The oil royalty conundrum

 

Distribution of oil wealth is a contentious issue. Azam Aris looks at a possible solution. 

 

Azam Aris, fz.com 

 

A FEW weeks ago, an ex-colleague who is now working with a foreign embassy sent me several questions about Malaysia’s oil royalty. The issue, she added, was of interest to them. 

 

I did not ask why that was so but I guess it is the job of an embassy to get as much information as possible on socio-economic and political matters that could have an impact on the country it represents. 

 

The oil and gas industry worldwide, including here in Malaysia, attracts a lot of investments from multinationals (MNCs). Nearly all the big petroleum players are doing business here, with super majors like Exxon-Mobil, Shell and Conoco-Phillips awarded offshore exploration and production blocks.

 

The industry also attracts its fair share of controversy – ranging from human rights and environmental issues to the fair distribution of oil wealth by the central government in places like Nigeria, Sudan and Indonesia’s Aceh province.

 

Distribution of the oil wealth, which is related to the royalty, has been an issue in Malaysia since 2000 when the federal government directed the national oil corporation, Petronas, to stop payments to the Terengganu government, which was then controlled by opposition party PAS.

 

On Jan 22, the Kelantan government – also controlled by PAS – filed an application for a court injunction to prevent Petronas from paying the state’s “share” of the royalty to the federal government. Petronas and the federal government say Kelantan is not entitled to the royalty – which is the subject of another court case.

 

Kelantan had in fact mooted the idea of a G5 – to include the four other oil-producing states of Terengganu, Sabah, Sarawak and Pahang, all controlled by the ruling Barisan Nasional – to make a united stand when negotiating oil royalty.

 

It may all be a bit complicated for uninitiated readers. I will try to shed some light on the issue based on the questions asked by the foreign embassy. Of course, these are my personal views.

 

 

First and foremost, get hold of the Petroleum Development Act (PDA). It is the Act that governs the oil and gas sector and Petronas’ role as custodian of the country’s hydrocarbon resources. 

 

The oil companies are just contractors and Petronas is the owner of the blocks awarded. The oil companies sign a production-sharing contract (PSC) with Petronas. The PSC stipulates the sharing of the resources among the federal government, states, Petronas and the oil companies.

 

In simple terms, this is how the royalty works for the first-generation PSCs, based on the gross production of crude oil or gas. 

 

Let’s assume that gross production of crude oil is 100 barrels. Of this, 10% or 10 barrels are set aside as payment for royalty. The federal and state governments where the oil is produced get five barrels (or 5%) each. Oil companies are then allowed to claim a recovery cost up to a maximum of 20 barrels (or 20%) – considered “cost oil”. The remaining 70 barrels (or 70%) – “profit oil” – are split in the ratio of 70:30 in favour of Petronas.

 

That’s the basic formula. As oil and gas extraction becomes more difficult, with exploration moving into deeper waters, the percentage of cost oil and profit oil are increased in favour of the contractors. But the royalty remains at 10% – 5% each for the federal and respective state governments. Payment is made twice a year by Petronas straight into the state’s coffers.

 

 

Almost all offshore oil and gas fields in the country – whether in Terengannu, Sabah or Sarawak – are more than three nautical miles from shore. They all get their royalty. 

 

The PDA 1974 was crafted in the spirit of sharing revenue between the federal and state governments. There wasn’t any issue until 1999, when PAS took control of the Terengganu government. The federal government, as the sole shareholder of Petronas, decided in 2000 that payment to the state government should stop. Part of the royalty – known as wang ehsan or goodwill money – was then channelled to federal-based agencies in the state.

 

PAS then took the federal government and Petronas to court. One of the main defences was that the Terengganu government was not entitled to royalty as the oilfields were not within the state’s waters as they were more than three nautical miles from shore and thus belong to the federal government. So, based on the same argument, Kelantan too is not entitled to the oil royalty.

 

But if that were the case, Sabah and Sarawak should similarly not be entitled to the royalty. However, the federal government’s counter argument was that oil was first discovered in Sarawak and Sabah during British rule and that they were governed by a different set of rules.