Reserves vs. Stock Prices
The current flap over Royal Dutch/Shell's restatement of oil and gas reserves highlights one of the central paradoxes of the oil and gas business. While neither the company nor most analysts see the elimination of roughly 20% of Shell's stated reserves as having an impact on earnings in the next couple of years, the market has responded by sharply devaluing the company's stock.
This may seem odd, considering that oil company stocks have not appreciated in line with the increases in oil and gas prices over the last couple of years. So if future reserves (and the future production, earnings and cash flow they would generate) don't count for much in stock prices when energy prices go up, why do they suddenly matter so much when they are restated?
Despite all the assets the major oil companies have tied up in service stations, refineries, tankers, pipelines, and other plant and equipment so necessary to extract full value from the oil and gas in the ground, it is the exploration and production side of the business that is both the core competency and primary long-term earnings engine (if not necessarily cash engine) of these companies. Anything that casts doubt on this competency puts a big cloud over the whole company, regardless of whether it has a short-term earnings impact. I don't think the market is over-reacting here, despite my general sense that Shell is a solid, well-run company.