The rights of oil producing states

THE Sarawak state assembly recently passed a resolution calling for an increase from 5% to 20% of its oil royalty entitlement, along with seeking more developmental grants from the federal government. Kelantan has also followed suit to call for an increase in its oil royalties.

Increasing oil royalties to the states may seem fairly straightforward, but it is in reality a far more complex issue, and not as simple as one may think.

The logic is that oil producing states should receive a higher proportion of oil revenues vis-a-vis that given to the central government. While royalty paid to the state and federal governments is equal (5% each), the federal government receives other large revenues in the form of taxes and duties, as well as dividends from its wholly-owned Petronas.

In 2012, the federal government received RM207 billion revenues from oil and gas alone, having grown significantly as a proportion of total government revenue over the years.

This is how a typical production-sharing contract works in Malaysia: assuming that the production of oil comes up to 100 barrels, 10 barrels would be taken as royalty payments, five of which are given to the oil-producing state and another five to the federal government.

Up to 60 barrels are for "cost oil" (costs incurred by the oil operator that is recovered) and the remaining 30 barrels are "profit oil", which are again split between the operator and Petronas according to the terms of the contract.

First, should states be allowed more fiscal responsibility?

There are two sides to this: on one hand, it is true that those whose resources are being extracted ought to have primary ownership and self-determination of the accruing wealth. After all, if there are any side effects – both positive and negative – this would affect the surrounding community first and foremost.

At a course I recently attended on "Improving the Governance of the Extractive Industry" at the Universitas Gadjah Mada, Yogyakarta, I learnt that Indonesia follows a strict revenue sharing model, with the central government receiving 84.5% of oil revenue and the local government receiving 15.5%.

The latter is further split into 6.1% for the relevant province, 3.2% to other regencies in the same province, and 6.2% in the producing regency. The producing regency of Bojonegoro, for example, is actively able to negotiate with the local oil company in demanding for information transparency.

But not all regencies have similar leverage. The regency office of Tuban had minimal knowledge of how oil revenues had been able to benefit them, if at all. In such cases, it is impossible to tell if Tuban's oil wealth has contributed to its development.

This seems to be the case in Malaysia, where poverty rates in the four oil-producing states are the highest, at 7.8%, 2.4%, 2.7% and 1.7% for Sabah, Sarawak, Kelantan and Terengganu respectively. (The average national poverty rate is 1.7%). The most resource-rich states also happen to be the worst economically.

On the other hand, shouldn't the resources of all states be used for the betterment of all citizens? This is in fact the current philosophy, where revenues from a multitude of sources are pooled together in the federal government's consolidated fund and Putrajaya decides on how they are best used and distributed throughout the country.

The second question is whether or not increasing the oil royalty is even possible.

The Petroleum Development Act 1974, which governs all aspects of the oil and gas industry in Malaysia, does not specify quantitative amounts owed to oil-producing states, mentioning only that Petronas should make cash payments to the federal and state governments "as may be agreed between the parties concerned".

However, all 13 states simultaneously signed deeds and vesting grants agreeing to vest the rights to petroleum onshore or offshore to Petronas in return for cash payments of the 5% of the value of petroleum produced.

Passing a motion in the state assembly to increase oil royalty from 5% to 20% does not therefore automatically apply, since these agreements signed back in 1974 would need to be revoked, redrafted and signed with new terms and conditions. Note that these are tri-party agreements, so the terms would have to be renegotiated between state governments, the federal government and Petronas.

There is an additional complication of how far exactly offshore can be considered as state territory, since the Emergency Ordinance 1969 that defines how far "territorial waters" go was revoked in 2011. This is a fairly complex issue that requires another column.

In principle, sharing oil revenues fairly with oil-producing regions is a form of compensation and equalises benefits between poorer and richer regions. This also allows better decentralisation of decision-making and accountability to more efficiently monitor spending and benefits derived from oil production.

In Sarawak's case, while it is worth exploring the case for greater fiscal decentralisation, the state government should first be willing to be fully transparent in its budget – how are they spending existing revenues, for instance?

As more oil-producing states increasingly demand for greater rights – which is all well and good in the pursuit of local democracy – they must also specify what the additional money would be used for, what are the appropriate fiscal rules, what sort of institutional oversight should be introduced at the state level, and whether cash transfers are in fact preferable over, say, transfers in kind, and so on. There are more issues at play here than merely demanding oil royalty of 20%.

Tricia Yeoh is the chief operating officer of a local, independent think-tank. Comments: