The real deal behind oil royalty

THERE's still some gross public misunderstanding about the formula of oil royalty paid out to the three oil-producing states of Sabah, Sarawak and Terengganu.
This has, by and large, led to regular demands from these states for Petronas to increase the 5% royalty they have been getting all along to 20% and has become the hottest point of contention between them and the national oil company.
To the public at large, when one talks of a 5% royalty to the states, the impression one gets is that what happens to the other 95% and on paper, the formula seems very lop-sided.
But in reality, nothing could be further from the truth.
This is how it actually works out – both the federal government and oil-producing states get 5% royalty each.
Of the balance, up to 70% goes to what is known as "cost oil" to recover the cost of production.
This leaves a balance of 20% that is split between the operators and Petronas.
The operators are multinational companies, both foreign and local, that invest billions into drilling oil in the fields awarded to them by Petronas under the production sharing contract (PSC).
Like all investments, there are risks involved and more so in the oil and gas (O&G) industry as at times, they spend billions without striking oil of the volume required to make it commercially viable.
If the federal government, for instance, is to accede to demands for a 20% royalty, this time-tested formula that's been working very well with foreign investors like Shell, which has been drilling oil for over 100 years in Malaysia, will be in jeopardy.
And it will undermine our direct foreign investment attractiveness in the O&G sector and worse, might very well kill the goose that lays the golden eggs for Malaysia's most critical and biggest revenue earner.
Today, there are more than 40 investors in PSC of which 80% are foreign.
And contrary to general perceptions, Petronas pays these cash royalty payments to the federal government and the states irrespective of whether the production from the fields is profitable or not.
These cash payments are paid twice a year.
There have been quite regular outbursts by Sarawak politicians in demanding for a higher royalty.
But in actual fact, Petronas has invested so much in the state, about RM183 billion in the upstream sector alone.
Beside this, it has paid out cash worth RM33 billion since 1976 with another RM18 billion payouts from Sarawak's stake in the Malaysia Liquefied Natural Gas plant in Bintulu.
On top of this, Petronas is employing some 5,000 professionals from Sarawak in its operations worldwide, apart from RM411 million worth of scholarships.
The bottom line is, let us be fair and objective when discussing oil matters and not be swayed by emotions.
Giving a 15% hike to the producing states will also undermine Petronas's own sustainability to contribute to the nation because it would result in lower petroleum income tax receipts.
According to Petronas, for five years from 2012, planned projects with a total capital expenditure of RM170 billion are at risk of being cancelled if the royalty payment is increased.
Furthermore, any such hike will also reduce the profitability and economic viability of all current and future O&G projects under development.
What this also means is that Petronas and the PSC contractors will be discouraged from further investing in looking for new fields that are critical to making up for depleting oil reserves.
And naturally, a reduction in O&G production could result in lower instead of higher payments to the states themselves.
In other words, acceding to their demands would backfire economically especially with world oil prices no longer hovering around US$100 (RM407) per barrel like in the good old days of the oil boom.
We all have to remember that about 30% of Malaysia's gross domestic product comes from Petronas's output and it contributes over 40% of federal government revenue.
Strictly speaking, according to a former senior minister, it would be impossible for Putrajaya to raise the royalty to 20%.
"Perhaps a few percentage points might be okay but certainly not a 15% hike," he told me.
And even with 5% royalty, these three states are getting a cool few billion ringgit annually while the states that don't sit on oil reserves get none.
More clarity and transparency on the oil royalty poser was revealed in Parliament on Wednesday by Economic Affairs Minister Datuk Seri Mohamed Azmin Ali.
He warned that Petronas might "cease operations" if it acceded to the 20% royalty based on gross production as demanded by the states, instead of net profit.
"Our position is, if you want 20% based on gross value, then we have to cease the operations of Petronas," he said, warning of the serious implications on the financial position of both the oil company and the federal government.
Azmin has promised to engage the oil-producing states on this crucial issue.
As for these states, it's time for them to get to the bottom of how the distribution of income in the industry works out instead of pursuing demands that are beyond what the industry itself could afford.
Comment: letters@thesundaily.com