Oil royalties for Sabah and Sarawak: Dead on arrival

Brent crude oil prices dipping below US$30 and US oil prices turning negative for the first time in history is bad news for Sabah and Sarawak, which are dependent on oil royalties as a major source of revenue.

Analysts predicted the depressed oil price will continue in the short and middle term as demand continues to fall. Oil producers like Petronas facing a glut market are riding in uncharted deep waters as Covid-19 batters the world oil markets.

For Sabah, petroleum royalty remains the highest contributor to the state coffers. For 2020, the total projected revenue from oil is RM1,7 billion. Oil royalty accounts for 40.55% of the state revenue. This estimate is based on royalty payment received from Petronas in 2019 amounting to RM1,703.5 million, the highest amount received since the Petroleum Development Act 1974 was passed.

As a major oil-producing state, the plunging oil prices will mean the state will get less oil royalties, perhaps less than half of what was budgeted for in 2020.

With additional expenditures allocated to fight Covid-19, the state government funds will be fully stretched to continue its development agenda.

In every crisis there is some light at the end of the tunnel.

Sabah expects to collect RM50 million every month following its decision to impose a 5% sales tax on all petroleum products.

Chief Minister Shafie Apdal said: “This is based on oil and gas production in 2019 and a forecast price of US$25 per barrel for crude oil and US$1.80 per million British thermal unit (MMBTU) for natural gas”. If this comes through without any hiccups, it will give some financial relief to the state.”

THE 20% royalty promised under the Pakatan Harapan government has been the bone of contention between the federal government and the oil-producing states, notably Sabah and Sarawak, which claim exclusive oil rights within their territories under the Malaysia Agreement 1963.

What stands in the way is the petroleum act which states: “An Act to provide for exploration and exploitation of petroleum whether onshore or offshore by a Corporation (Petronas) in which will be vested the entire ownership in and the exclusive rights, powers, liberties and privileges in respect of the said petroleum.

“In return for the ownership and the rights, powers, liberties and privileges vested in it by virtue of this Act, the Corporation shall make to the Government of the Federation and the Government of any relevant State such cash payment as may be agreed between the parties concerned.”

The clamour for more oil royalties is like the idiom “dead on arrival”; the promise was defunct from the start.

In July 2018, Dr Mahathir Mohamad announced in Parliament that oil-producing states would receive 20% of profit from their resource, only to backtrack a short time later.

Mahathir, realising the consequences of his promise later, said paying more than 5% would “kill” Petronas.

According to Reuters, a 20% royalty would roughly mean a payment of US$7bil or nearly RM29bil a year to Sabah and Sarawak.

Petronas CEO Wan Zulkiflee Wan Ariffin said about 70% of oil revenue is actually spent on production costs, and such cost becomes even higher when it involves ultra-deep water production.

Aside from the production costs, there is also oil royalty that has to be paid to the federal government and state government at 5% and a petroleum income tax at 7.6%, which would then leave Petronas and production-sharing contractors (PSCs) with 13.4%.

From the 13.4% left, 30% goes to Petronas, while 70% goes to PSC.

Wan Zulkiflee said, “Out of every US$100 (RM415), in this scheme, Petronas gets US$3.70. Not many people realise that. The respective governments get US$5 risk-free,” he was quoted saying.

There were other options on the table that were being discussed, taking a share in Petronas and taking part in PSC contract.

In December last year, Mahathir floated the idea that the government could sell Petronas shares privately to states such as Sabah and Sarawak where the company has most of its energy assets.

One report estimated Petronas’ average market value at about RM862 billion. This means that even a 10% stake would cost RM86 billion.

Sabah and Sarawak should temper their high expectations with reality as Petronas or the federal government can ill afford to give a big chunk of its equity for free.

Buying stakes in Petronas is also not an option as no state can afford spending billions on buying Petronas shares.

Going the PSC way is also not a good option for Sabah. The cost of oil extraction in deep waters is huge and the risks are high.

Sabah has already invested heavily in the upstream sector via its vehicle Sabah International Petroleum (SIP) buying and operating FPSO and in PSC Blocks SB 331 and SB 332 with Sapura Energy, SIP and Petronas Carigali.

The situation brought on by Covid-19 will put enormous pressures on Sabah’s upstream investments. It will mean additional funds are required to keep these assets afloat, which the state can ill afford.

As Wan Zulkiflee said, out of every US$100, Petronas gets US$3.70 and the respective governments get US$5 risk-free. Pursuing oil royalty is a less riskier option.

There are two schools of thoughts on the oil royalty issue. Short of seceding from Malaysia as in the case of Singapore, based on all the facts and arguments laid before us, the federal government will not be able to pay more than 5%.

The other school of thought is more of “hope”: oil and gas belong to the state and Petronas has to pay a fair quantum for any extraction within the state boundaries. The latter is the most unlikely scenario. - FMT