20% royalty will harm O&G industry

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KOTA KINABALU: An increase in cash payments, which some people prefer to call royalty, by Petronas to the state and federal governments would have an adverse impact on the project viability and the industry at large, according to the vice president of Malaysia Petroleum Management, Adif Zulkifli.

He said that if the cash payments were to be increased to 20 per cent for Sabah, some projects undertaken by Petronas may be in jeopardy.

The immediate impact would be projects being dropped by foreign investors, investors’ confidence will be eroded and the country’s energy security will be at risk, he said.

Adif said the mid-term impact would be contract and opportunity losses for supporting industry, no further exploration activities and retrenchment.

“In the long run, we would experience shrinkage in Malaysia’s oil and gas industry, lower government revenue and reduction in the GDP as well as GNI,” he stressed.

“We may have problems sustaining the Cash Payments to Sabah if we cannot sustain production,” he said at a briefing for the local media here yesterday.

Adif pointed out that Malaysia’s cash payment rate is already high when bench-marked with other countries.

“If we increase the Cash Payment, we will not be competitive with other countries. Foreign contractors will not want to invest in Malaysia and will opt to go to other countries,” he said, adding that each country and jurisdiction have different fiscal arrangements and range of Cash Payment to governments.

Based on IHS, a reputable research house in the oil and gas industry, percentage of Cash Payments equivalent ranges from 0-10 per cent in most countries that were bench-marked with world average at about five per cent, he disclosed.

Adif said that production sharing contractors are already facing multiple challenges in the industry such as small oil fields which are not cost effective, increasing upstream costs that have doubled since 2000 and the processing of complex gas which is highly contaminated.

“In Sabah, the oil fields are in deep water of between 1,000 metres to 2,000 metres, so production here requires higher costs and high capital,” he said and stressed that Petronas must ensure that the industry remains attractive to foreign investors as they come with the experience and technologies needed.

“Already we are hearing that international companies operating in Malaysia are thinking for divesting out of the country for places like Mexico, Angola, Brazil and North America. We, therefore, must provide a conducive environment for the industry,” he stressed.

Adif explained that Malaysia adopts the Production Sharing Contract (PSC) for its Exploration and Production (E&P) industry, whereby qualified oil and gas companies are engaged for the exploration, development and production of petroleum in a contract area for a specific duration based on agreed terms and conditions.

A typical PSC, he said, is designed to ensure sufficient returns to the contractors to undertake the highly risky and capital intensive oil and gas projects.

He pointed out that fiscal terms under the PSC determines the commerciality of any oil and gas development as it ensures fair returns to the PSC contractors that commensurate with the level of risk exposure and basin prospectively.

“Stable and fair terms are vital to attract capable players to invest in and develop our increasingly challenging petroleum resources,” he stressed.

Explaining about the Cash Payments to governments, Adif said that the PSC first guarantees Cash Payments to the state and federal governments at the agreed five per cent each at gross revenue level.

“This comes first even before accounting for the costs, and is risk-free to the government. This means that as long as there is production, we will pay the state and federal governments five per cent each. Whether Petronas or the contractor makes money that is beyond the point,” he stressed.

Adif said that 70 per cent of the revenue is then allocated for paying the costs of exploration, development and production costs incurred by the contractors of PSC, and this allocation is known in the industry as Cost Oil/Cost Gas and is paid as second priority after Cash Payments.

The relatively high split is to cater to the capital intensive nature of E7P projects which can typically run from USD1billion to USD4 billion (RM3.2 billion to RM12.8 billion) per project. With greater challenges in finding, developing and producing hydrocarbon resources in Malaysia, the provision for Cost Oil/Cost Gas is expected to continuously increase in the future.

“The remaining 20 per cent is known as Profit Oil and this is the balance after Cash Payments and Cost Oil/Cost Gas have been accounted for. This Profit Oil is subjected to Petroleum Income Tax (PITA) at 38 per cent. Production Sharing (PS) Contractors and Petronas will share the remaining profit after tax, usually in 50:50 split.

“This is the profit earned after the parties have made upfront investments and undertook risks associated with the projects. Typically the profit is about six per cent of the gross revenue,” he said.

He added that since 1976, the Cash Payment made by Petronas to Sabah has been about RM9 billion and has also invested RM83 million towards the conservation of Imbak Canyon and for the state’s safety, it has contributed RM250 million towards the early warning radar system in the east coast and another RM250 million for the Eastern Sabah Security Command’s sea basing project.

On the inclusion of Sabah oil and gas companies in its projects, Adif said that Petronas needs very capable companies that can deliver and are competitive as well as cost effective as cost is very important in this industry.

“The number of Sabah companies has increased in the past two years and Petronas will continue to assist Sabah companies,” he said.