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Higher Royalty versus State Ownership of Petronas

The oil royalty debacle is perhaps one of the popular components for both Barisan Nasional (BN) and Pakatan Rakyat (PR) as the nation approaches polling day on 5th May. In Kelantan, the “R” for “royalty” movement has in fact been proliferating, especially amongst PR supporters. For years, we have seen the fight for royalty highlighted by the four producing states, namely Terengganu, Kelantan, Sabah and Sarawak. While Kelantan continues with its ongoing battle for legitimacy of its claims under the Petroleum Development Act 1974, Sabah and Sarawak local dailies have been putting forth their plight for a bigger than 5% share over oil and gas incomes.

In an unprecedented move, PR in its Buku Jingga launched in December 2010 proposed an increase of oil royalty contributions from Petronas to state governments from 5% to 20%. This is again reiterated in its election manifesto. Upping the ante, BN too in its recently-launched manifesto has promised the same, albeit under a different name.  Whoever wins the next election, the four states will see increased revenue, if this promise is kept. But how will this change affect Petronas?

The Truth behind the 20 Percent Royalty

First, we must know that royalties or cash payout as per PDA 1974 is cost charged to revenues, rather than a share of operating outcomes. Whatever income Petronas or oil operators get from selling oil and gas, royalties are entitled to the first cut. To illustrate, a barrel of oil sold for USD 100 will see USD 5 or USD 20 (depending on the percentage) immediately taken away as royalties. Only what is left after that and taxes, will be left for Petronas to recover its tremendous capital and operating costs, and to reimburse other oil operators and producers.

Imagine what it means in times of lower crude oil prices! This puts tremendous pressure on Petronas’ profitability, which will ultimately affect revenues dispersed to the federal government as dividends. (Note that the federal government receives revenues from Petronas via multiple avenues; including royalties and taxes as the government, and dividends as Petronas shareholder).

Second, based on the above, a 20% oil royalty payment will potentially render many in-place existing Production Sharing Contracts (PSCs) unattractive. Without going too much into the intricacies of a PSC, oil operators like Shell and Exxon Mobil having operations in Malaysia, under the PSC, owe royalties and taxes to Malaysia but is then promised some form of “cost oil” and “profit oil”.

The PSC essentially ensures Malaysia is compensated as much as possible for oil coming out of its territories, while these operators still makes some attractive margins for their productive efforts. Unless Petronas takes the entire hit from losing a further 15 percentage-points worth of revenues by promising the same profitability to oil operators, the attractiveness of PSCs will be unavoidably severed.

Third, it may be argued an incentive system by way of oil royalty leaves the states with no interest over the profitability of Petronas. This is only natural, as getting a first cut over oil incomes makes it too convenient to worry about the processes thereafter. Thus, states may not be too concerned if foreign operators are no longer incentivized to operate on Malaysian wells and use their valuable expertise on Malaysian oil wells, or if Petronas’ long term productivity and sustainability is at stake.

Petronas Inclusive Ownership: Give Shares to the States

The three points above highlight the few potential challenges in applying a 20% royalty contribution from Petronas to the state governments. After all, Petronas is one of Malaysia’s few true success stories contributing to a large part of Malaysia’s growth. Its sustainability without question is in the interest of all states and Malaysians alike.

It is important to note that Petronas could indeed credit its success to effective management of hydrocarbon resources out of the producing states. Although revenue contributions attributable to domestic petroleum resources has now reduced to 60% of revenues, Petronas would have not arguably been where it is today; if not for the petroleum “capital” contributed by these states to the corporation, by virtue of the PDA 1974, and other enactments entrusting custody of oil fields over to Petronas. Although today, incomes from domestic oil and gas blocks are not the single largest component of Petronas’ incomes, other incomes would have never been there in the first place without the petroleum from these producing states.

A whole slew of Petronas subsidiaries, including downstream industries such as Petronas’ Gas, LNG, petro-chemicals, and retailing businesses, as well as the inception of local contractors such as Sapura Kencana, MMHE and many others have created a plethora of job opportunities, and positive spillover economic impacts onto Malaysia which would have not happen without oil and gas from the four producing states.

It is proposed here that ownership of Petronas is made more inclusive. Currently, the federal government owns 100% of Petronas. Let’s maintain the 5% royalty rate but give oil producing states some profit participating stake in Petronas via non-voting equity shares without participation at the board as to evade a corporate governance nightmare. With this, decision-making and executive matters are still left to the hands of professionals who have done a fantastic job at running the country’s only Fortune 100 company.

A 2% ownership each to the four producing states for example, would mean RM600 million out of the fixed annual RM30 billion dividends would go to each shareholding state, while the remaining is still paid to the federal government as the major shareholder. However, how much equity each state will get is for another discussion.

Being shareholder, oil producing states will want to see Petronas as a company grow and maintain profitability as to enjoy dividend incomes from the company. Meanwhile, the dynamics and attractiveness of current and future PSCs and RSCs will not be tampered with.  In the case of oil royalty, the states have no interest with Petronas’ profitability as they take directly from revenue.

The bottom line is, a higher royalty and equity stake will increase revenue for the four producing states which is among the poorest in Malaysia, which is the ultimate blanket intention. The equity route, however, maintains maintains the status quo for Petronas and PSC Contractors and still rewards the states, especially the poorer ones that deserve the oil royalty income they badly need.

Furthermore, oil royalty cash payments will only exist as long as oil and gas are being produced while an equity stake and dividend payments will continue to be there as long as Petronas exists and does well. Alternatively, as proposed by PR, little Petronas can be setup e.g Petronas Kelantan, Petronas Sarawak, etc which will be governed by Petronas with equity participation in the oil producing states.

* A version of this article first appeared in The Edge

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