IN less than two months from now, Malaysia’s natural gas supply industry is scheduled to undergo a new three-year regime, which will dictate base tariffs for gas regasification, transport and distribution, should things go according to plan.

And the base tariffs will be a key contributing factor to the earnings prospects for Petronas Gas Bhd.

The regime, under the Incentive-Based Regulation (IBR) framework, is scheduled for renewal for the Regulatory Period 2 (RP2 2023-2025) at an interesting time when the world is suffering from high fuel prices and the US dollar is strengthening rapidly.

The first regulatory period (RP1 2020-2022) will expire by the end of the year.

Speaking with The Edge in an interview, group managing director and CEO Abdul Aziz Othman reveals that PetGas is seeking an annual adjustment of tariffs in RP2, based on the fuel costs and US dollar foreign exchange rates of the year before — a step taken to protect its profit margin from the volatility of energy prices.

The Brent crude oil price, which influences the gas price, is still hovering above US$90/bbl — levels not seen in the last eight years. That has eaten into the margins of infrastructure players like PetGas.

The proposed annual adjustment is much like the tariff adjustment in the power sector every six months. When the fuel price is high, the power sector takes on the cost before it is compensated by end-users through a tariff surcharge. Similarly, end-users eventually get tariff rebates when the fuel price drops below the benchmark.

With RP2 expected to be announced soon, PetGas is seeking to de-risk from the swing in commodity prices and the US dollar — risks faced when the its gas transportation and regasification segments were first opened up for third-party access (TPA) by new gas shippers a few years ago.

The TPA is part of the liberalisation of the gas industry, first mooted in 2016 to encourage gas imports by new gas players into Malaysia, to reduce dependence on local supply and cater for the rising demand. PetGas’ role is to facilitate this by allowing the players to use its regasification and gas transport pipelines for a fee.

“[PetGas’] returns are fixed and commensurate with utilities,” says Abdul Aziz. “Our business is [in] capacity, we are not in the molecule side where when the price goes up, we get the benefit. So it is fair that you have those adjustments,” he says, adding that both proposals have been made to the government.

During the last three volatile years, gas prices slumped during the Covid-19 pandemic and then unexpectedly staged a strong rebound mainly due to demand and the supply shock caused by the Russia-Ukraine tension.

Coincidentally, the price swings happened during RP1 2020-2022. Typically, regulated businesses are seen to be immune to any cost and price fluctuations. But this is not the case for PetGas, according to Abdul Aziz, speaking from experience.

The group realised that RP1 did not seem to shield it from the uncertainties that impact its financial returns. Instead, the internal gas costs exceeded the benchmark set in its base tariffs, causing it to absorb the increments.

“We are still profitable, although [the earnings were] lower than what we enjoyed in the lower price environment,” says Abdul Aziz, who was appointed to helm of PetGas in January 2021 — right during the wild market swings.

To be sure, PetGas profited from low gas costs in 2020-2021, and was only negatively impacted this year when gas prices skyrocketed. “We kept what we saved [from the fuel costs in RP1],” he says, adding that on average, it made some margins from the allowable internal gas costs through RP1.

Added to this year’s negative impact is the ultra-strong greenback, by virtue of PetGas’ cost structure related to regasification terminals, which are paid in US dollars.

Prior to the TPA, gas transport tariffs were scheduled for review every four years, while regasification tariffs covered both ringgit and US dollar exposure.

Its leasing of the Melaka floating LNG storage, which is owned by its sister company MISC Bhd, is paid in US dollars, Abdul Aziz says, adding that its Pengerang regasification business also faces US dollar exposure.

However, Petronas, the major user of regasification terminals, and other shippers are paying PetGas in ringgit to use the facilities. “So, obviously, I’m exposed [to forex risks]. That’s why the request is to pass through,” Abdul Aziz explains.

Apart from gas transport and regasification, PetGas operates a gas processing business with Petronas as a major client, as well as a utilities segment, which comprises the power plant business as well as steam, oxygen and nitrogen production.

Affected by slow electricity tariff adjustments

The RP2 is not the only regulatory risk faced by PetGas at present.

The gas industry IBR review is happening on the back of a separate review for the power sector, which was delayed for one year in 2021 and for another month in January this year due to the pandemic.

For the power sector, which is already in its third regulatory period (RP3 2022-2024), the base tariffs have remained unchanged despite the spike in fuel prices, particularly coal, which makes up over 50% of the generation mix.

That has now weighed on the balance sheet of Tenaga Nasional Bhd as the government had decided to extend the tariff rebate position to avoid worsening the current high inflation environment.

Interestingly, the non-revision of Tenaga’s tariff is also impacting PetGas’ performance in its electricity generation division under the non-regulated utilities segment.

This is because PetGas benchmarks its electricity sales to Tenaga’s tariffs for 47% of its 541MW electricity capacity — and like Tenaga, PetGas is exposed to fuel costs for this capacity portion.

Only PetGas’ 60%-owned, 285MW Kimanis power plant in Sabah operates under a power purchase agreement (PPA), where the fuel cost risk is borne by its client.

“[PetGas’ gas costs in the peninsula] is benchmarked against MRP (Malaysia Reference Price) with a certain premium, which I consider as market price. There is no discount whatsoever. I have to pay market price for my business (both regulated and non-regulated),” says Abdul Aziz.

Thus, just like Tenaga, it is not cushioned from fuel price swings given that tariffs are subject to the government’s interference. “If the tariff increases, we stand to benefit also because our tariff is pegged to Tenaga’s tariff. That could be the upside for us,” he adds.

Gas price still stumbling block for liberalisation

Like PetGas, the non-power sector has begun to purchase gas at MRP — a domestic reference price that is benchmarked against the international price — as part of the industry liberalisation since early 2022.

To further prepare the industry for the gradual reopening, PetGas’ RP2 proposals include certain recommendations to make it easier for people to book the capacity, says Abdul Aziz.

Concurrently, the group is also eyeing growth opportunities from the impending market shift, including expanding into floating LNG storage vessels and onshore storage facilities near its regasification terminals.

PetGas has been investing in expanding the gas pipeline networks to support gas import activities in the future, from an infrastructure perspective.

To facilitate imports, in the past, national oil firm Petronas had also released some of the regasification capacity that it had booked from PetGas, and PetGas in turn sought third-party shippers to take up the spare capacity.

Two years on, that has taken a pause due to a lack of demand from third parties.

Alignment is another issue. Just recently, glovemaker Careplus Group Bhd entered into a legal dispute with third party shipper Petrolife Aero Sdn Bhd in relation with a gas supply contract that escalated to a RM27 million suit. The glove sector had just entered a downcycle, where the tight market swiftly turned into oversupply. The episode highlights the challenge of getting the formula right in a liberalised market.

“We had only one shipper who took 7mmscfd (million standard cubic feet per day) for two years,” Abdul Aziz says. “So, there are some fundamental issues that are not supporting people in taking up the capacity.

“PetGas has done a lot to map out the third party access, to make it as easy as possible to come in. But the other part (further gas price liberalisation) needs to happen too.”

Despite the MRP’s introduction, the power sector, which makes up at least 40% of Peninsular Malaysia’s gas demand, still buys piped gas at a discount to the MRP.

This is as opposed to the non-power sector, which adopted the MRP in 1Q2022. At the time,  the price has yet to spike owing to a lagged effect to market price. Since then, the domestic gas supply has entered the current high price environment as the Russia-Ukraine tensions have changed the dynamics, at least for the time being.

This has again widened the gap with local prices, which closes the window for market liberalisation.

The situation is not unique to Malaysia. Reuters reported that Germany’s soon-to-be-nationalised gas importer Uniper booked €40 billion (RM186 billion) in net losses in the January to September period for buying LNG at market price and selling it cheaply domestically.

Explaining the gas market dynamics, Abdul Aziz says for new long-term LNG contracts, its price as a percentage of crude oil price (slope) has gone up to 13%-14%, as opposed to 11%-12% just a few years ago, owing to the lack of global investments in new LNG plants.

“The slope is dependent on supply and demand … the trick is to lock in [long-term contracts] when the slope is low,” Abdul Aziz says. “Of course, the oil price moves [but] your margin is protected. That’s how the business is done.”

For PetGas, it is protected as the long-term capacity contract with Petronas is scheduled to last until 2033 for the Sungai Udang regasification terminal, and 2042 for the one in Pengerang.

But until new shippers come in, growth for the group in the regasification segment is limited. It mulled a regasification project in Sabah in 2013-2014, but that did not materialise.

“If somebody is willing to pay for the capacity, PetGas will build it. But again, they must have gas [coming in at the imported price] and a customer that is willing to buy [at that price] to give you the margin.

“It takes effort to make the business [work]. Sometimes alignment is not easy,” he says.