Higher royalty versus state ownership of Petronas
Give oil producing states some profit participating stake in Petronas via non-voting equity shares
By Anas Alam Faizli, FMT
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 May 5. 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.
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.
