The truth about oil royalty

ONE of the populist ideas from the Pakatan Rakyat (PR) to win more votes in Sabah and Sarawak is a promise to increase the states’ annual oil royalty from 5% to 20% if it comes to power.

For opposition leaders, this has been the gist of their speeches in the two states, especially after the political tsunami of 2008 when Sabah and Sarawak came to be known as Barisan Nasional’s (BN) “fixed deposit” states. This is because BN managed to win almost all of the 56 parliamentary seats in these states in the last election that enabled it to retain power while doing badly in Peninsular Malaysia.

Several top PR leaders went on a roadshow to Sabah and Sarawak on Sept 16 in conjunction with the Malaysia Day celebration and again they hyped up this oil royalty issue. To the man on the street, it’s a very attractive proposition because everyone wants their state to have more money so that they can have a better life.

But in reality, the quota of oil royalty distribution to the country’s three oil producing states – Sabah, Sarawak and Terengganu – is not as straight forward or simplistic as the 5% figure suggests. When you give them 5% for drilling oil in their offshore fields, the impression given is that Petronas, the national oil company, gets the other 95%. This is not the case and to a large extent this public misconception is due to the fact that many Malaysians, including parliamentarians, have been kept in the dark about who’s getting what in the oil and gas production industry, which is by far our biggest revenue earner.

Despite this issue being recycled, no one has come out to reveal the royalty sharing formula. I did my own enquiries and a former senior executive of a multinational oil company told me something informative that I am delighted to share here.

According to my source, this is how it works – 5% is federal royalty and another 5% is state government royalty. Of the balance, up to 20% goes to what is known as ‘cost oil’ to recover the cost of production. This leaves a balance of 70% which is split between the operator and Petronas. The operator here means foreign oil companies that commit billions in investment to drill for oil in the fields awarded to them by Petronas. At times, they spend billions without striking any oil of the volume required to make it commercially viable.

He cited as an example, a typical production sharing contract (PSC) between a foreign oil company and Petronas – of the 70%, 30% goes to the company and the balance to Petronas.

In terms of oil barrels, let’s say for every 100 barrels, the PSC split is five barrels to the Federal Treasury, five barrels to the State Treasury, and up to 20 barrels claimed by the operator as cost oil. The balance of 70 barrels is split 70:30 with Petronas getting 70% or 49 barrels, and the operator 30% or 21 barrels.

To the credit of Petronas, at long last on Oct 12, it came out with what I consider to be one of the most significant press statements it has ever released. As far as I can recall, this was the first time that Petronas has reacted to the oil royalty issue, a departure from its past policy of avoiding to discuss it openly.

Petronas said that its own sustainability to contribute to the nation would be undermined should royalty payments to the states be increased from 5% to 20%, because it would result in lower petroleum income tax payments.

What politicians like PR de facto leader Datuk Seri Anwar Ibrahim, who once served as finance minister and who’s been harping on increasing the royalty to 20%, deliberately don’t tell the people is that what they are trying to do is to put our entire oil and gas industry at risk.

Petronas explained that over the next five years alone, planned projects with a total capital expenditure worth about RM170 billion are at risk of being cancelled if the royalty payment to the states is increased.

Any increase in oil royalty to the states would automatically reduce the profitability and economic viability of all current and future oil and gas projects under development. This in itself will deter Petronas and PSC contractors from further investing in these projects.

There are some among the ruling BN leaders in the two states who are beginning to be influenced by the prospect of a royalty increase. They are voicing out to the federal government to consider giving them an increase, but what they fail to realise is that a reduction in the oil and gas production will result in lower payments to the states. It’s still 5% but this 5% in monetary terms will be much less.

On the bigger picture, a reduction in oil and gas production – which could happen if foreign investors are put off by the prospect of getting less from the PSC – will also threaten Malaysia’s energy security.

“Apart from this direct impact, the resulting slowdown will have an adverse multiplier effect on the domestic oil and gas industries such as service companies as well as spin-off industries, leading to a reduction in employment opportunities for the people residing in those states,” warned Petronas. This is indeed a very grim scenario akin to killing the goose that lays the golden eggs.

Close to 30% of our gross domestic product comes from Petronas’s output and the oil company contributes well over 40% of federal government revenue. Federal government revenue is ploughed back to all states, and since Sabah and Sarawak became BN’s safe deposit states, they have been receiving huge allocations for development much to the envy of the non-oil producing states. And whatever extras the federal government is giving the two states, as per their requests, actually come from the federal portion of the Petronas royalty.

Under our laws, oil belongs to the federal government and the oil producing states are already blessed with the 5% royalty which amounts to a cool few billion annually. Asking for more is tantamount to having the best of both worlds and this is not the way to run a federation of states like Malaysia. It’s just unfair to other states.

Politics is of course politics, but Malaysia will be better off with politicians who know what they are talking about especially when it comes to such important issues. They have to get their facts right so that they don’t simply create issues out of thin air. Just like the PR’s shadow Budget 2013 with its slew of highly populist proposals.

Second Finance Minister Datuk Seri Ahmad Husni Mohamad Hanadzlah has described the budget as “mathematically wrong, misleading and will definitely increase the country’s fiscal deficit and national debt”.

It would be wise for the government and the Opposition to heed Petronas’s warning against any review of the oil royalty formula which has worked so well in enriching Malaysia and in the process, made Petronas recognisable as the world’s most profitable national oil company.