Is Petronas on The Right Track?

By Dr Fong Chan Onn

Many nations blessed with rich resources have enjoyed economic booms, but many have also been cursed by it. So what is Malaysia’s standing among the world matrix of oil-producing nations, and how well are we managing our oil revenue?

In 1973, OPEC unexpectedly imposed a six month embargo on oil supplies, inducing the first global oil shock. Malaysia’s response to that was the incorporation of Petronas as the Malaysian oil corporation. The timing seemed right given that in 1971, the price of oil was just US$ 1.50 but by 1974, it was already averaging US$ 12 per barrel making it viable for Petronas to extract oil from our off-shore reserves.

From 1974 till 2000, oil prices hovered between USD$ 20 to USD$ 30 per barrel. At these price levels, government subsidies for oil then was not an issue; nor was there much of a debate regarding Petronas and the management of Malaysia’s oil reserves until 1997, when Petronas money was used to build the Twin Towers and Putrajaya in-spite of the onset of Asian Financial Crisis.

Petronas came under scrutiny again in the 2007 when oil prices ballooned to USD$ 140 per barrel. In parliamentary debates questions were being asked about the windfall profits that were being made, and how these profits were being managed and spent. At the same time there was also public demand for transparency and accountability of Petronas.

Once again the recent change in the leadership of Petronas has sparked off debates on the company’s operations and reporting; additionally the question of sustainability of its contributions to government revenues was also widely discussed.

True, many nations blessed with rich resources have enjoyed economic booms, but many have also been cursed by it. Perhaps, now is a good time to explore Malaysia’s standing among the world matrix of oil producing nations, as well as the road ahead of us in the management of our oil revenue.

1. Did we suffer Dutch Disease?

Some nations upon the discovery of a rich natural resource such as petroleum have experienced the Dutch Disease that is their economy shrinking instead of expanding. This is because the discovery has led to an automatic boom in the export revenue and consequent appreciation of its exchange rate; which then caused the subsequent non-competitiveness of its non-oil sector, particularly its manufacturing sector. The experience of Netherlands in 1959 after the discovery of large natural gas fields only to see the rest of its economy shrinking has led to the term “Dutch Disease”.

I will argue that Malaysia did not experience Dutch Disease since 1974, for reasons that:

a) A single-minded pursuit of an export-oriented industrialization policy since the 1970s, have seen the manufacturing sector grew from RM36.5 billion in 1987 to RM 491.9 billion by 2008. In fact, it was during this period that Malaysia emerged to be the world largest exporter of Electrical and Electronics (E&E) appliances with its export value growing from RM 11 billion in 1987 to RM 277.3 billion in 2008. Similarly, the service sector was not impinged by the presence of oil reserves, growing from RM36.7 billion in 1987 to RM334.6 billion by 2008.

b) And as a consequences of a deliberate drive to push exports up, the Ringgit was maintained at about RM2.20 to RM 2.70 to the US$ since the1970s, until Malaysia was hit by the Asian Financial Crisis in 1997 when the currency was then pegged at RM 3.80 per US$. In fact the Ringgit exchange rate has also declined since 1974 vis-à-vis other currencies; Japanese Yen from RM 0.80 per 100 Yen in 1974 to RM 3.77 per 100 Yen, Singapore Dollar from parity in 1980 to now RM 2.43 per S$.

c) In addition, recognizing the limits of Malaysia’s petroleum reserves, there was the deliberate national policy of curtailing our oil output to about 600,000 barrels per day, in order to extend the lifespan of our oil production. The policy has been strictly adhered to by Petronas even during period of peak oil prices in 2007 and 2008.

2. Petronas’s Report Card

Notwithstanding the absence of Dutch Disease symptoms, have we really made optimum use of our oil revenue? To answer this question let us examines the record of Petronas’s contribution to the nation.

3. Role in National Development

Over the period 1974-1990, Petronas was focused on building up the company. It expanded into downstream activities firstly with a urea plant in Sarawak in 1976. Next it ventured into direct exploration and production in 1978. Then it went on to build the Kerteh and Malacca refineries in 1983 signaling its foray into refining and distribution.

As Malaysia was also keen to be involved in Liquid Natural Gas (LNG), Petronas bought up five tankers through its subsidiary, MISC. And as part of the gasification policy of the Peninsular, the Peninsular Gas Utilization Pipeline (PGU) was built with its first phase completed by 1985 at an estimated cost of RM 720 million. The PGU now runs from Terengganu to Songhkla, Thailand. The PGU was not only crucial to the development of a domestic gas industry but it helped transformed Malaysia to become the 3rd largest LNG producer in the world.

An International Corporation

Given Malaysia’s limited oil reserves, Petronas knew that for its long term survival requires it has to extend beyond the shores of Malaysia. It made crucial discovery in Vietnam in 1994, and later in Cambodia, China, and Algeria. Today, Petronas operates in at least 30 different countries; has more than 100 subsidiaries and owns a fleet of more than 100 tankers and ships through MISC. Its production from its oversea ventures now makes up almost half of it total overall oil and gas production.

Further, because of Petronas’s large financial reserves and sound independent management, it is well respected internationally. In 2008 it ranked as the 8th best profits making company, and the 5th in the Petroleum industry. Its bond issues are always eagerly subscribed at A1 levels; thus acting as a surrogate Malaysia Sovereign Bond. This thus enables the nation to borrow at low interest rates from the financial global market for its development progress. For comparison, Thailand’s sovereign rating is at BBB, Indonesia at BB+ and Singapore AAA.

As a Contributor to Government Expenditure

Petronas started contributing to the government revenue in 1976 with a sum of RM 300 million rising to RM 2 billion by 1981. Due to increasing oil prices, by 2005 it was able to provide RM 32.1 billion (56.5% of net profits) to government revenue, increasing to RM 74 billion (78.9% of net profits) in 2009, which formed about 45% of government revenue for the year. Since its incorporation, Petronas has paid RM 471 billion to government, in addition to bearing a cumulative subsidy of RM 97 billion under the national gas utilization plan.

As the Controversial White Knight

The Petronas as an off-budget agency directly under the Prime Minister is not without controversy. Its large reserves made it a tempting target for bail-outs. It was asked to bail out Bank Bumiputera in 1985 with an injection of RM 2.5 billion, when the Bank collapsed under the weight of loans to the Hong Kong Carrion Property Group. And again it was directed to bail out the same bank at RM 1 billion in 1991. When Bank Bumiputera collapsed for the third time in 1997, was Petronas again asked to rescue? Only the fly at Tan Sri Merican’s (then CEO) office at that time would know. Suffice to say Bank Bumiputera now is part of CIMB. Petronas also bailed out Konsortium Perkapalan Berhad (KPB), through MISC, which suffered RM 2 billion losses during the 1997 Financial Crisis. This, of course, was a subject of much political debate then.

Petronas’s Mega Projects

At the peak of Asian Financial Crisis, Petronas went ahead and completed the Petronas Twin Tower (RM6 billion) and Putrajaya (RM22 billion). At that time it was subjected to much ridicules. There were jokes that “we could sell off one tower to Brunei to get some cash…” etc.

With the benefit of hindsight, however, are these decisions wrong?

The presence of the Twin Tower has transformed Kuala Lumpur into an international city; and KLCC is now the benchmark for property prices in the city. Similarly, although Putrajaya is still a quiet place, but its completion contributed to the rise of prosperous townships stretching from Kajang, Puchong, and Subang to Petaling Jaya.

Nevertheless, one may still ask – is it really Petronas’s core business to undertake mega infrastructure projects on its own? Is it not going beyond its mission (as the agency in charge of the nation’s petroleum reserves) to venture into activities that it is not an expert in? By spending RM544 million in building the six-star Prince Court Medical Centre, is it not really stretching itself way beyond its border?

Absence of a Vibrant Oil and Gas Sub-sector.

With Petronas’s emergence as an international oil company, there seem to be a glaring missing link; and that is its failure to nurture a vibrant oil and gas sub-sector in the country. The oil and gas sub-sector is barely a key driver of the Malaysian economy. In fact, the key leading sector that has primarily driven the Malaysian economy over the last three decades has been the E&E industries, which now contribute to over 30% of our exports in the country.

Malaysia is known for being a premier E&E hub for Asia but, not as an oil and gas hub. There are only about 60 companies listed on Bursa that is related to oil and gas activities, which is equivalent to the number listed on the Singapore Stock Exchange. And Singapore is not even an oil producing nation!

The wealth of our national oil resource has not filtered down to the economy, particularly the small and medium enterprises (SMEs) sub-sector that should be the backbone of any growing economy. No doubt the development of downstream activities such as polypropylene, fertilizers and other chemicals are present and substantial. However, an absence of a significant value chain of oil and gas suppliers, including supporting industries like catering, basic raw materials, tooling and equipment, uniforms, packaging and so forth.

As an oil producing nation, there is no significant Malaysian oil and gas talent pool. There are only a handful of Malaysians involved in technical support in the oil and gas sector such as welders, toolers, and riggers.

The bidding process by Petronas has been structured in a way that stifles local SME growth in this sector. The Bumiputra requirements, depending on the size and nature of the contract, can vary from 30 percent to as high as 70 percent. Oil and gas license are excruciatingly difficult to acquire and the requirements are stringent to a point of exclusion. It has also been long felt that the bidding process is not transparent and favored the foreign players more than the non-Bumiputra players. Petronas contracts signed with the foreign players far outnumber those with local companies.

4. A Comparison with Some Other Oil Producing Nations

How does Petronas’s record and our management of the oil revenue compare with other countries?

I have chosen five other models namely Nigeria, Venezuela, Indonesia, Alaska and Norway; looking at how each country has scored in the management of their oil reserves. While it may be arbitrary but it helps give us some indication beyond our own parochial, sometimes prejudiced view of ourselves.

Nigeria

Nigeria is the largest oil producer in Africa and the tenth largest producer of crude oil in the world. In 2005, total Nigerian oil production averaged 2.6 million barrel per day. The Nigerian economy is almost totally dependent on the oil sector; it makes up 95 percent of export revenues, 76 percent of government revenues, and accounts for about 30 percent of GDP. Nigeria was among the richest 50 countries in the early 1970s. But the blatant abuse of petrol power (coupled with its record of ethnic conflicts) has pitifully regressed Nigeria to the rank of the 25 poorest countries by 2000. Although the situation in Nigeria has improved over the last few years, the amount of human suffering that has beseeched the men, women and children due to mismanagement, and greed leading to violence against its own people, is unspeakable.

Venezuela

The oil and gas sector constitutes a third of the nation’s GDP, around 80% of the nation’s export and more than half of government's revenue. It is the ninth largest oil producer in the world. Oil revenue is central to Venezuelan politics, giving rise to a rent-seeking culture and an entrenched patronage system. Due to the volatility of oil prices, the Venezuelan economy goes through boom and bust cycles, along with it a “yo-yo” cycle of government spending. Despite Venezuela’s estimated $600 billion in oil exports since the early 1970s, real per capita income fell by 15 percent between 1973 and 1998. Its GDP has been declining on an average of 2.2% from 1985 to 2000. Due to its huge production value, Venezuelans have no incentive to look elsewhere for diversification. Today, the Venezuelan economy continues to be plagued with structural problems, and is ever more dependent on its oil reserves.

Indonesia

Pertamina was set up in 1968, during a time when foreign companies mostly dominated the oil industry. Its oil output then increased from 500,000 barrels per day to 1.5 million barrels per day in 1974, contributing up to 15% of Indonesia's GDP then. By 1974, it a huge company to be reckoned with, with its own drilling equipment, a chain of gasoline filling stations, and a fleet of about fifty five tankers. It had non–oil assets as well; with ownership of hotels, tourism complex, automobile distributorship, first class hospitals, television studios, insurance companies, and the US$ 2.5 billion Krakatau Steel mill.

Unfortunately Pertamina fell into mismanagement and abuse and collapsed as an oil company in 1975.

In the early 1980s the Indonesian oil and gas industry underwent extensive reforms. One key aspect of the reforms is the revamp of Pertamina through the establishment of independence; with authorities remove from regulators to agencies. The oil and gas industry was also liberalized, which resulted in the ending of oil and gas monopolies, and this improved production efficiency and profits. Through these reforms the Indonesian government managed to revitalize not only the oil sector but also the non-oil sectors, such as manufacturing, and improved the livelihood of its people with aggressive rates of economic growth.

Alaska

Petroleum extraction constitutes more than 80% of the state’s revenue. Alaska is very concerned about government expenditures being overly dependent on oil, as well as the impact of price volatility on the state economy. In 1976, an Act was passed requiring 25% of the government's oil royalty to be deposited into Alaskan Permanent Fund.

As at 2007, the fund stood at US$ 33 billion and about half of the year’s dividend income was distributed to all Alaskans as cash payouts.

The net effect of the Alaska Permanent Fund is that it helps to stabilize the cash flow for the state, and also improve the income of its people, especially those in the rural areas. The argument being that since Alaska is a poor state, the annual cash payments, given out equally to all residents (rich and poor), would be re-circulated into the economy spurring trade and creating job

Norway

In the 1960s, Norway’s gross domestic product per capita was lower than that of Sweden and Denmark. By the year 2000, the situation has reversed with Norway in the lead, due to the discovery of oil off the Norwegian coast and the establishment of the national oil company, Statoil. Currently, oil and gas industry is a very important component of the Norwegian economy, producing 3 million barrels of oil per day. With a population of 4.8 million, this works out to be 0.63 barrels of oil per day per Norwegian!

Norwegians were quick to learn from the Dutch that its resources had to be managed in a sustainable manner. In 1990, A Norwegian Petroleum fund was established with the main aim of acting as a buffer to smoothen oil price fluctuations, and stabilizing the exchange rate to avoid the dreaded Dutch Disease. As Norway has an aging population, the purpose of the Fund is also meant to help address the future needs of the country.

As at the end of 2001, the size of the fund (at US$ 400 billion) was equivalent to 45% of its GDP; and this fund is invested abroad to avoid overheating the Norwegian economy. Its success is due to the strict guidelines for the Fund's operations for which the authority goes back to the Parliament. Any transfer to and from the funds needs Parliamentary approval. The government is also required to report to Parliament on the Fund's status - three times a year.