THE past year would have been one of redemption of sorts for the Malaysian oil and gas (O&G) industry. There are more upstream activities and players are making up for lost time after prices started to stabilise following the severe downturn that began in 2015.

But just weeks before the year ends, one issue is threatening to put a dent in the sector’s business prospects in the country’s top oil-and-gas producing state, Sarawak.

Last month, what started off as diplomatic discussions over Sarawak’s share of oil revenue, under the broader Malaysian Agreement 1963, escalated into a lawsuit by the state government, which is claiming billions of ringgit in unpaid sales tax from national oil corporation, Petroliam Nasional Bhd (Petronas).

“In a way, I was quite surprised they took that route,” Petronas president and group chief executive officer Tan Sri Wan Zulkiflee Wan Ariffin tells The Edge in an exclusive interview.

But Wan Zul, as he is fondly known, stops short of implying that Sarawak jumped the gun. “I think it’s their prerogative. Since we have been served with the summons, the legal process will have to take its course.”

At the beginning of the year,  the Sarawak government, which is made up of the Gabungan Parti Sarawak (GPS) coalition, imposed a 5% state sales tax on exports of petroleum products. On Nov 21, the state made its move and filed a lawsuit against Petronas at the Kuching High Court to recover the unpaid taxes.

The lawsuit comes at an interesting time. Sarawak is scheduled to hold its 12th state election before September 2021. The incumbent GPS was formed by four component parties that pulled out from the Barisan Nasional coalition, which is now in opposition, months after it was defeated in the 14th general election last year.

As history has shown, cases with huge implications such as this could take years to be disposed as they make their way through the High Court to the Federal Court. To Sarawakians, whoever takes over the mantle must continue the fight.

For Wan Zul, the suit is yet another hurdle to cross just before he concludes his fifth year as Petronas chief — a tenure marked by the prolonged oil price downturn from 2015 to 2017, a change in government (which means a change in Petronas’ shareholder), and now, a looming risk over the larger O&G ecosystem that the national oil corporation has built over the years.

“Our legal view is that, in this case, Sarawak has no legal competence to charge us the sales tax,” he says, pointing out that the matter appears under the federal lease and Petronas cannot be double-taxed.

State government officials have gone on record to say that production-sharing contractors (PSCs) in Sarawak, such as Shell, Murphy Oil and Pertamina, have all complied with the new sales tax.

But, according to industry experts, a clause in the production-sharing contract allows the PSCs to claim the additional 5% tax payment from Petronas — essentially putting the entire burden on the national oil company. Looking into Petronas’ portion in every oil barrel raised (see infographics on Page 64), it has no way out but to contest the claim.

How much oil money the producing states should receive has long been a thorny issue. Pakatan Harapan, in its GE14 manifesto, promised Sabah, Sarawak and Terengganu 20% oil royalty.

After the coalition took over Putrajaya, Prime Minister Tun Dr Mahathir Mohamad was quoted as saying that the 20% “will be based on the profit made by Petronas” in the respective states — which is a far cry from the revenue portion, which is understood to be what royalty entails.

In September, Mahathir told the press in New York that the 20% oil royalty “is really not workable”. The prime minister’s view is in line with that of Wan Zul.

“In the past, we have tried to explain why this 20% royalty is a no-go,” Wan Zul says.

It is understood that Petronas’ margin from oil production in Malaysia is a thin 3.7%.

A huge chunk of the oil revenue — 70% — goes to production costs. “For our ultra-deepwater [production], the cost is even higher,” says Wan Zul, an engineer by training.

To show how complex it is, he says drilling could be in waters 2.8km deep just to hit the seabed.

“This cost has increased because all the early simple reservoirs — the low- hanging fruit back in the 80s, 90s and early 2000s — did not require as much technology as is required today,” Wan Zul explains.

“Today, we’ve got to deal with higher contaminants, higher carbon dioxide (CO2), hydrogen sulphide …  Today, there are fields that are 70% CO2.”

After deducting costs, oil royalty to the federal and state governments (5% each), and petroleum income tax (7.6%), Petronas and the PSCs are left with 13.4%.

“And from this balance, 30% goes to Petronas and 70% goes to the PSC,” said Wan Zul. “Out of every US$100, in this scheme, Petronas gets US$3.70. Not many people realise that. The respective governments get US$5 risk-free.”

Uncertainty not good for anyone

“You can run another scenario where it is 20% royalty by the state and you will straightaway realise that the project is not viable. So, nobody will invest in Malaysia, and you can’t have projects and you can’t have more exploration and development, and production,” Wan Zul points out.

The friction is already affecting O&G ventures in Sarawak. Petronas had planned to award the EPCIC (engineering, procurement, construction, installation and commissioning) contract for the Kasawari gas project offshore Sarawak — which has an estimated three trillion cubic feet (tcf) of gas reserves — in January or February, but “uncertainties” hindered it from a final decision. It awarded the EPCIC contract to Malaysia Marine and Heavy Engineering Holdings Bhd (MMHE) in July.

“Now that Kasawari has received the green light, perhaps the future outlook is not so bad,” mulls one analyst covering the oil and gas industry. Another O&G services company executive with operations in Sarawak is of the view that the business case in Sarawak is still solid.

“All the contractors are very busy and activities are robust,” he says. “Existing contracts are fixed so there is no worry about our margins [being squeezed due to the sales tax on Petronas and the PSCs].

“The common understanding is that to avoid immigration and licensing hurdles, companies will comply with the state laws,” he adds.

Kenanga Research in a note on July 5, 2018, pointed out that Petronas had opened up four new exploration blocks in Sarawak for bidding since January that year.

To date, there has been no news about any of them being awarded. It had been reported earlier this year that new awards of acreage are on hold until the dispute between the two administrations is resolved.

“People don’t want to enter because of uncertainty,” says another industry expert. “The impact will be seen seven, eight years down the road.

“I hope, behind the scenes, all the diplomatic channels are being exhausted. This is something that affects the nation’s economy — more than a fifth of the federal government revenue [an estimated RM244 billion in 2020] is petroleum-related.”

As at October, federal government officials told the Dewan Rakyat that MA63 discussions on oil royalty are still ongoing.

‘Our role is to increase the value pie’

In the meantime, Wan Zul, who is tasked with preparing Petronas for a low-carbon future (see Q&A on Page 61) has not been deterred from focusing on the oil corporation’s main objective.

“For Petronas, our role is to increase the value pie. So we will do whatever we can within our means and expertise to increase the value pie for the whole country — whether it is in Sabah, Sarawak or the peninsula.

“How the value is being distributed among the relevant stakeholders actually is a matter of our shareholder and the other states in this instance.”

Previously, the Dewan Rakyat was told that Sarawak had received royalty payment of RM33 billion between 1976 and 2017, which is more than double that of Sabah’s over the same period, indicating the state’s prominence in the industry.

Concurrently, Petronas has invested over RM183 billion in Sarawak’s upstream sector, with more to come.

On that note, Petronas maintains that it welcomes the participation of Petroleum Sarawak Bhd (Petros) in the industry, although not in the manner that Petros would want, which is to be the sole authority to issue licences and permits for all upstream activities in the state — a role that belongs to Petronas.

Says Wan Zul, “We kind of welcome state participation in the O&G industry … all the states. The only thing is that we have to respect what is already in place, essentially, the Petroleum Development Act (PDA) of 1974. We welcome anybody, but you know, we’ve got to recognise and respect the PDA.

“We were hoping that in the MA63 discussions, we could come to a holistic agreement between all the relevant states, and we would definitely respect whatever the outcome is.”