Shell Production Dropping, Reserve Replacement Low

29 July 2004

Pushed by the “strong tailwind” of oil prices, Royal Dutch Shell posted a hefty $8.7 Billion profit for the first half of 2004, up 7% from the same period the year before. This incorporated a $4B profit for the second quarter, up 54% from 2Q 2003. At the same time, the company announced it was paying penalties to both US and UK regulators to resolve the reserve scandal from earlier this year—some $150 million worth. That works out to about 4% of the profit just from the second quarter. Not a bad deal to get that off your back.

The timing of the penalty announcement also deflected attention on more serious underlying conditions:

• Shell’s upstream production, both in crude oil and natural gas, is dropping.
• Shell’s reserve replacement ratio is extremely low.

Globally, Shell’s crude oil production dropped 6.5% from the first half of 2003 to the first half of this year. As you can see from the chart, the only area of substantial increase is in Africa. Shell will look to increase production from Russia and the Former Soviet Union as well. Shell is also putting a great deal of effort into oil production from oil sands to offset the decline in regular oil.

With all that, however, Shell sees no net increase in production for the next several years.

Production in 2005 and 2006 is likely to remain in the range of 3.5 to 3.8 million boe [barrels of oil equivalent—everything in, normalized to the measure of a barrel of crude] per day, again subject to price effects.

In other words, in an era of unprecedented energy demand, the best, stated case is that Shell cannot produce more—hence it will be steadily losing market share. Who picks up the slack? More disturbing from a long-term view is this:

The latest outlook for the proven reserves replacement ratio (RRR) for 2004 is some 60% to 80%.

The reserves replacement ration (RRR) is a measure of offsetting the production depletion of a company’s resources. An RRR of 100% means that for every barrel pumped, a new barrel appears in the reserves. An RRR of less than 100% indicates that your reserves are declining. Shell in essence is saying that it will be drawing down on its reserves accounts without replacing them fully. Not a good position for an energy company dependent upon hydrocarbons, and definitely worrisome for a global economy that maintains its dependency on the same.

Shell’s RRR has been low for several years now: down to 63% in 2003, and at an average 66% for the five years from 1999-2003.

Analysts were mildly disappointed by the overall financial results—as a group, they had expected Shell to benefit even more from the oil price surge. That it did not reflects the production issues, including the rising cost of production.

Presentations, financials and other documents from the results announcement are here.