulted in a major misuse of the accounting standards and that is exactly what happened to RDS Group’s oil reserves. Between January 9 and April 19, 2004, Shell announced the reclassification of 4.47 billion barrels of oil equivalent, or approximately 23% of previously reported “proved reserves,” because they did not correspond to the definition of applicable law as it is required by SEC Rule 4-10 therefore the large quantity of reserves had to be stated as “un-proved” and in accordance to the SEC and FASB rules have to be virtually excluded from the company’s balance sheet. Shell also announced a

reduction in its Reserves Replacement Ratio. The Reserve Replacement Ratio (RRR) is probably one most significant figure in the oil industry, which is serving as a basis of long run analysis for the oil and gas companies. This is a ratio of oil production in any particular period to the quantity of new oil reserves discovered and booked as proved. In other words the ratio is aimed to measure whether the company is discovering less resources than it produces and eventually will have to reduce or even shut down the production (this is in case RRR is less than 100%) or will be able to sustain or increase the level of production in the long run (this is in case RRR is equal or greater than 100%) Although, restatement of oil reserves is a normal practice in the oil companies, in case