Independent Auditor’s Report to the members of Shell plc

Identifying key audit matters (Section 6)

The key audit matters that we identified in the 2022 audit were:

• impact of climate change and the energy transition on the Consolidated Financial Statements;
• estimation of oil and gas reserves;
• impairment assessment of property plant and equipment (PP&E) and joint ventures and associates (JVAs);
• accounting for complex transactions within Shell’s trading and supply function and the valuation of financial derivatives.

Assessing materiality (Section 7)

We based materiality on normalised Adjusted Earnings on a pre-tax basis. This approach removes both the effects of changes in oil price on inventory carrying amounts and non- recurring gains and charges disclosed as identified items, which can significantly distort Shell’s results in any one particular year. By applying a normalised Adjusted Earnings approach, we concluded that it was appropriate to set planning materiality at $1.2 billion. We adopted the following materiality measures in our 2022 audit:

Determining the scope of our audit (Section 8)

Our scope was tailored to the circumstances of our audit of Shell and is influenced by our determination of materiality and our assessed risks of material misstatement. Similar to the prior year, during the course of the 2022 audit, we did not make any substantial changes to our assessment of the components where we performed full or specific scope audit procedures, nor the number of IT applications to test; however, what did change was the nature and emphasis of our testing in response to our significant audit risks and areas of audit focus. By following this approach, our audit effort focused on higher risk areas, such as management judgements.

The impact of climate change and the energy transition on the Consolidated Financial Statements

Description of the key audit matter

The financial statement and audit risks related to climate change and the energy transition remain an area of audit focus in 2022. This is due to the continuing uncertainty surrounding the impact of climate change and the pervasive impact it has on many areas of accounting judgement and estimation and, therefore, our audit.

Climate related issues impact Shell in many ways, as set out in Our journey to net zero, within the Strategic report, which forms part of the “Other information,” rather than the audited financial statements. Within this section, Shell have described how climate-related issues are considered when reviewing and guiding strategy, major plans of action and risk management policies, annual budgets, and business plans. Shell also identified climate-related risks and opportunities in this section and in Risk factors, which form part of the “Other information,” rather than the audited financial statements.

In Note 4 to the Consolidated Financial Statements, Shell describe how they consider climate related impacts and their stated emissions reduction targets in key areas of the Consolidated Financial Statements and how this translates into the valuation of assets and measurement of liabilities.

In carrying out our audit, we have focused on the alignment of assumptions adopted by Shell in the preparation of their financial statements with commentary on climate change within their Strategic Report, which includes the Powering Progress strategy. We also focused on how Shell had reflected material climate change risks in their financial statements, including the impact of the emissions reduction targets on accounting estimates and judgements.

In focusing on how Shell has the reflected material climate change risks in Shell’s Consolidated Financial Statements, we have considered:

1. how Shell’s assumed future commodity price assumptions compare to energy transition scenarios;
2. the reasonableness of Shell’s forecast future carbon costs;
3. the incorporation of Shell’s stated emissions reduction targets within Shell’s operating plan (OP22);
4.  the carbon intensity of Shell’s assets;
5. the useful economic lives of assets beyond 2030 and the risk of material stranded assets; and
6. how physical risk considerations have been incorporated into Shell’s asset plans.

The critical accounting judgements and estimates that are impacted by climate change and the energy transition are disclosed within Note 4 to the Consolidated Financial Statements.

Our response to the risk

Overall response

In order to respond to the impact of climate change and the energy transition on our audit, we ensured that we had the appropriate skills and experience on the audit team. Our group engagement team included professionals with significant experience in climate change and the energy transition. Most of the audit procedures were performed by the group engagement team. Where work was carried out by component teams, this was under the direction of team members with significant experience in climate change.

In addition, during the planning phase of our audit, the group engagement team, including climate change and sustainability specialists, held a series of climate change risk workshops. In these workshops, the team focused on industry and regulatory developments on climate change and how these developments apply to Shell’s business. The team also assessed the transition and physical climate risks facing Shell’s business, the audit risks associated with climate change and our planned audit response. An output from the workshop was a specific audit plan to address climate change risk in the 2022 audit, the key aspects of which are set out below.

In designing our audit procedures, we considered the CA 100+ Climate Accounting and Audit Alignment assessment of Shell, published by Carbon Tracker. We also considered the content of the document entitled “Investor Expectations for Paris-aligned Accounts”, published on 5 November 2020 by the Institutional Investors Group on Climate Change (IIGCC), which was reiterated in a letter that EY received from Sarasin and Partners on 29 November 2022 titled Investor expectations: net zero-aligned accounts. The group engagement partner also met with the head of stewardship at Sarasin and Partners to discuss the IIGCC document.

The procedures performed to address the climate risks included:

Alignment of statements made in Strategic Report with the financial statements

• in connection with our audit of the financial statements, we read the Other information in the Annual Report and Accounts (as defined in section 9 below) and, in doing so, considered whether the Other information, which includes Shell’s climate targets, are materially consistent with the financial statements or our knowledge obtained in the audit;
• evaluated whether the effects of material climate risks, as disclosed within Our journey to net zero, within the Strategic report, had been appropriately reflected in asset values and associated financial statement disclosures, and in the timing, nature and measurement of liabilities recognised in accordance with IFRS, which is discussed further below;
• read and challenged the completeness of management’s disclosures in Note 4. We audited the sensitivity disclosures in Note 4 of the carrying value of Shell’s Upstream and Integrated Gas PP&E assets to a range of future oil and gas price assumptions, reflecting reduced demand scenarios due to climate change and the energy transition, including the IEA Net Zero Emissions by 2050 scenario. This included considering whether the downside sensitivities could have reduced the level of Shell’s distributable profits such that their 2022 dividends and repurchases of shares would not have been in compliance with the Companies Act. We also considered the appropriateness of the estimated useful lives of Shell’s refineries; and
• assessed whether the various climate change litigations represented obligations where the likelihood of a cash outflow was probable and therefore requiring provision. Also, we considered the appropriateness of the climate change litigation disclosures within Note 31, Legal proceedings and other contingencies, by comparing the disclosures to our understanding of the claims and allegations.

The reflection of material climate change risks and the impact of Shell’s emissions reduction target in the critical accounting estimates and judgements

• tested management’s internal controls over the identification and estimation of costs of the potential impacts associated with energy transition and climate change, and related financial statement disclosures in Note 4;
• made enquiries of Group Planning, Group Reporting, Shell’s Carbon Strategy group and, where necessary, individual asset managers to understand and challenge management on how the following five transition and one physical risks of climate change were being factored into Shell’s financial statements:

1) The comparison of commodity price assumptions to energy transition scenarios

• compared Shell’s oil and gas price assumptions to energy transition scenarios such as the International Energy Agency (‘IEA’) Announced Pledges Scenario ('APS’) and Net Zero Emissions ('NZE50’)
• considered specifically the extent to which management’s mid-price outlook and production assumptions incorporated the potential impact of climate change and the energy transition. This included consideration of assumed hydrocarbon and renewables demand and the impacts of such demand movements and supply constraints on future prices;
• evaluated the reasonableness of Shell’s refining and petrochemical margin assumptions, by comparing Shell’s assumptions to external benchmarks, in light of the expected impact on demand for oil products in a transition to a net zero economy. Refining margin and petrochemical assumptions underpin the recoverable amount of refineries and petrochemical plants respectively;

2) The reasonableness of Shell’s forecast future carbon costs

• engaged our climate change and sustainability specialists to consider the appropriateness of Shell’s carbon pricing methodology adopted and the reasonableness of the carbon prices applied in 10 countries. As part of this, we independently determined our view of a range of acceptable carbon price assumptions. Where countries were outside of our benchmarking ranges, we performed sensitivity analysis to determine if the impact of these different assumptions was material; and
• performed sensitivity analysis using the carbon price assumptions in both the IEA NZE50 and APS scenarios.

3) The incorporation of emissions reductions targets into Shell’s 2022 operating plan

• confirmed that Shell’s operating plan (OP22), included costs associated with Shell’s plans to achieve Scope 1 and 2 emission reduction targets and their and net carbon intensity (‘NCI’) targets; and
• challenged the basis of assumed oil product sales reductions and power sales increases by comparing the assumptions applied in OP22 to external demand outlooks. We evaluated whether necessary renewable energy certificates and carbon credits, carbon storage plans and increased asset energy efficiencies included in OP22 were supported by executable plans by assessing whether the expected impact was based on historical experience and whether capital had been allocated to the project.

4) The carbon intensity of Shell’s assets

• in order to identify assets that we regarded as carbon intensive (which we set at approximately 40kg/boe), we used our Climate Risk data analytics tool to identify correlations between reserves, production and emissions data; and
• for assets that we identified as carbon intensive that are expected to have material carrying value in 2030, we evaluated the risk that the carrying value of these assets will not be recovered. This included considering the decarbonisation plans of these assets and the associated costs.

5) The useful economic lives of assets beyond 2030 and the risk of stranded assets

• verified that the oil, gas and carbon price sensitivity disclosures in Note 4 incorporated life of field assumptions; and
• estimated the carrying amount of the assets that were not forecast to be fully depreciated by 2050 to assess the risk of stranded assets beyond 2050.

6) Whether physical risk considerations have been incorporated into the asset plans

• with assistance from our climate change specialists, we performed a risk assessment on Shell’s assets from a physical risk perspective. The assessment considered asset and geographic specific factors to assign a physical risk exposure rating to Shell’s assets. Our assessment also considered forecast increased temperatures, forecast occurrence of hurricanes and rising sea levels.
• in order to assess whether these increased physical risks represented a trigger for impairment, we obtained an understanding of how management has incorporated historic, current and potential future risk into asset integrity plans.

Our audit response relating to oil and gas reserves and the impairment of PP&E and JVAs is included in the KAMs below.

Key observations communicated to the Shell Audit Committee

We reported to the Audit Committee the key procedures that we had performed and the results of those procedures, which are set out below:

Alignment of statements made in Strategic Report with the financial statements

• We reported that we had not identified any material inconsistencies between Shell’s disclosures in Note 4 to the Consolidated Financial Statements, which covers the material impacts of climate-related matters, and the disclosures included within the Other information.
• We reported that the various climate change litigations involving Shell did not represent obligations where the likelihood of a cash outflow is probable. We also reported that, based on our understanding of the claims and allegations, we were satisfied with the disclosures within Note 31, Legal proceedings and other contingencies.

The reflection of material climate change risks and the impact of Shell’s emissions reduction target in the critical accounting estimates and judgments

1) the comparison of Shell’s assumed future commodity price assumptions to energy transition scenarios

• We reported that Shell’s long-term oil and gas price assumptions and margin assumptions were reasonable and represent management’s current best estimate of the range of economic conditions that will exist in the foreseeable future. We have included our observations on Shell’s price assumptions, including margins, within the impairment of PP&E key audit matter in section 4 above.
• We concluded Shell’s oil and gas price assumptions are broadly in line with the IEA APS scenario from 2024 onwards. Shell’s Brent price assumption for 2023 is 16% higher than the APS assumption; however, we were satisfied that Shell’s assumptions remain appropriate for 2023 as there is more external evidence to support price assumptions in the short term.

2) the reasonableness of Shell’s forecast future carbon costs

• We concluded that Shell had adopted an appropriate methodology to forecast carbon prices. Also, through our independent testing, we verified that Shell’s forecast carbon prices were within a reasonable range, other than for four countries. We have performed sensitivity analysis and we are satisfied that for the material assets in these countries: (1) there is sufficient headroom within the assets in these countries such that there is no impairment; and (2) these differences would not have a material impact on the overall carbon costs included in OP22.
• Our sensitivity analysis indicated that applying the IEA NZE50 carbon prices would not have a material impact on asset valuation, as the additional operating cost per annum is less than 2% of actual operating expenses in 2022. 

3) the incorporation of Shell’s stated climate targets within Shell’s operating plan

• We reported that Shell’s operating plan reflected the expected financial impact of management’s current planned actions to address these climate change risks. We confirmed that the operating and capital expenditure estimates to deliver the emissions reductions were included in the operating plan. Where impairment assessments were performed, we are satisfied that the climate change factors had been reflected in the assessments throughout the field life of the asset.
• We have confirmed that the operating and capital expenditure estimates for the main assumed climate-related changes, including assumed oil product sales reductions, power sales increases, necessary renewable energy certificates and carbon credits, carbon storage plans and increased asset energy efficiencies, were supported by formal plans and the related costs were included in OP22. We also reported Shell’s assumed reductions in oil product sales on a percentage basis was more than the decrease in oil products demand in IEA’s APS and NZE50 scenario.

4) the carbon intensity of Shell’s assets

• For assets that we assessed as carbon intensive, we are satisfied that the operating plan forecast expenditure included the expected costs of decarbonisation plans, thereby reducing the risk that the carrying value of these assets will not be recovered.

5) the useful economic lives of assets beyond 2030 and the risk of material stranded assets

• For Shell’s Upstream and IG assets, which are around $148 billion as at 31 December 2022, we projected the carrying value to 2050. We have estimated the 2050 carrying amount of current Upstream and IG assets, based on SEC reserves. We have estimated approximately 10 assets would remain on the balance sheet in 2050, which would have an individual carrying value of less than our performance materiality. On this basis, we were satisfied that the risk of there being a material stranded assets in 2050 was low. We estimated the carrying value of Shell’s Oil Mining Sands in 2050 and we were satisfied that by 2050, the carrying amount will be immaterial. We also concluded that there was a low risk of Shell’s current refineries being stranded as the assets are expected to be fully depreciated in the next 15 years.
• Also, based on the climate risk factors we considered for each of the assets that we identified as higher risk from a climate perspective, we assessed the headroom in the most recent impairment models, the alignment of long term oil and gas price to IEA and the reasonableness of the costed plans in place to decarbonise the assets within the OP22 period and overall we concluded there was no impairment trigger arising from the impact of climate change in the 2022 financial statements.

6) whether physical risk considerations have been incorporated into Shell’s asset plans

• We concluded Shell have adequately considered physical risks in asset integrity plans and are satisfied that there was no impairment triggers.

Other observations

• We reported that management’s controls over the identification and estimation of costs of carbon emissions, the potential financial statement impacts associated with climate change and energy transition, and the related financial statement disclosures, were designed and operating effectively.
• The E&E assets ($6.4 billion) that are being carried are consistent with both OP22 and Shell’s strategy. Our independent assessment of the appropriateness of carrying the E&E assets included consideration of their strategic fit and their carbon intensity. The assets that we assessed as being on our watch-list have decreased compared to 2021 and are now below our planning materiality level. We were satisfied that it remains appropriate to continue to carry these assets whilst the technical feasibility and commercial viability of extracting commercial reserves are still being assessed.
• $1 billion of Deferred Tax Assets (DTAs) are expected to be utilised by taxable profits that are forecast to be generated beyond OP22. The most significant judgements relate to the DTAs in countries where Shell primarily has a downstream presence where $0.2 billion is recognised against profits arising beyond OP22. However, the recognition of DTAs against profits beyond OP22 in these jurisdictions has decreased significantly from the prior year (2021: $0.8 billion) primarily as a result of utilisation of losses driven by increased profits from higher energy prices. As a result, the risk that there will be a material error in the recognition has decreased significantly. We are satisfied that the DTA recognition appropriately reflects climate and energy transition risk.
• Our procedures included consideration of the impact of our climate change findings on expected Decommissioning & Restoration (D&R) timing, including the recoding of D&R provisions for six refineries. We concluded that the Decommissioning & Restoration provisions are fairly stated.
• With regards to the sensitivity analyses provided by Shell in Note 4 to the Consolidated Financial Statements, including commodity and carbon prices, refining margins and the discount rate applied for impairment assessments, we were satisfied that the descriptions of the sensitivities reflected the sensitivities performed. Also, the prices and assumptions applied by Shell in their calculations were agreed to the scenarios as described. We reperformed the sensitivities and were satisfied that the ranges disclosed by Shell in Note 4 were materially correct, including the illustrative disclosures on the impact of commodity prices averaged from three 1.5-2 degrees Celsius external climate change scenarios and from the IEA NZE50 scenario.
• We reported to the Audit Committee that we had considered Shell’s dividend resilience statement in Note 4. Had Shell applied the IEA NZE50 scenario, and had this impairment of $23 billion directly reduced the carrying value of investments within the Parent Company, Shell plc, this would not have impacted the distributable reserves available to Shell from which to pay dividends in 2022. This is on the basis that Shell plc had a merger reserve of $234 billion and under Companies Act 2006, the adverse impact from an impairment would be on the merger reserve as opposed to distributable reserves.

Our audit observations relating to oil and gas reserves and impairment of PP&E and JVAs are included in the KAMs below.

---

Cross-reference: See the Audit Committee Report on page 172 for details on how the Audit Committee reviewed climate change and energy transition. See the Strategic Report on pages 83 to 87 for details on energy transition strategy. Also, see Notes 2, 4, 12, 13 and 31 to the Consolidated Financial Statements.

The estimation of oil and gas reserves

Description of the key audit matter

This is a forecast-based estimate. Oil and gas reserves estimates are used in the calculation of depreciation, depletion and amortisation (DD&A), impairment testing and in the estimation of decommissioning and restoration (D&R) provisions. The risk is the inappropriate recognition of proved reserves that impacts these accounting estimates. Given the current environment, there may be a heightened risk of proved reserves with a high carbon intensity not ultimately being produced (also see climate change and energy transition key audit matter).

As described in Notes 12 and 13 to the Consolidated Financial Statements, at December 31, 2022, production assets amounted to $117.4 billion and had an associated DD&A charge of $9.7 billion and joint ventures and associates (JVAs) amounted to $23.9 billion. As further described in Note 12, exploration and production impairment losses of $0.9 billion and exploration and production impairment reversals of $6.0 billion were recorded during the year. As described in Note 24 to the Consolidated Financial Statements, D&R provisions amounted to $20.3 billion.

If proved reserves are recognised that are not ultimately produced, depreciation will be understated, and the recoverable amount of assets may be overstated. In-year reserve movements are driven by revisions of previous estimates resulting from reclassifications, changes to recovery assumptions, extensions and discoveries and purchases and sales of reserves in place. Revisions generally arise from new information, for example additional drilling results, changes in production patterns and changes to development plans, which are an input to the cash flows used in the measurement of production assets and D&R provisions.

Auditing the estimation of oil and gas reserves is complex. There is significant estimation uncertainty in assessing the quantities of reserves and resources in place. The estimates are based on the Company’s central group of experts’ assessments of petroleum initially in place, production curves and certain other inputs, including forecast production volumes, future capital and operating cost assumptions and life of field assumptions. Estimation uncertainty is further elevated given the transition to a low-carbon economy, which increases the risk of underutilised or stranded oil and gas assets.

Our response to the risk

We obtained an understanding of the controls over Shell’s oil and gas reserves’ estimation process. We then evaluated the design of these controls and tested their operating effectiveness. For example, we tested management’s controls over review of changes to year-on-year estimated oil and gas reserves volumes.

Our substantive audit procedures provided coverage of 69% of proved reserves.

We involved professionals with substantial oil and gas reserves audit experience in evaluating the key assumptions and methodologies applied by management.

Our procedures included, amongst others:

• testing that significant additions or reductions in reserves had been made in the period in which the new information became available, by understanding the change in circumstance that drove the change;
• verifying that reserve movements were in compliance with Shell’s reserves and resources guidance and SEC regulations;
• evaluating the professional qualifications and objectivity of management’s experts who performed the detailed preparation of the reserve estimates and those who are primarily responsible for providing independent review and challenge, and ultimately endorsement of, the reserve estimates. This covered around 20 individuals involved in the process;
• evaluating management’s estimation of the point at which the operating cash flow from a project becomes negative (the economic limit), as this impacts DD&A and impairment. Where relevant, we assessed whether the economic limit test incorporated Shell’s estimate of future carbon costs to reflect the potential impact of climate change and the energy transition;
• evaluating the completeness and accuracy of the inputs used by management in estimating the oil and gas reserves by agreeing the inputs to source documentation;
• performing back-testing of historical data to identify indications of estimation bias over time;
• attending nine of Shell’s Upstream Reserves Committee meetings to observe the internal review and endorsement process. These meeting are part of Shell’s proved reserves assurance process, which is described on page 308;
• we focused our audit procedures on those assets that are currently forecast to be producing beyond 2030 and the carbon intensity of the post 2030 production from those fields in order to identify assets that are carbon intensive, where there may be a higher risk of the reserves not ultimately being produced. The purpose of performing such analysis was to identify assets that were at higher risk of the current net book value being overstated. For volumes expected to be produced beyond 2050, we further analysed those assets with the most significant carrying amounts and assessed whether or not the expected production profile was consistent with Shell’s NZE ambitions.

Our procedures were led by the group engagement team, with input from our teams in Australia, Brazil, Canada, Malaysia, Nigeria, Qatar, and the USA.

Key observations communicated to the Shell Audit Committee

We reported to the Audit Committee in January 2023 that the inputs and assumptions used to estimate proved reserves and resources were reasonable. Also, we also reported that we had not identified any impairment triggers as a result of any of the movements in reserves during the year. In our view, Shell follows a robust process for recognising oil and gas reserves.

We found no contra indicators that the recognition of the reserve volumes expected to be lifted beyond 2030 results in the overstatement of Shell’s balance sheet by overstating the recoverable amounts of Shell’s assets or understatement of D&R liabilities. For the reserves and resources that were expected to be produced post 2050, we were satisfied that this was not inconsistent with Shell’s NZE ambitions and that it remains appropriate to recognise these reserves.

Please see key audit matter on the impact of climate change and the energy transition on the financial statements for details of our considerations on the carbon intensity associated with reserves expected to be produced beyond 2030.

---

Cross-reference: See the Audit Committee Report on page 172 for details on how the Audit Committee reviewed assurances for oil and gas reserves. Also, see Notes 2, 4, 12 and 24 to the Consolidated Financial Statements and Supplementary information – oil and gas (unaudited) on page 308.

Impairment of Property, plant and equipment (PP&E) and Joint ventures and associates (JVA)

Description of the key audit matter

This is a forecast-based estimate. The risk is that potential impairments are not identified on a timely basis, including whether the impacts of climate change and the energy transition have been considered in Shell’s impairment trigger assessments (also see climate change and energy transition key audit matter).

As described in Notes 12, and 13 to the Consolidated Financial Statements, at December 31, 2022 Shell recognised $117.4 billion of production assets, $49.9 billion of manufacturing, supply and distribution assets (primarily refineries and petrochemical plants) and $23.9 billion of joint ventures and associates (JVAs). As disclosed in Note 12, in 2022, Shell recognised $1.8 billion impairment losses and $6.2 impairment loss reversals. As discussed in Note 13, Shell recognised an impairment loss of $1.6 billion related to the withdrawal from Russian oil and gas activities.

As Shell recorded pre-tax impairment charges of $26.7 billion of PP&E and JVAs in 2020, the recoverable amounts are sensitive to smaller changes in key assumptions, which increases the risk of indicators of impairment or impairment reversal not being identified. Our audit effort has therefore focused on the completeness and timely identification of indicators of impairment charges or impairment reversals.

Auditing the impairment assessments is subjective due to the significant amount of judgement involved in determining whether indicators of impairment or impairment reversal exist, particularly for longer term assets. Indicators should reflect significant upward or downward revisions in assumptions impacting the future potential long-term value of an asset, rather than drivers of short-term fluctuations in value.

Assumptions underpinning the impairment or impairment assessments include:

• changes in forecast oil and gas prices, in particular over the mid-to-long term;
• changes in petrochemical and refining margin assumptions;
• movements in oil and gas reserves;
• the assumed weighted average cost of capital (WACC);
• cash generating units (CGUs) assessments, which sets the level upon which impairment assessments are considered; and
• individual asset impairment assessments including the impacts of Shell’s withdrawal from Russian oil and gas activities.

As described in Note 2, the most complex of these judgements relate to management’s view on the long-term oil and gas price outlook. Forecasting future prices is inherently difficult, as it requires forecasts that reflect developments in demand such as global economic growth, technology efficiency, policy measures and, on the supply side, consideration of investment and resource potential, cost of development of new supply and behaviour of major resource holders. These judgements are particularly difficult because of increased demand uncertainty and pace of decarbonisation due to climate change and the energy transition.

Our response to the risk

We obtained an understanding of the controls over Shell’s asset impairment process. We then evaluated the design of these controls and tested their operating effectiveness. For example, we tested the controls over management’s identification of indicators of impairment and reversals of impairment and the approval of oil and gas prices and petrochemical and refining margins.

Our procedures included, amongst others:

Oil and gas prices

• assessing the reasonableness of future short and long-term oil and gas price assumptions by comparing these to an independently developed reasonable range of forecasts based on consensus analysts’ forecasts and those adopted by other energy companies;
• given the continued improvement in commodity prices and short-term refining margins, assessing whether these higher price markers represented a trigger for impairment reversal; and
• comparing Shell’s oil and gas price scenarios to the IEA’s Net Zero Emissions 2050 (NZE50) and to the IEA’s APS price assumptions as potential contradictory evidence for best estimates of future oil and gas prices. The APS assumes that all climate commitments made by governments around the world, including Nationally Determined Contributions (NDCs) and longer-term net zero targets, will be met in full and on time.

Petrochemical and refining margins

• we involved our valuations specialists to assess the reasonableness of Shell’s margin estimation methodologies and assumptions;
• evaluating the reasonableness of Shell’s refining margin assumptions by comparing these to independent market and consultant forecasts;
• as there are only a few market consultants who forecast petrochemical product prices and there are no consultant forecasts of chemical margins, we evaluated the reasonableness of Shell’s petrochemical margin assumptions by independently projecting margins. We did this by using regression analysis and performing correlation analysis of historical product prices to historical margins to cross check future external prices to assumed margins; and
• considering whether the downward pressure on petrochemical margins represented an impairment trigger by assessing the impact of reduced margins in the context of the overall lives of Shell’s petrochemical facilities.

Oil and gas reserves

• see oil and gas reserves key audit matter.

WACC

• with the assistance of valuation specialists, independently assessing a range of reasonable input assumptions for calculating Shell’s WACC; and
• assessing whether Shell’s risking in their impairment assessments, through both a discount rate and individual asset cashflows, adequately reflects the risks associated with Shell’s different classes of assets.

CGUs

• challenging management’s identification of CGUs based on industry practice and how cash flows are generated.

Individual assessments

• evaluating Shell’s assessment of impairment losses and impairment reversal triggers, including changes in the forecast commodity price assumptions, movements in oil and gas reserves (see oil and gas reserves key audit matter), changes in asset performance, changes in Shell’s operating plan assumptions, including those relating to Shell’s carbon emissions reductions targets, and whether these are indicators of impairment or impairment reversal;
• separately from management, for material assets, we also assessed independently whether or not indicators of impairment or reversal triggers exist and considered the existence of contradictory evidence such as external commentary on asset performance, which could indicate a significant increase or decrease in the recoverable amount of any of Shell’s assets;
• where triggers were identified, we assessed the inputs to the impairment assessment by comparing forecasts to OP22 and life of field plans, historical actuals and other independent expectations. We also performed a consistency check on the assumptions to other assumptions applied by the group;
• testing the model integrity of material impairment assessments.
• evaluating the assumptions used in the preparation of the 2022 operating plan at a group, segment and asset level and compared the actual performance of assets to the forecasts made in the prior year;
• considered the existence of other contradictory evidence, such as the results of any comparable market transactions that could indicate a significant increase or decrease in the recoverable amount of any of Shell’s assets, public comments or commitments made by Shell in relation to the Powering Progress strategy and whether these could impact the future potential value of any assets; and
• assessing potential operational changes that have or are expected to have a significant adverse effect on an asset, such unplanned shutdowns, and whether they should be considered as impairment triggers.

The audit procedures were performed primarily by our group engagement team as well as our local audit teams in Argentina, Australia, Brazil, Canada, Kazakhstan, Malaysia, Nigeria, Qatar, Trinidad & Tobago, UK and USA.

Key observations communicated to the Shell Audit Committee

In January 2023, we reported to the Audit Committee that:

Oil and gas prices

• Shell’s oil and gas price assumptions are in line with the requirements of IAS 36 for the purposes of PP&E and JVA impairment assessments. We believe that the assumptions are reasonable when compared against a range of third party forecasts and peer information. Given supply and demand uncertainties, we do not believe that Shell’s Brent assumptions are overly conservative by being at the lower end of a range of international oil companies.
• Shell’s assumed oil prices are broadly consistent with the IEA’s APS price assumptions; however, in 2023-2024 Shell’s Brent price assumption is 16% higher than the APS assumption. We were satisfied that Shell’s assumptions remain appropriate for 2023 as there is more evidence to support price assumptions in the short term. Shell’s Henry Hub price assumptions were broadly similar to the IEA APS scenario and lower in the short term.

Petrochemical and refining margins

• The short-term decline in petrochemical margins in 2022 does not represent an impairment trigger for Shell’s chemicals assets given the expected increase in margins in the medium-term. Prices are expected to increase in the medium-term as: (1) lower margins are not sustainable for an extended period, which is supported by our own reversion to mean analysis of historical margins; and (2) feedstock prices are expected to fall from current high levels (primarily gas prices and refinery margins). We also do not consider the higher refining margins experienced in 2022 represent a trigger for impairment reversal for Shell’s refineries.

Oil and gas reserves

• See oil and gas reserves key audit matter.

WACC

• Shell’s impairment discount rate overall is reasonable when you consider the WACC applied and additional risking included in the cash flows of individual assets.

CGUs

• Shell’s CGU assessment is in line with IFRS. Shell’s approach to identifying CGUs is well established and follows industry practice. For low-carbon assets, which are often located on the same site as other Shell assets, it is appropriate to treat these assets as separate CGUs.

Individual asset assessments

• We believe that Shell’s impairment assessment process is in line with IFRS. For the assets where management’s impairment assessment resulted in an impairment loss or reversal, the charges or reversals were within an acceptable range. Also, we were satisfied that the impairment charges were recorded in the appropriate period
• Shell’s upwards revision to their oil and gas price assumptions represented a trigger for the potential reversal of previously recorded impairments. The subsequent impairment reversal of $6 billion is within our range of acceptable outcomes. For those assets where an impairment loss was reversed, there was limited judgement as in most cases, the headroom was well in excess of the potential maximum reversal. Where impairment reversals were not recorded, we were satisfied that other factors, such as asset performance, meant that a reversal would not have been appropriate.
• For the Russian-related impairments, we were satisfied that Shell had performed a thorough exercise to determine the appropriate accounting for each of the ventures impacted by Shell’s withdrawal from Russian oil and gas activities.

---

Cross-reference: See the Audit Committee Report on page 172 for details on how the Audit Committee considered impairments. See the Strategic Report on pages 83 to 87 for details on energy transition strategy. Also, see Notes 2, 4, 6, 12 and 13 to the Consolidated Financial Statements.

Accounting for complex transactions within Shell’s Trading and Supply (T&S) function and the valuation of financial derivatives

Description of the key audit matter

This is an estimation based on both complex valuations and uncertain inputs to valuations, and requires judgements in the accounting treatment. There is a risk of error in revenue due to the increased complexity of trades that are executed by Shell’s T&S function.

Also, there is an inherent higher risk of unauthorised trading activity or deliberate misstatement of trading positions due to the volume and complexity of trades that are executed by T&S.

As described in Note 8 of the Consolidated Financial Statements, at December 31, 2022 Shell recognised $381 billion of revenue. As described in Note 25, Shell recognised commodity derivatives assets of $23.7 billion and commodity derivatives liabilities of $22.9 billion.

Also, Shell has identified trading in their risk factors on pages 22 to 24, which form part of the “Other information”, rather than the audited financial statements.

Shell’s T&S function is integrated within the Integrated Gas, Upstream, Marketing, Chemicals and Products and Renewables and Energy Solutions segments. The function executes and settles over a thousand standard vanilla trades a day across multiple geographic locations; however, the business also enters into non-standard complex trades. The number of these complex trades have increased year on year as Shell is increasingly focussed on growth in low carbon fuels and on executing long-term renewable power offtake and sale contracts in existing and new markets.

The T&S function has a traditional commodity trading structure, with a defined front, middle and back office for the execution, monitoring and settlement of trades. The IT environment supporting the function is complex and involves a large number of systems. Consequently, there is a high level of manual intervention required in operating the business, largely controlled through detective financial controls within the back and middle office.

The global regulatory requirements for commodity traders continue to increase, which, together with the increase in complexity of trades, means there is greater financial, reputational and operational risk within the business.

Auditing unrealised trading gains and losses arising from non standard trades is complex because of the significant judgement used in determining the appropriate accounting treatment, and the key assumptions used in valuing the trades. Trading is not always carried out in active markets where prices are readily available, increasing subjectivity used in determining the pricing curve and volatility assumptions, which are key inputs to valuing the trades.

Furthermore, the lack of market transparency of executed deals creates significant opportunity for unauthorised trading activity or deliberate misstatement of Shell’s trading positions or mismarking of positions. This creates a risk of understated trading losses, overstated trading profits and/or individual bonuses being manipulated through inappropriate inter-period profit/loss allocations.

Our response to the risk

We obtained an understanding of the controls over Shell’s process for the recognition of revenue relating to unrealised trading gains and losses, including controls over management’s processes around complex deals accounting and valuations. We then evaluated the design of these controls and tested their operating effectiveness. For example, we tested controls around the review of pricing curves and volatility assumptions applied in the valuation models.

We involved professionals with significant experience auditing large commodity trading organisations. Our audit procedures focus on the appropriateness of the accounting treatment and the valuation of these contracts. In our audit we:

• tested the completeness of the complex deal register, to ensure it contained all material, complex and long dated trades;
• obtained an understanding of the commercial rationale of complex and long-dated deals by analysing transaction documentation and agreements, and through discussions with management;
• performed an independent assessment of the accounting treatment of complex and long-dated deals, challenging managements accounting treatment against contract terms and previous accounting judgements. Where relevant, we involved our technical accounting specialists to assist in this assessment;
• assessed the reasonableness of Shell’s valuation methodology by comparing it to market practice, analysing whether a consistent framework was applied and confirmed the consistency of inputs used in deal valuations with other assumptions applied in the financial statements, for example impairment assumptions;
• tested the forward pricing curve and volatility assumptions in management’s valuation models, including comparisons to external broker quotes, market consensus providers and our independent assessments;
• involved valuation specialists to assist us in performing independent testing of complex valuation models, including Level 3 contracts; long-dated offtake contracts; and contracts with illiquid components. Our valuations were established using independently sourced inputs and specialists’ judgement for certain unobservable parameters;
• reviewed valuation reserve adjustments, such as credit valuation adjustments, and reperformed the calculation for a sample of material contracts;
• tested key controls around management’s onerous contract assessment, including how management assess completeness;
• we challenged management’s accounting consideration of whether forward physical contracts to buy and sell LNG are in the scope of IFRS 9 and should be fair valued.
• performed a suite of third party confirmation tests for the completeness of forward positions recorded by Shell. Our tests included requesting Shell’s counterparties to confirm their entire position with Shell; asking counterparties to provide details of individual trades per their records; and, sending confirmations to key counterparties for which there was a material position in the previous year but no material position in the current year; and
• searched for unrecorded liabilities by identifying any transactions after the reporting date that were settlements of derivatives, determining if the transaction being settled was appropriately included or excluded from the open trading position at year-end and whether they were recorded in the correct period.

The audit procedures were performed principally by the group engagement team and the UK and US component teams.

Key observations communicated to the Shell Audit Committee

In January 2023, we reported to the Audit Committee that:

• The valuation of complex and long-dated derivative contracts was appropriate and in accordance with accounting standards;
• Unrealised gains and losses related to complex and long-dated deals were recorded appropriately in the financial statements;
• Management’s key accounting judgments and the application of their accounting polices, including the accounting treatment of non-standard deals related to illiquid non-financial items, were appropriate; and
• We also highlighted that the accounting judgement around LNG liquidity was a significant judgement. We explained that we were satisfied that, under current market conditions, management’s conclusion remains appropriate on the basis that:
  • contracts in the LNG portfolio do not include a provision for, nor is there a significant history of, express net settlement via mechanisms such as book outs;
  • Shell is active in the short-term LNG physical market. Judgement is required to determine if this presence relates merely to optimisation of the group’s long-term portfolio of contracts, or, for the purpose of taking advantage of short-term price fluctuations or to realise dealer’s margins. The latter would constitute net settlement practices under IFRS 9. The ability to demonstrate such net settlement practices is inherently reliant on the underlying liquidity of the market. Shell has assessed a range of market liquidity indicators, which do not indicate any increase in liquidity since the previous assessment performed. Shipping constraints, demand/supply imbalances, sanctions, and a reduction in market participants due to the liquidity challenges of hedging in high price environments have all hampered the increase of LNG liquidity in the past twelve months.

---

Cross-reference: See the Audit Committee Report on page 172 for details on how the Audit Committee reviewed the Trading and Supply’s control framework. Also see Notes 8 and 25 to the Consolidated Financial Statements.

Overall materiality

What we mean

We define materiality as the magnitude of an omission or misstatement that, individually or in the aggregate, could reasonably be expected to influence the economic decisions of the users of the financial statements. Materiality provides a basis for determining the nature and extent of our procedures.

Level set

Group materiality

We set our preliminary overall materiality for Shell’s Consolidated Financial Statements at $1.2 billion (2021: $1 billion). We kept this under review throughout the year and reassessed the appropriateness of our original assessment in the light of Shell’s results and external market conditions. We did not find it necessary to revise our level of overall materiality.

Parent Company materiality

We determined materiality for the Parent Company to be $1.2 billion (2021: $1 billion), which is 0.6% of equity (2021: 0.4%). We concluded that equity remains an appropriate basis to determine materiality for an investment holding company. The range we normally apply when determining materiality on an equity measurement basis is 1- 2%. We applied a lower percentage to align the materiality of the Parent Company with that of the Group.

Our basis of determining materiality

Our assessment of overall materiality that we applied throughout the year was $1.2 billion, which represented 2.6% of the two-year average Adjusted Earnings pre-tax (see table below). We normally apply 5% when determining materiality on a profit measurement basis; however, actual 2022 results were higher than what we based our assessment on and we did not revise our materiality upwards. Our materiality was derived from an average of Shell’s earnings, including an initial estimate of the 2022 result, on an Adjusted Earnings basis, which we then adjusted for an average effective tax rate. At the end of the year, we reassessed materiality based on the actual results for 2022. As disclosed on page 362 within non-GAAP measures reconciliations, the “Adjusted Earnings” measure aims to facilitate a comparative understanding of Shell’s financial performance from period to period by removing the effects of oil price changes on inventory carrying amounts and removing the effects of identified items. Shell’s identified items are disclosed on page 363.

Our key criterion in determining materiality remains our perception of the needs of Shell’s stakeholders. We consider which earnings, activity or capital-based measure aligns best with their expectations. In so doing, we apply a ‘reasonable investor perspective’, which reflects our understanding of the common financial information needs of the members of Shell as a group.

We continue to believe that these needs are best met by basing materiality on normalised Adjusted Earnings on a pre-tax basis. This approach removes both the effects of changes in oil price on inventory carrying amounts (current cost of supplies adjustment as defined on page 362) and non-recurring gains and charges disclosed as identified items on page 363 that can significantly distort Shell’s results in any one particular year. Through applying a normalised earnings approach, large year-on-year swings in materiality are minimised. These swings would be driven primarily by price fluctuations rather than specific structural changes to Shell’s business.

We have considered alternative benchmarks to Adjusted Earnings, including profit before taxation and EBITDA. These indicate a range of $1.5 billion to $2.4 billion.

---

We believe that a normalised Adjusted Earnings approach remains appropriate on the basis that:

• segment earnings are presented on an Adjusted Earnings basis, which is the earnings measure used by CEO for the purposes of making decisions about allocating resources and assessing performance;
• Adjusted Earnings exclude the effect of changes in the oil price on inventory carrying amounts, allowing investors to understand how management has performed despite the commodity price environment, as opposed to because of it;
• analyst forecasts predominately feature Adjusted Earnings, which exclude identified items, as the basis for earnings. The analyst consensus data supports our judgement that Adjusted Earnings remains the key indicator of performance from a reasonable investor perspective; and
• although this is an unprecedented time for Shell and the industry and there is uncertainty around the future price environment, views of economists and market participants was that the supply/demand balance will be re-addressed over time.

By applying a normalised Adjusted Earnings approach, we have concluded that it is appropriate to apply a materiality of $1.2 billion (2021: $1.0 billion).

The Adjusted Earnings were as follows:

Performance materiality

What we mean

Having established overall materiality, we determined ‘performance materiality’, which represents our tolerance for misstatement in an individual account. It is calculated as a percentage of overall materiality in order to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds overall materiality of $1.2 billion for Shell’s financial statements as a whole. We assigned performance materiality to our various in-scope operating units. The performance materiality allocation is dependent on the size of the operating unit, measured by its contribution of earnings to Shell, or other appropriate metric, and the risk associated with the operating unit.

Level set

In our assessment for 2022, we considered the nature, number and impact of the audit differences identified in 2021. We also noted the way in which management navigated the financial statement close throughout 2021, and the fact that we did not experience any notable increase in control deficiencies in the prior year audit. Based on our assessment of these factors, our judgement was that performance materiality for the 2022 audit should be 75% (2021: 75%) of our overall materiality or $0.9 billion (2021: $0.75 billion).

The level of materiality that we applied in undertaking our audit work at the operating unit level, for the purpose of obtaining coverage over significant financial statements accounts, was determined by applying a percentage of our total performance materiality. This percentage is based on the significance of the operating unit relative to Shell as a whole and our assessment of the risk of material misstatement at that operating unit. In 2022 the range of materiality applied at the operating unit level was $135 million to $585 million (2021: $113 million to $488 million).

The planning and performance materiality was kept under ongoing review, but the conclusion remained unchanged at our year-end re-assessment of materiality.

Audit difference reporting threshold

What we mean

This is the amount below which identified misstatements are clearly trivial. The threshold is the level above which we collate and report audit differences to the Audit Committee. We also report differences below that threshold that, in our view, warrant reporting on qualitative grounds. We evaluate any uncorrected misstatements against both the quantitative measures of materiality discussed above and in the light of other relevant qualitative considerations in forming our opinion.

Level set

We agreed with the Audit Committee that we would report to the Committee all audit differences more than $60 million (2021: $50 million), as well as differences below that threshold that, in our view, warranted reporting on qualitative grounds. This represents 5% of our planning materiality (2021: 5%).

What we mean

We are required to establish an overall audit strategy that sets the scope, timing, and direction of our audit. Audit scope comprises the physical locations, operating units, activities, and processes to be audited that, in aggregate, are expected to provide sufficient coverage of the financial statements for us to express an audit opinion.

Criteria for determining our audit scope and selection of in-scope operating units

Our assessment of audit risk and our evaluation of materiality and our allocation of performance materiality determined our audit scope for each operating unit within Shell which, when taken together, enabled us to form an opinion on the financial statements. Our audit effort was focused towards higher risk areas, such as management judgements, and on operating units that we considered significant based upon size, complexity or risk.

We assessed our 2022 audit scope following the completion of our 2021 audit. We identified those Areas of Operation (AoOs or operating units) that were significant by virtue of their contribution to Shell’s results or significant by virtue of their associated risk or complexity. In doing this we considered the history or expectation of unusual or complex transactions, potential for or history of material misstatements, the previous effectiveness of controls, our forensic assessment in relation to fraud, bribery or corruption, and internal audit findings. We then considered the adequacy of account coverage and remaining audit risk of AoOs not directly covered by audit procedures. Finally, we sense checked our scope to the prior year; ensured that there was appropriate unpredictability in our scope and made the necessary changes where appropriate. We applied our Risk Scan analytics techniques, which consolidate internal and external data to inform us on higher risk components to be included in scope. This allowed us to risk rate the group’s operating units. We identified 101 operating units where we believed that it was appropriate to carry out targeted testing.

By following this approach, our audit effort focused on higher risk areas, such as management judgements. Our group wide procedures enabled us to obtain audit evidence over the AoOs that were not full, specific or specified procedure scope.

We did not make substantial changes to our 2021 assessment of the components where we performed full or specific scope audit procedures. Also, there were no significant changes to the number of IT applications we tested. However, what did change was the nature and emphasis of our testing in response to our significant audit risks and areas of audit focus.

We kept our audit scope under review throughout the year to reflect changes in Shell’s underlying business and risks; however, no significant changes were required.

The table below illustrates the scope of work performed by our audit teams:

Coverage

Our coverage by full, specific, specified and group procedures is illustrated below. The summary is by Total Assets, Adjusted Earnings and Revenue. Overall, our full, specific and specified procedures accounted for 64% of Shell’s absolute Adjusted Earnings reported by Shell in its quarterly results announcements and adjusted for an effective tax rate. The remaining Adjusted Earnings were covered by Group wide procedures.

The Parent Company is located in the United Kingdom and audited directly by the Group engagement team

Group evaluation, review and oversight of component teams

The group engagement partner and Senior Statutory Auditor, Gary Donald, has overall responsibility for the direction, supervision and performance of the Shell audit engagement in compliance with professional standards and applicable legal and regulatory requirements. He is supported by segment and function partners, who are based in the Netherlands and the UK, and who together with related staff comprise the integrated group engagement team. This group engagement team established the overall group audit strategy, communicated with component auditors, performed work on the consolidation process, and evaluated the conclusions drawn from the audit evidence as the basis for forming EY’s opinion on the group financial statements.

The group engagement team is responsible for directing, supervising, evaluating and reviewing the work of EY global network firms operating under their instruction (local EY teams) to assess whether:

• the local EY audit team had the appropriate level of experience;
• the work was performed and documented to a sufficiently high standard;
• the local EY audit team demonstrated that they had challenged management sufficiently and had executed their audit procedures with an appropriate level of scepticism; and
• there is sufficient appropriate audit evidence to support the conclusions reached.

The group engagement team provided detailed instructions to our component teams to drive the audit strategy and execution in a coordinated manner. Group audit partners visited Australia, Brazil, Malaysia, Singapore, USA, covering operating units from all segments and functions. In addition, Group audit partners visited all of Shell’s BSCs on at least one occasion, which included India, Poland, Malaysia and Philippines. During these visits, we exercised direction, supervision, oversight and review of our overseas EY audit teams. We were satisfied that we have had adequate involvement in their work and that we exercised sufficient and appropriate direction to the component teams.

Our oversight of component teams included maintaining a continuous and open dialogue with our global component teams, as well as holding formal closing meetings quarterly, to ensure that we were fully aware of their progress and results of their procedures. Also, group audit partners visited our T&S component teams in India, the UK and US and visited Shell’s trading operations in Singapore, UK and Singapore.

Involvement with local EY teams

Shell has centralised processes and controls over key areas within its BSCs. Members of the group engagement team provide direct oversight, review, and coordination of our BSC audit teams. Our BSC teams performed centralised testing in the BSCs for certain accounts, including revenue, cash and payroll. In establishing our overall approach to the group audit, we determined the type of work that needed to be undertaken at each of the operating units or BSCs by the group engagement team or by auditors from other local EY teams.

For the operating units where the work was performed by local EY auditors, we determined the appropriate level of involvement of the group engagement team to enable us to conclude that sufficient appropriate audit evidence had been obtained, as a basis for our opinion on the Group as a whole.

During the 2022 audit, the group team were able to carry out 16 physical site visits, including Australia, Brazil, India, Malaysia, Philippines, Poland, Singapore and the US. In addition, we performed virtual site visit in Nigeria. These visits were carried out multiple times during the audit and were attended by either the Senior Statutory Auditor or other group audit partners on the group engagement team. We also joined the Audit Committee at their site visit to the London trading floor which is discussed in the Audit Committee report.