OUR BUSINESS

With around 102,000 employees in more than 100 countries and territories, Shell helps to meet the world’s growing demand for energy in economically, environmentally and socially responsible ways.

UPSTREAM
Our Exploration & Production business searches for and recovers oil and natural gas around the world. Many of these activities are carried out as joint venture partnerships, often with national oil companies.

Our Gas & Power business liquefies natural gas and transports it to customers across the world. Its gas to liquids (GTL) process turns natural gas into cleaner-burning synthetic fuel and other products. It develops wind power to generate electricity and is involved in solar power technology. It also licenses our coal gasification technology, enabling coal to be used as a chemical feedstock and for more efficient generation of electricity.

DOWNSTREAM
Our Oil Sands business, the Athabasca Oil Sands Project, extracts bitumen — an especially thick, heavy oil — from oil sands in Alberta, western Canada, and converts it to synthetic crude oils that can be turned into a range of products.

Our Oil Products business makes, moves and sells a range of petroleum-based products around the world for domestic, industrial and transport use. Its Future Fuels and CO₂ business unit develops biofuels and hydrogen and markets the synthetic fuel and products made from the GTL process. It also leads company-wide activities in CO₂ management. With around 45,000 service stations, ours is the world’s largest single-branded fuel retail network.

Our Chemicals business produces petrochemicals for industrial customers. ey include the raw materials for plastics, coatings and detergents used in the manufacture of textiles, medical supplies and computers.

 

ABOUT THIS REPORT

This Report combines the Annual Report and Accounts and the Annual Report on Form 20-F (Report) for the year ended December 31, 2008, for Royal Dutch Shell plc (Royal Dutch Shell, the Company) and its subsidiaries. It presents the Consolidated Financial Statements of Royal Dutch Shell (pages 113-159) and the Parent Company Financial Statements of Royal Dutch Shell (pages 187-191). This Report complies with all applicable UK regulations. This Report also includes the disclosure included in the Annual Report on Form 20-F, as filed with the U.S. Securities and Exchange Commission (SEC). Cross references to Form 20-F are set out on page 3 of this Report.

 

In this Report “Shell” and the “Shell group” are sometimes used for convenience where references are made to Royal Dutch Shell and its subsidiaries in general. Likewise, the words “we”, “us” and “our” are also used to refer to subsidiaries in general or to those who work for them. These expressions are also used where no useful purpose is served by identifying the particular company or companies. “Subsidiaries”, “Shell subsidiaries” and “Shell companies” as used in this Report refer to companies over which Royal Dutch Shell, either directly or indirectly, has control through a majority of the voting rights or the right to exercise control or to obtain the majority of the benefits and be exposed to the majority of the risks. The Consolidated Financial Statements consolidate the financial statements of the Parent Company and all subsidiaries. The companies in which Shell has significant influence but not control are referred to as “associated companies” or “associates” and companies in which Shell has joint control are referred to as “jointly controlled entities”. Joint ventures are comprised of jointly controlled entities and jointly controlled assets. In this Report, associates and jointly controlled entities are also referred to as “equity-accounted investments”.

 

The term “Shell interest” is used for convenience to indicate the direct and/or indirect (for example, through our 34% shareholding in Woodside Petroleum Ltd.) ownership interest held by Shell in a venture, partnership or company, after exclusion of all third-party interests.

 

Except as otherwise specified, the figures shown in the tables in this Report represent those in respect of subsidiaries only, without deduction of minority interest. However, where figures are given specifically for oil production (net of royalties in kind), natural gas production available for sale, and both the refinery processing intake and total oil product sales volumes, the term “Shell share” is used for convenience to indicate not only the volumes to which subsidiaries are entitled (without deduction in respect of minority interest in subsidiaries) but also the portion of the volumes of equity-accounted investments to which Shell is entitled or which is proportionate to the Shell interest in those companies.

 

The Financial Statements contained in this Report have been prepared in accordance with the provisions of the Companies Act 1985, Article 4 of the International Accounting Standards (IAS) Regulation and with both International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB) and IFRS as adopted by the European Union. IFRS as defined above includes International Financial Reporting Interpretations Committee (IFRIC) interpretations.

 

Except as otherwise noted, the figures shown in this Report are stated in US dollars. As used herein all references to “dollars” or “$” are to the US currency.

 

The Business Review (BR) and other sections of this Report contain forward-looking statements concerning the financial condition, results of operations and businesses of Shell. All statements other than statements of historical fact are, or may be deemed to be, forward-looking statements.

Forward-looking statements are statements of future expectations that are based on management’s current expectations and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in these statements. Forward-looking statements include, among other things, statements concerning the potential exposure of Shell to market risks and statements expressing management’s expectations, beliefs, estimates, forecasts, projections and assumptions. These forward-looking statements are identified by their use of terms and phrases such as “anticipate”, “believe”, “could”, “estimate”, “expect”, “intend”, “may”, “plan”, “objectives”, “outlook”, “probably”, “project”, “will”, “seek”, “target”, “risks”, “goals”, “should” and similar terms and phrases. There are a number of factors that could affect the future operations of Shell and could cause those results to differ materially from those expressed in the forward-looking statements included in this Report, including (without limitation): (a) price fluctuations in crude oil and natural gas; (b) changes in demand for Shell’s products; (c) currency fluctuations; (d) drilling and production results; (e) reserve estimates; (f) loss of market share and industry competition; (g) environmental and physical risks; (h) risks associated with the identification of suitable potential acquisition properties and targets, and successful negotiation and completion of such transactions; (i) the risk of doing business in developing countries and countries subject to international sanctions; (j) legislative, fiscal and regulatory developments including potential litigation and regulatory effects arising from recategorisation of reserves; (k) economic and financial market conditions in various countries and regions; (l) political risks, including the risks of expropriation and renegotiation of the terms of contracts with governmental entities, delays or advancements in the approval of projects and delays in the reimbursement for shared costs; and (m) changes in trading conditions. Also see “Risk factors” for additional risks and further discussion. All forward-looking statements contained in this Report are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. Readers should not place undue reliance on forward-looking statements. Each forward-looking statement speaks only as of the date of this Report. Neither Royal Dutch Shell nor any of its subsidiaries undertake any obligation to publicly update or revise any forward-looking statement as a result of new information, future events or other information. In light of these risks, results could differ materially from those stated, implied or inferred from the forward-looking statements contained in this Report.

 

This Report contains references to Shell’s website. These references are for the readers’ convenience only. Shell is not incorporating by reference any information posted on www.shell.com.

 

DOCUMENTS ON DISPLAY

Documents concerning Royal Dutch Shell, or its predecessors for reporting purposes, which are referred to in this Report have been filed with the SEC and may be examined and copied at the public reference facility maintained by the SEC at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. For further information on the operation of the public reference room and the copy charges, please call the SEC at (800) SEC-0330. All of the SEC filings made electronically by Shell are available to the public at the SEC website at www.sec.gov (commission file number 1-32575). This Report, as well as the Annual Review, is also available, free of charge, at www.shell.com/annualreport or at the offices of Royal Dutch Shell in The Hague, the Netherlands and London, UK. You may also obtain copies of this Report, free of charge, by mail.

 

 

 

 

 

 

REVIEW OF THE YEAR

 

 

 

SELECTED FINANCIAL DATA

The selected financial data set out below is derived, in part, from the Consolidated Financial Statements. The selected data should be read in conjunction with the Consolidated Financial Statements and related Notes, as well as the Business Review in this Report.

 

The Consolidated Financial Statements have been prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standard Board (IASB).

 

 

 

 

 

 

 

 

 

CHAIRMAN’S MESSAGE

The past year was one of extraordinary global economic turbulence. The economic downturn is expected to bite deeper in the year ahead. It has already slowed consumer demand. The oil price plunged from a record high of around $145 a barrel to under $35. All this inevitably affects our income, and our outlook.

 

As Shell, we depend on making the right long-term investments against a range of business assumptions. Such market volatility tests our resolve – and our strategy.

 

It is for the Board and management to chart the right course. We rigorously assess every decision against cost. But we must also ensure that capital investment continues for core projects. Simultaneously, we need to pay particular attention to our great pool of human talent, making sure our people remain motivated and fully equipped for the future. When the global economy emerges from this downturn we must be strong enough to respond.

 

To achieve this, we must stay true to our beliefs. Our strategy of More Upstream, Profitable Downstream remains on track. Three hard truths still shape our approach: when the economic crisis passes, global demand for energy will continue upward as populations grow and living standards rise; supplies of easy-to-access oil will struggle to keep pace with demand; and an increasing use of fossil fuels will drive up emissions of carbon dioxide (CO₂).

 

The global long-term challenge remains: how to produce more energy and less CO₂. At Shell, we are working to improve energy efficiency at our refineries and chemicals plants, and we are developing more efficient fuels and lubricants.

Technology remains central to Shell’s efforts to produce more oil and gas and to turn them into everyday products. It helps us to access resources previously out of reach or too costly: in the deep waters of the Gulf of Mexico, sub-Arctic Russia and Canada’s oil sands, for example. Our Pearl GTL gas to liquids plant in Qatar, which I visited in 2008, is the kind of mega-project Shell excels at. It is large, complex, and uses advanced technology.

 

Our spending on research and development has again increased as we develop new technologies to unlock difficult resources, such as oil sands too deep to mine and gas heavily contaminated with sulphur. We are also looking at biofuels as a fuel for the future.

 

Sound leadership is essential to our long-term success. Appointing a successor to Jeroen van der Veer as Chief Executive was one of the most important decisions the Board has faced during my time as Chairman. The process gave me a deeper insight into the strength of leadership in Shell. I believe Peter Voser is exceptionally well-equipped to provide strong leadership, building on the excellent progress made by Jeroen. The Board looks forward to working with Peter to tackle the pressing issues at hand.

 

Indeed, the talent and hard work of all our people will count for much in the tough times to come. In the global economic storm, our focus must stay clear. By following a steady course we can continue to deliver results to our shareholders and ensure growth. And we can continue to provide our customers with the energy they need to thrive.

 

Jorma Ollila
Chairman

 

 

 

CHIEF EXECUTIVE’S REVIEW

In a difficult year for many, our focus on delivery and growth continued to yield results. Our financial performance in 2008 was satisfactory with income of $26.5 billion and the return of $13.1 billion to shareholders. I would like to express my gratitude to everyone at Shell for the hard work they have put in to achieve this.

 

In a volatile business environment, the need to cut costs is paramount. At the same time, we must continue to improve our performance and maintain our sharp focus on safety. In 2008, there were fewer recordable incidents than ever, but sadly fatalities among employees and contractors were up. We must redouble our efforts to further improve our safety performance and avoid such tragedy. Our goal of zero fatalities and serious injuries must remain firmly in our sights at all times.

 

Our strategy of More Upstream, Profitable Downstream stayed on track. We pressed forward with cash-generating mega-projects. Sakhalin II, one of the world’s largest integrated oil and gas projects, began year-round oil shipments and was preparing to start exports of liquefied natural gas (LNG) in 2009. Construction of our major gas to liquids plant, Pearl GTL in Qatar, made further good progress.

 

We postponed some investment decisions, including the second expansion phase of our oil sands operations in Canada. The current expansion goes on.

 

Nigeria remains a difficult challenge, especially in the areas of security and funding. Our installations were attacked and thefts from pipelines forced us to shut down the Soku gas plant temporarily. But achievements included the start-up of the Afam VI power plant that uses gas from the new Okoloma gas plant to provide electricity to millions.

 

Our Exploration & Production earnings were $20.2 billion, 38% up on the previous year. We made 11 notable discoveries of potential resources and secured rights to some 40,000 km² of exploration acreage – an area around the size of the Netherlands – including 275 blocks in the Chukchi Sea off Alaska. We completed the acquisition of Duvernay Oil Corp. with its acreage containing significant gas resources in western Canada.

 

The Arctic’s resources could significantly boost global supplies and we will develop them safely and responsibly, recognising the need to protect the environment and work in partnership with local communities. During the year we continued to strengthen our commitment to biodiversity through partnerships with the International Union for Conservation of Nature (IUCN) and Wetlands International. Our relationship with the IUCN, for example, gives us the opportunity to discuss social and environmental issues for future projects in sensitive areas such as the Arctic.

 

Our Gas & Power earnings were $5.3 billion, 92% up on the previous year. LNG sales remained strong at 13.05 million tonnes. The fifth train

of the North West Shelf LNG project in Australia started production, while construction of the Qatargas 4 LNG project made good progress. We also signed two significant LNG supply agreements with PetroChina. In the USA, the 264 MW Mount Storm wind project began operations.

 

Our downstream businesses of Oil Products and Chemicals experienced a particularly tough latter part of the year with demand sliding as a result of the global economic crisis. Our Marketing business did well. Our Oil Sands business, also in downstream, achieved record earnings. Again, our Trading and Shipping organisations continued to provide essential support to our key businesses.

 

We also moved ahead with major downstream projects such as the 325,000 barrels per day expansion of the Motiva Port Arthur refinery in the USA, and the Shell Eastern Petrochemicals Complex in Singapore. We divested some assets in France and Africa. And there was expansion of our retail presence in Switzerland, Ukraine and Scandinavia.

 

In biofuels, we increased our stake to 50% in Iogen, the Canadian company that operates an advanced process using enzymes to make ethanol from straw. We also formed six new research partnerships with leading universities that complement our own research into the development of biofuels.

 

Despite the economic crisis, the focus on reducing CO₂ remains important. We are involved in a number of demonstration projects helping to advance technology to capture CO₂ and store it safely underground, and we are keen to be involved in more. We also continue to work with governments to establish the incentives and policies needed to make this technology viable.

 

As the business environment grows tougher, we cut costs and we continue to step up energy efficiency in our own operations. Technology, operational excellence and first-class project management will remain vital.

 

Our performance in 2008 again shows our ability to deliver results to our partners and shareholders, and leaves us in a strong position to face the challenges of the coming year. Our portfolio management continues to deliver strong results with significant proceeds from divestments made during 2008.

 

In mid-2009, after some five years as Chief Executive, I shall hand over to Peter Voser, currently our Chief Financial Officer. I wish Peter every success. I would also like to thank our people for the tremendous effort, dedication and passion they have shown. I am proud of them, and I look forward to seeing more delivery and growth in the future.

 

Jeroen van der Veer
Chief Executive

 

 

 

INDEX TO THE BUSINESS REVIEW

 

 

 

BUSINESS AND MARKET OVERVIEW

From 1907 until 2005, Royal Dutch Petroleum Company (Royal Dutch) and The “Shell” Transport and Trading Company, p.l.c. (Shell Transport) were the two public parent companies of a group of companies known collectively as the “Royal Dutch/Shell Group” (Group). Operating activities were conducted through the subsidiaries of Royal Dutch and Shell Transport. In 2005, Royal Dutch Shell plc (Royal Dutch Shell) became the single parent company of Royal Dutch and Shell Transport, the two former public parent companies of the Group (the Unification).

 

Today, Shell is one of the world’s largest independent oil and gas companies in terms of market capitalisation, operating cash flow and oil and gas production. Our oil- and gas-producing heartlands are the core countries that have the available infrastructure, expertise and remaining growth potential for Shell to sustain strong operational performance and support continued investment. They are in countries such as Australia, Brunei, Canada, Denmark, Malaysia, the Netherlands, Nigeria, Norway, Oman, the UK and the USA. We are exploring for oil and gas in prolific basins such as the Gulf of Mexico while new supplies will be brought on-stream from major projects in frontier environments, such as Sakhalin in Russia and the ultra deep-water development BC-10 in Brazil. We are investing in growing our leading liquefied natural gas (LNG) portfolio, and in the large-scale commercialisation of GTL technology (Qatar).

 

We have a diversified and balanced portfolio of refineries and chemicals plants and are a major distributor of biofuels.

 

ACTIVITIES, INTERESTS AND PROPERTY

Our activities are conducted in more than 100 countries and territories. Oil and gas, by far the largest of our business activities (including the oil and gas related revenues from the Exploration & Production, Gas & Power, Oil Sands and Oil Products segments), accounted for just over 90% of revenue in 2008. We market oil products in more countries than any other oil company and have a strong position not only in the major industrialised countries but also in the developing ones. The distinctive Shell pecten (a trademark in use since the early part of the twentieth century) and trademarks in which the word Shell appears support this marketing effort throughout the world. Shell also ranks among the world’s major chemical companies (by sales); in 2008, the Chemicals segment accounted for around 9% of the revenue of Shell.

A summary of revenue of Shell by business segment and by geographical region for the years 2006, 2007 and 2008 is set out below:

 

 

 

 

STRATEGY

Our strategy of More Upstream, Profitable Downstream remains on track. We selectively strengthen our existing assets and pursue growth via attractive long-term investments, all supported by strong capital discipline. Our strategy seeks to reinforce our position as an industry leader in order to provide investors with a competitive and sustained total shareholder return; and to help meet energy demand in a responsible way – the energy challenge.

 

Three hard truths shape the way we tackle the energy challenge. First, while the current weaker global economy will lessen demand growth in the short to medium term, the demand for energy will continue to rise in the longer term. It is expected that three billion people will be added to

 

 

the world population by 2050, while rapidly-developing economies such as China and India are entering into a more energy-intensive phase. Second, energy supplies from conventional sources of oil and gas will struggle to keep up with demand. Alternative sources of energy will increasingly be needed. Third, environmental stresses are increasing as emissions of greenhouse gases, such as CO₂, continue to rise in step with the increased use of fossil fuels.

 

Intense competition will remain both for access to resources by our upstream businesses as well as for access to new markets by our downstream businesses. We believe our technology, project delivery and operational excellence capabilities will remain key differentiators for our upstream and downstream businesses.

 

In our upstream businesses, in line with our strategy, we focus on developing major new projects where our technology and know-how adds value to the resource holders. In our downstream businesses, our emphasis remains on sustained cash generation from our existing assets and a continued shift in our portfolio to the faster-growing emerging markets in Asia.

 

In 2009, however, the global economic environment is likely to affect the ability to execute certain plans in the short to medium term. Specifically, we expect the financial market turbulence to impact energy investment. We will continue to focus on capital and cost discipline. Nonetheless, these near-term events will not affect our overall strategic direction. We expect around 80% of our capital investment in 2009 will be in upstream and oil sands projects. In downstream, we will maintain our capital programme and enhance our competitive position by improving the efficiency and safety of our refineries.

 

Meeting the growing demand for energy worldwide in ways that minimise environmental and social impact is a major challenge for the global energy industry. Shell is committed to improving energy efficiency in our own operations, supporting customers in managing their energy demands and continuing to research and develop technologies that increase efficiency and reduce emissions in oil and gas production. We are working to create a leading biofuels business and aim to build our capability in the capture and storage of CO₂.

 

Our commitment to technology and innovation continues to be at the core of our strategy. As energy projects become more complex and more technically demanding, we believe our technical expertise will be a deciding factor in the growth of our business. Shell’s key strengths include the development and application of technology, the financial and project management skills that allow us to deliver large oil and gas projects, and the management of integrated value chains. We leverage our diverse and global business portfolio and customer-focused businesses built around the strength of the Shell brand.

 

MARKET OVERVIEW

The demand for oil and gas is strongly linked to the strength of the global economy and as such projected economic growth is considered an indicator for future demand for our products and services.

 

The financial crisis that began in August 2007 in the US sub-prime mortgage market – and spread to other credit market segments – intensified dramatically since September 2008, following the bankruptcy of a major US investment bank. This escalation of the financial crisis occurred when the global economy was already slowing significantly and tipped most developed economies into recession. At 3.4% in 2008, global gross domestic product (GDP) growth was down significantly from the 5.2% registered in 2007, and 5.1% in 2006. China, India, Russia and

other emerging markets accounted for more than half of global growth in 2008. In contrast, growth in developed economies weakened significantly in 2008, particularly in the second half of the year.

 

In the USA, GDP growth in 2008 was 1.1% for the year as a whole but turned negative in the second half of the year, with sharp falls in consumer and business confidence and tightening credit conditions. For 2009, cuts in consumer spending and business investment and the downturn in housing and tight credit conditions are likely to continue to weigh on the US economy.

 

European GDP growth slowed sharply in 2008 to 0.8% from 2.6% in 2007. Appreciation of the euro, based on an average for the year, reduced the contribution of net exports to growth and severe stresses in international financial markets increasingly weighed on business and consumer sentiment as the year progressed. These factors point to a possible further slowing of growth in 2009.

 

GDP in Japan contracted in 2008 by (0.7)% compared to a growth rate of 2.4% in 2007. This reflects a decline in export growth with the slowdowns in the USA and Europe as well as weakening domestic demand.

 

China and India saw growth moderate in 2008 to below recent trend rates, but both countries remained somewhat resilient to the economic and financial stresses in the USA and Europe. In China, domestic consumption made an increasing contribution to growth as exports slowed. Meanwhile in India, domestic demand and the services sector supported continued expansion. However, for 2009, growth in these two countries is expected to continue to moderate further below recent trend rates.

 

In 2009, global growth is likely to fall well below its longer-term trend rate, with the risk profile indicating a continued downward trend. The main risk remains the potential for a wider and deeper slowdown in US, European and Japanese domestic demand. The main factors that are likely to contain the depth of the recession in developed economies are significant monetary stabilisation and fiscal stimulus programmes and lower oil and other commodity prices. It is not expected that the emerging economies will fully offset these trends.

 

Oil and natural gas prices

Brent crude oil prices averaged $97.14 per barrel in 2008 compared with $72.45 in 2007, while West Texas Intermediate (WTI) averaged $99.72 per barrel compared with $72.16 a year earlier. Oil prices saw great volatility in 2008 with Brent starting the year at $97 per barrel, reaching just under $145 per barrel in July and then falling to a low of just under $34 per barrel in December.

 

Henry Hub gas prices in the USA averaged $8.87 per million British thermal units (Btu) in 2008 compared with $6.94 in 2007. Gas prices also saw a wide range in 2008 from a high of $13.58 per Btu in July, when storage was in a deficit and summer cooling demand was at its peak, down to a low of $5.29 per Btu in December, when the economic slowdown hit industrial and power demand, while supply was still showing significant growth.

 

In the UK, prices at the National Balancing Point averaged 57.97 pence/therm in 2008 compared with 30.02 pence/therm in 2007.

 

The drivers of natural gas prices are more regional than the relatively global nature of crude oil pricing. While the Henry Hub price is a recognised price benchmark in North America, Shell also produces and sells natural gas in other areas that have significantly different supply,

 

 

demand and regulatory circumstances and therefore pricing structures. Natural gas prices in continental Europe and Asia-Pacific are predominantly indexed to oil prices. In both regions, annual average prices have risen reflecting higher oil prices and strong demand during the first three quarters of the year.

 

Oil and natural gas prices for investment evaluation

The range of possible future crude oil and natural gas prices used in project and portfolio evaluations within Shell are determined after assessment of short-, medium- and long-term price drivers under different sets of assumptions. Historical analysis, trends and statistical volatility are part of this assessment, as well as analysis of possible future global and regional economic conditions, geopolitics, OPEC actions, cost of future supply and the balance of supply and demand. Sensitivity analyses are used to test the impact of low-price drivers like economic weakness, and high-price drivers like strong economic growth and low investment levels in new production. Short-term events, such as relatively warm winters or cool summers, weather and (geo)political related supply disruptions and the resulting effects on demand and inventory levels, contribute to price volatility.

 

During 2008, Shell used a grid based on low, medium and high oil and gas prices to test the economic performance of long-term projects. As part of our normal business practice, the range of prices used for this purpose continues to be under review and may change.

Refining and petrochemical market trends

Refining margins were robust in Europe and the Asia-Pacific region in 2008, but trended lower in the USA compared with 2007 when the industry experienced extensive refinery disruptions and prolonged shutdowns. Margins in the USA also came under downward pressure as gasoline demand contracted with the deepening of the economic crisis in the latter half of 2008. The outlook for margins in 2009 is weak with the expectation that advanced economies will be in recession or a period of reduced growth with some knock-on impact on developing economies, at a time when significant new refining capacities are expected to come online globally. However, the eventual margin levels are uncertain and will be strongly influenced by the depth and duration of the recession and the start up timing of expected refinery expansions.

 

During the second half of 2008, the effects of the financial crisis on the economy impacted the chemical industry as industrial demand declined and falling crude and gas prices led to substantial reduction of stock levels. The demand for petrochemicals in 2009 is expected to be depressed. Globally, new additions to industry capacity coupled with the prospect of suppressed economic growth are expected to put continued downward pressure on margins.

 

 

 

RISK FACTORS

Shell’s operations and earnings are subject to risks from changing conditions in competitive, economic, political, legal, regulatory, social, industry, business and financial fields. Investors should carefully consider these risks. If these risks are not adequately managed, they could have a material adverse effect separately or in combination on Shell’s operational performance, earnings or our financial condition.

 

Shell’s operating results and financial condition are exposed to fluctuating prices for oil, natural gas, oil products and chemicals.

Prices of oil, natural gas, oil products and chemicals are affected by supply and demand. Factors that influence supply and demand include operational issues, natural disasters, weather, political instability, or conflicts, economic conditions and actions by major oil-exporting countries. Price fluctuations can have a material effect on our earnings and our financial condition. For example, in a low oil and gas price environment Shell would generate less revenue from its upstream production, and as a result certain long-term projects might become less profitable or even incur losses. Additionally, low oil and gas prices could result in the debooking of oil or natural gas reserves, as they become uneconomic in this type of environment. Prolonged periods of low oil and gas prices, or rising costs, could also result in projects being delayed or cancelled, as well as in the impairment of certain assets. For example, Shell has recently delayed the investment decisions for further expansions of our oil sands activities in Canada as a result of rising costs. In a high oil and gas price environment, we can experience sharp increases in cost and, under some production-sharing contracts, our entitlement to reserves would be reduced. Higher prices can also reduce demand for our products. Lower demand for our products might result in lower profitability, particularly in our downstream businesses.

 

Shell’s future hydrocarbon production depends on the delivery of capital projects, some of them large and complex, as well as the ability to replace oil and gas and oil sands reserves.

In developing capital projects, especially large ones, we face numerous challenges. These include uncertain geology, frontier conditions, the existence and availability of necessary technology and engineering resources, availability of skilled labour, project delays and potential cost overruns, as well as technical, fiscal, regulatory, political and other conditions. Such potential obstacles may impair our delivery of these projects and, in turn, adversely affect our operational performance and financial position (including the financial impact from failure to fulfil contractual commitments related to project delivery). Future oil and gas and oil sands production will depend on our access to new reserves through exploration, negotiations with governments and other owners of known reserves, and acquisitions. Failure to replace proved reserves could result in lower future production.

 

See below Shell’s production and proved oil and gas reserves.

 

 

 

 

Shell’s ability to achieve its strategic objectives depends on our reaction to competitive forces.

We face significant competition in each of our businesses: in obtaining access to raw materials, including oil and gas and oil sands reserves and refinery feedstock; in the sale of our products to customers; in the development of innovative products and solutions, including the development of new technologies necessary to our core upstream and downstream businesses and our alternative energy businesses; and in our search for employees with the skills and experience we need. Increasingly, we compete with state-run oil and gas companies, particularly in seeking access to reserves. Today, these state-run oil and gas companies control vastly greater quantities of oil and gas reserves than the major publicly-held oil and gas companies. State-run entities have access to significant resources and may be motivated by political or other non-economic factors in their business decisions.

 

An erosion of Shell’s business reputation would adversely impact our licence to operate, our brand, our ability to secure new resources and our financial performance.

Shell is one of the world’s leading energy brands, and our brand and reputation are important assets. The Shell General Business Principles and Code of Conduct govern how Shell and our individual companies conduct our affairs. While we seek to ensure compliance with these requirements by all of our over 100,000 employees, it is a significant challenge. Failure – real or perceived – to follow these principles, or other real or perceived failures of governance or regulatory compliance could harm our reputation, which could impact our licence to operate, damage our brand, harm our ability to secure new resources and affect our operational performance and financial condition.

 

Rising climate change concerns could lead to additional regulatory measures that may result in project delays and higher cost.

Emissions of greenhouse gases and associated climate change are real risks to Shell and society in general. In the future, in order to help meet the world’s energy demand, we expect to produce more hydrocarbons from unconventional sources than currently. The production of hydrocarbons from those sources has an energy intensity that is a number of times higher than that for production from conventional sources. Therefore, in the long term, it is expected that the CO₂ intensity of our production will increase. If we are unable to find solutions that reduce our CO₂ emissions for new and existing projects or products, future government regulation or challenges from society could lead to project delays, additional costs as well as compliance and operational risks.

 

The nature of Shell’s operations exposes us to a wide range of significant health, safety, security and environment (HSSE) risks.

Given the geographic range, operational diversity and technical complexity of Shell’s daily operations, our potential HSSE risks cover a wide spectrum. These risks include major process safety incidents; failure

 

 

to comply with approved policies; effects of natural disasters and pandemics; social unrest; civil war and terrorism; exposure to general operational hazards; personal health and safety; and crime. The consequences of such risks materialising can be injuries, loss of life, environmental harm, disruption to business activities and, depending on their cause and severity, material damage to Shell’s reputation.

 

Shell operates in more than 100 countries, with differing degrees of political stability. This exposes us to a wide range of political developments and resulting changes to laws and regulations.

Developments in politics, laws and regulations can and do affect our operations and earnings. Potential developments include forced divestment of assets; expropriation of property; limits on production; import and export restrictions; international conflicts, including war; civil unrest and local security concerns that threaten the safe operation of company facilities; price controls, tax increases, additional windfall taxes and other retroactive tax claims; re-writing of leases; cancellation of contract rights; and environmental regulations. It is difficult to predict the timing or severity of these occurrences or their potential effect upon us. When such risks materialise they can affect the employees, reputation, operational performance and financial position of Shell as well as of the Shell companies located in the country concerned.

 

Our investment in joint ventures and associated companies may reduce our degree of control as well as our ability to identify and manage risks.

Many of our major projects and operations are conducted in joint ventures or associated companies. In certain cases, we may have limited influence over and control of the behaviour, performance and cost of operations in which a Shell company holds an equity interest. Additionally, our partners or members of a joint venture or associated company (particularly local partners in developing countries) may not be able to meet their financial or other obligations to the projects, threatening the viability of a given project.

 

Reliable information technology (IT) systems are a critical enabler of our operations.

Organisational changes and process standardisation, which lead to more reliance on a decreasing number of global systems, outsourcing and relocation of information technology services as well as increased regulations increase the risk that our IT systems may fail to deliver products, services and solutions in a compliant, secure and efficient manner.

 

Shell’s future performance depends on successful development and deployment of new technologies.

Technology and innovation are essential to all of our businesses, including our upstream and oil sands businesses and downstream businesses, as well as our alternative energy businesses. If we do not develop the right technology, do not have access to it or do not deploy it effectively, it may affect the delivery of our strategy, our profitability and our financial condition.

 

Skilled employees are essential to the successful delivery of Shell’s strategy.

Recruiting and retaining staff in sufficient quality and quantity is a prerequisite for the delivery of our strategy. We periodically face shortages in the availability of qualified staff, particularly for our operations in remote or frontier locations.

 

Shell is subject to many legal regimes, with different fiscal and regulatory systems, as well as to changes in legislation.

Changes in legislation, taxation (tax rate or policy), regulation and policies on nationalisation and the seizure of property all pose a risk to our operations. In our upstream and oil sands activities these policies affect

land tenure, entitlement to produced hydrocarbons, production rates, royalties, pricing, environmental protection, social impact, exports, taxes and foreign exchange. Our Oil Products business is subject to price controls in some countries. If we do not comply with these policies, it may result in regulatory investigations, lawsuits, and ultimately fines.

 

Economic and financial market conditions affect our profitability.

Shell companies are subject to differing economic and financial market conditions throughout the world. Political or economic instability affect such markets. If the current worldwide economic downturn deepens or is prolonged, it could contribute to instability. Shell uses debt instruments such as bonds and commercial paper to raise significant amounts of capital. Should our access to debt markets become more difficult, we might not be able to maintain a level of liquidity required to fund the implementation of our strategy.

 

The estimation of reserves is not an exact calculation and involves subjective judgements based on available information.

The estimation of oil and gas and minable oil sands reserves involves subjective judgements and determinations based on available geological, technical, contractual and economic information. The estimate may change because of new information from production or drilling activities or changes in economic factors. It may also alter because of acquisitions and disposals, new discoveries and extensions of existing fields and mines, as well as the application of improved recovery techniques. Published reserves estimates may also be subject to correction due to the application of published rules and guidance.

 

Shell’s Articles of Association determine the jurisdiction for shareholder disputes. This might limit shareholder remedies.

Our Articles of Association generally require that all disputes between our shareholders in such capacity and Royal Dutch Shell or our subsidiaries (or our Directors or former Directors) or between Royal Dutch Shell and our Directors or former Directors be exclusively resolved by arbitration in The Hague, the Netherlands under the Rules of Arbitration of the International Chamber of Commerce. Our Articles of Association also provide that if this provision is for any reason determined to be invalid or unenforceable, the dispute may only be brought in the courts of England and Wales. Accordingly, the ability of shareholders to obtain monetary or other relief, including in respect of securities law claims, may be determined in accordance with these provisions. Please see “Corporate governance and Control of registrant” for further information.

 

Violations of antitrust and competition law pose a financial risk for Shell and expose Shell or our employees to criminal sanctions.

Antitrust and competition laws apply to Shell companies in the vast majority of countries in which we do business. Shell companies have been fined for violations of antitrust and competition law. These include a number of fines by the European Commission Directorate-General for Competition (DG COMP). Due to the DG COMP’s fining guidelines, any future conviction of Shell companies for violation of European Union (EU) competition law could result in significantly enhanced fines. Violation of antitrust laws is a criminal offence in many countries, and individuals can be either imprisoned or fined. Furthermore, it is now common for persons or corporations allegedly injured by antitrust violations to sue for damages.

 

An erosion of the business and operating environment in Nigeria could adversely impact our earnings and financial position.

We face various risks in our Nigerian operations. These risks include security issues surrounding the safety of our people, host communities, and operations, our ability to enforce existing contractual rights, limited infrastructure, difficulty in obtaining a mutually agreeable solution to the

 

 

funding structure and potential legislation that could increase our taxes. These risks could have a material impact on our production, reserves and/or earnings associated with our Nigerian operations.

 

Shell has investments in Iran and Syria, countries against which the US government imposed sanctions. We could be subject to sanctions or other penalties in connection with these activities.

US laws and regulations identify certain countries, including Iran and Syria, as state sponsors of terrorism and currently impose economic sanctions against these countries. Certain activities and transactions in these countries are banned. Breaking these bans can trigger penalties including criminal and civil fines and imprisonment. For Iran, US law sets a limit of $20 million in any 12-month period on certain investments knowingly made in that country, prohibits the transfer of goods or services made with the knowledge that they will contribute materially to that country’s weapons capabilities and authorises sanctions against any company violating these rules (including denial of financings by the US export/import bank, denial of certain export licences, denial of certain government contracts and limits of loans or credits from US financial institutions). However, compliance with this investment limit by European companies is prohibited by Council Regulation No. 2271/96 adopted by the Council of the EU, which means the statutes conflict with each other in some respects. While Shell did not exceed the limit on investments in Iran in 2008, we have exceeded it in the past and may exceed the US-imposed investment limits in Iran in the future. While we seek to comply with legal requirements in our dealings in these countries, it is possible that Shell or persons employed by Shell could be found to be subject to sanctions or other penalties under this legislation in connection with their activities in these countries.

 

Shell faces property and liability risks and does not insure against all potential losses.

Shell companies are exposed to property and liability risks, for example from natural disasters such as hurricanes, civil war or unrest, and terrorism, that can result in business interruptions and casualty losses, and we do not insure against all potential losses and, therefore, we could be seriously harmed by unexpected events or liabilities. We may be subject to losses that could affect our earnings or financial condition.

 

Shell’s business model involves trading, treasury and foreign exchange risks.

Trading and treasury risks include among others exposure to movements in commodity prices, interest rates, and foreign exchange rates, counter

party default and various operational risks (see also page 101). As a global company doing business in over 100 countries, we are exposed to changes in currency values and exchange controls. While Shell does undertake some currency hedging, we do not do so for all of our activities. The resulting exposure could affect our earnings and cash flow. See Notes 5 and 25 to the Consolidated Financial Statements.

 

Shell has substantial pension commitments, whose funding is subject to capital market risks.

The risk regarding pensions is the ability to fund defined benefit plans to the extent that the pension assets fail to meet future liabilities. Liabilities associated with and cash funding of pensions can be significant and are dependent on various assumptions. Volatility in capital markets, such as occurred in 2008, and the resulting consequences for investment performance and interest rates, may result in significant changes to the funding level of future liabilities. In case of a shortfall, Shell might be required to make substantial cash contributions, depending on the applicable regulations per country. In 2008, the value of the assets in our pension plans decreased and at year end the present value of pension obligations exceeded plan assets by $8.3 billion. See “Liquidity and capital resources” for further discussion.

 

Shell companies face the risk of litigation and disputes worldwide.

From time to time cultural and political factors play a significant role in unprecedented and unanticipated judicial outcomes contrary to local and international law. In addition, certain governments, states and regulatory bodies have, in the opinion of Shell, exceeded their constitutional authority by attempting unilaterally to amend or cancel existing agreements or arrangements; by failing to honour existing contractual commitments; and by seeking to adjudicate disputes between private litigants. Adverse outcomes in these areas could have a material effect on our operations and financial condition.

 

Shell is currently under investigation by the United States Securities and Exchange Commission and the United States Department of Justice for violations of the US Foreign Corrupt Practices Act.

In July 2007, Shell’s US subsidiary, Shell Oil, was contacted by the US Department of Justice regarding Shell’s use of the freight forwarding firm Panalpina, Inc and potential violations of the US Foreign Corrupt Practices Act (FCPA) as a result of such use. Shell has an ongoing internal investigation and is co-operating with the US Department of Justice and the US Securities and Exchange Commission investigations. While these US investigations are ongoing, Shell may face fines and additional costs.

 

 

 

SUMMARY OF RESULTS

KEY FEATURES

 

 

EARNINGS 2008 COMPARED TO 2007 AND 2006

In a highly volatile business environment, Shell delivered satisfactory operational and financial performance in 2008, resulting in earnings of $26.5 billion. Shell’s financial position allowed us to return $13.1 billion to shareholders, through dividends and share repurchases, while capital investment reached $38.4 billion (see page 6). The 2008 dividend increased 11% to $1.60 per share compared to $1.44 in 2007.

 

Return on average capital employed (ROACE)[A] for 2008 was 18.3% compared with 23.7% for 2007.

 

The most significant factors affecting year-to-year comparisons of earnings and cash flow generated by our operating activities are changes in realised prices for crude oil and natural gas; crude oil, natural gas and oil sands (bitumen) production levels; and refining and marketing margins.

 

Earnings in 2008 were 17% lower than in 2007, when they were 21% higher than in 2006. The decrease in 2008, compared with 2007, reflected the effect of declining oil prices on inventory in the second half of the year, lower production volumes, lower realised refining margins and higher operating costs. These more than offset the positive impact on earnings from higher realised oil and gas prices as well higher LNG and GTL product prices. Oil and gas production in 2008, including oil sands production, was 3,248 barrels of oil equivalent per day (boe/d) compared to 3,315 boe/d in 2007. The change reflected the effects of various factors, positive and negative, including field declines, production from new fields, divested volumes, shutdowns due to hurricanes and price impacts of production-sharing contracts.

 

In 2008, Exploration & Production earnings were $20,235 million, 38% higher than in 2007 and 39% higher than in 2006. Earnings in 2008 reflected the impact of higher realised oil and gas prices, which were partly offset by lower production volumes, higher exploration expenses and higher taxes and royalties. In 2007 earnings increased 1% on 2006, reflecting the impact of higher realised oil and gas prices, which were partly offset by lower production volumes, higher exploration expenses and higher costs, reflecting industry conditions.

 

Gas & Power earnings were up 92% in 2008 reaching $5,328 million, compared with $2,781 million in 2007 and $2,633 million in 2006. The 2008 earnings reflected strong LNG and GTL prices and a net gain of $1,302 million, mainly related to the divestment of the BEB Erdgas und Erdoel GmbH gas transport business in Germany. The increase in 2007 earnings compared with 2006 reflected increased LNG sales volumes, strong LNG and GTL prices, and a net gain of $275 million mainly related to the sale of common units in Enterprise Products Partners LP. This was partly offset by lower earnings from marketing and trading activities. LNG sales volumes of 13.05 million tonnes (mt) in 2008 were 1% lower compared with 13.18 mt in 2007. LNG sales volumes in 2007 showed an increase of 9% compared to 12.12 mt in 2006, due to growth in Nigeria.

 

Oil Sands earnings were $941 million in 2008 compared with $582 million in 2007 and $651 million in 2006. In 2008 earnings benefited from higher average oil prices partly offset by higher operating costs and lower bitumen production compared with 2007. The 2007 earnings decreased compared with 2006 due to an unplanned shutdown in September and a fire in November at the Scotford Upgrader, higher operating and maintenance costs and increased royalty expenses, which were partly offset by the impact of higher oil prices and a favourable tax adjustment of $94 million.

 

Oil Products earnings in 2008 were $446 million compared with $10,439 million in 2007 and $7,125 million in 2006. After taking into account the impact of falling crude prices on our inventory, the 2008 earnings reflected higher operating costs and lower realised margins in the USA compared to 2007. In 2007, after taking into account the impact of increasing crude prices on our inventory, earnings were impacted by lower realised refining margins in the second half of 2007, a lower trading contribution and higher operating costs compared to 2006.

 

Chemicals losses were $405 million in 2008 compared with earnings of $2,051 million in 2007 and $1,064 million in 2006. The change in 2008 compared with 2007 results from significantly lower margins, lower income from equity-accounted investments and higher operating expenses. The higher earnings in 2007 compared with 2006 reflected higher margins, higher earnings from equity-accounted investments and lower fixed costs, which were partly offset by a reduced trading contribution.

 

BALANCE SHEET AND CAPITAL INVESTMENT

Shell’s strategy to invest in the development of major growth projects, primarily in the upstream businesses of Exploration & Production and Gas & Power, explains the most significant changes to the balance sheet in 2008. Property, plant and equipment increased by $10.5 billion in 2008 as capital investment increased by 42% compared with 2007 reaching $38.4 billion. This was partly offset by depreciation, depletion and amortisation of $13.7 billion. Of the total capital investment, $32.2 billion related to upstream and oil sands projects and acquisitions that will primarily deliver organic growth over the long term. These projects include several multi-billion dollar, integrated facilities that should provide significant cash flow for the coming decades. The capital investment programme in 2008 was primarily funded internally, either from cash from operations of $43.9 billion or with proceeds from divestments of $6.3 billion. Overall total equity increased $2.9 billion in 2008 resulting in a year-end balance of $128.9 billion. The balance sheet gearing ratio was 5.9% at the end of 2008, compared with 6.3% at the end of 2007. The adjusted gearing ratio increased from 16.6% at the end of 2007 to 23.1% at the end of 2008 reflecting the change to an under-

 

 

funded position of retirement benefit obligations. See Note 18[D] to the Consolidated Financial Statements for further discussion on gearing.

 

OUTLOOK

We want to maintain and enhance our competitive position and provide investors with a competitive and sustained total shareholder return. We plan net capital investment of $31-32 billion in 2009 (net capital investment represents capital investment, less divestment proceeds). This amount relates largely to investments in projects where the final investment decision already has been taken or is expected to be taken in 2009. The majority of our capital investment will be in upstream, including LNG and GTL, and oil sands projects. The remainder will be invested in downstream on improving or expanding our oil products and chemicals business.

 

The credit crisis and volatile commodity prices that emerged in the second half of 2008 affected many aspects of the business environment. Many of these effects will probably continue or increase with potential impact on our partners, customers and suppliers. We will continue to manage our exposures as well as costs carefully while maintaining our long-term strategy. See “Liquidity and Capital Resources” for further discussion.

 

In the longer term, reserve replacement of oil and gas and minable oil sands reserves will affect the ability of Shell to continue to maintain or increase production levels in Exploration & Production and Oil Sands, which in turn will affect our earnings and net cash from operating activities. We will need to take measures to maintain or increase production levels and cash flows in future periods, which may include developing new fields and mines, continuing to develop and apply new technologies and recovery processes to existing fields and mines and

making selective focused acquisitions. However, our investment decision-making will focus on generating value rather than specific reserves or volume targets.

 

It is our intention to continue to divest and, where appropriate, make selective acquisitions as part of active portfolio management. The level of this activity will depend on market opportunities.

 

Oil and gas production in 2009 is expected to be broadly similar to, or slightly down on, 2008 levels. Shell expects oil and gas production and LNG, refining and chemicals capacity to increase in the medium term. Actual growth each year will depend on project start-ups, portfolio management actions and project contracting conditions, among other factors.

 

PERFORMANCE AND CAPITAL

Please refer to pages 56-61 for discussion of key performance indicators and liquidity and capital resources.

 

PRODUCTION AND RESERVES

Total oil and gas production was 1,160 million boe for 2008. Production from subsidiaries was 846 million boe and 314 million boe from equity-accounted investments. After taking into account production we had a net increase of 404 million boe in proved oil and gas reserves from subsidiaries while the Shell share of proved oil and gas reserves from equity-accounted investments decreased by 315 million boe.

 

These totals reflect the net positive volume impact of year-end price changes of approximately 19 million boe for 2008; in 2007 the impact was a reduction of 183 million boe and a reduction of 59 million boe for 2006. See “Exploration & Production – Proved reserves” for further discussion.

 

 

 

EXPLORATION & PRODUCTION

KEY FEATURES