updated 7/6/2004 10:16:08 AM ET 2004-07-06T14:16:08

The Royal/Dutch Shell Group said Friday that the overstatement of its proven oil and gas reserves and “inappropriate” accounting in other business segments resulted in profits being exaggerated by $432 million.

The revision followed an embarrassing series of disclosures that in total reduced the company’s reported reserves by nearly one-quarter and led to the departure of several top executives.

The biggest downward revision was for 2002, when the faulty accounting resulted in profits being overstated by $208 million. In 2001 the reduction was $56 million, in 2000 it was $122 million and prior to 2000 it was $46 million.

The company disclosed the overstated profits in a filing with the Securities and Exchange Commission late Friday, explaining that in addition to the problematic reserves accounting it had also made errors in the way it accounted for exploration costs, certain gas contracts and the earnings per share of its parent companies.

However, because of a change announced Friday in the way Royal/Dutch Shell will now account for its inventories of oil and gas, the energy giant said its net income for 2002 was actually higher than previously reported at $9.72 billion, up from $9.42 billion it reported February 2003.

The accounting overhaul caused Royal/Dutch Shell’s 2001 net income to drop to $10.35 billion, down from $10.85 billion it reported in February 2002, while its 2000 net income increased slightly to $12.87 billion, up from $12.7 billion reported in early 2001.

In a string of four restatements that started in January, Shell downgraded its proven reserves by 4.47 billion barrels, or 23 percent.

Proven reserves are the amount of oil and gas a company expects to commercially pump to the surface. They are a crucial measure for investors of an oil company’s performance and future value.

Reserves snafu led to resignations
The reserves overstatement led to the resignations of chairman Philip Watts, head of exploration and production Walter van de Vijver, and chief financial officer Judy Boynton. It also drew the attention of regulators in the United States and Europe.

On Monday the leaders of Royal Dutch/Shell asked shareholders for forgiveness and time to revamp the Anglo-Dutch oil giant.

Shell has an unusual, bi-national structure in which Royal Dutch Petroleum Co. of the Netherlands controls 60 percent of the group and Britain’s Shell Transport & Trading Co. PLC holds the remaining 40 percent.

Investors and analysts alike have blamed this cumbersome structure for the breakdown in governance that led to significant overstatements of the company’s oil and gas reserves.

Shell’s restatement was released after the close of U.S. markets. Shares of Royal Dutch Petroleum closed up 11 cents at $51.72 on the New York Stock Exchange, where shares of Shell Transport finished 13 cents higher at $44.65.

The overstatement of its proven oil and gas reserves resulted in profits being inflated by $276 million between 1998 and 2002. The inaccurate accounting of exploration costs and certain gas contracts caused profits to be embellished by $156 million between 2000 and 2002.

Method change boosts 2000, 2002 profits
Yet the company actually increased its final tally of profits in 2000 and 2002 as a result of a change in the way it calculated the cost of the oil products sold during the year.

Royal Dutch/Shell said it was switching the accounting method for its North American inventory to conform with the way the cost for the rest of the company’s inventory is calculated, known as “First-In-First-Out,” or FIFO.

Because the cost of a raw material such as crude oil varies over time, an oil company’s inventory will include barrels of crude acquired at various prices. When a barrel is taken from that inventory and sold for revenue, the company needs to subtract a cost for barrel to calculate the profit on that barrel. Under the FIFO method, a company uses the cost of the oldest oil in its inventory.

The company’s decision to use the FIFO method for its North American inventory resulted in a $511 million increase in previously reported net income for 2002, a $446 million decrease in net income for 2001 and a $269 million increase in net income for 2000.

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