As reported by Stratfor (subscription required), Malaysia’s energy giant Petronas could go broke within a decade if the government takes all of its profits under a new tax scheme, the company’s president and chief executive Tan Sri Hassan Marican recently said.  Although Petronas would not be the first Asian energy major to bow under soaring costs, its superior operational capability means that its failure would seriously affect the country’s future energy supply and security.  As the article notes:

“…Time could be running out for one of the developing world’s most powerful state-owned energy companies….a failed Petronas would have major geopolitical implications because the Malaysian government depends on the firm’s success for stability. Moreover, the failure of Petronas would have serious consequences for Malaysia’s energy-hungry neighbors.

…Like other nationally owned energy giants, such as Brazil’s Petroleo Brasileiro (Petrobras), Russia’s Gazprom and Saudi Arabia’s Saudi Aramco, Petronas performs at a consistently high level and is rich in resources. In 2006, its total revenues were $23.3 billion and its net income was $14 billion — higher than Petrobras’. Petronas also has an energetic entrepreneurial mindset comparable (though not quite equal) to Petrobras’.

Petronas’ oil reserves — more than 3 billion barrels of mostly high-quality crude — are on par with Chevron and Royal Dutch/Shell’s, and its oil production is roughly half of Chevron’s at about 700,000 barrels per day (bpd). In the realm of natural gas, Petronas is especially formidable, with reserves at about 2.1 trillion cubic meters — larger than the reserves held by ExxonMobil, BP, Shell or Chevron. Its natural gas production has surpassed 62.3 billion cubic meters per day, above that of PetroChina and Petrobras, and it is one of the world’s top three producers of LNG, which it ships primarily to Japan, South Korea and Taiwan. Petronas’ natural gas production continues to increase.

However, the future does not seem so promising. Petronas is rapidly depleting its oil reserves. Oil production in Malaysia has fallen 18 percent since its 2005 total of 850,000 bpd and is expected to keep falling. Natural gas production continues to rise, but maintaining output depends on opening a number of offshore sites near Sabah and Sarawak, Malaysia’s two insular states. These sites and others in the South China Sea represent Petronas’ increasing reliance on deepwater deposits, which are extremely costly since they pose geological challenges that require the highest levels of managerial skill and technological expertise in order to be brought on line.

…The Malaysian government currently reaps about 63 percent of Petronas’ average gross income through royalties, dividends, conventional taxes and export duties; the government’s take amounted to about $9.5 billion in 2006. Petronas provides 32 percent of the Malaysian government’s total revenues and the vast majority of Malaysia’s domestic energy supply. Without Petronas, Malaysia would transform from a net energy exporter to a net importer, fundamentally weakening its geopolitical position. Moreover, Petronas is facing a major tax increase.

Recently, the government loosened long-standing fuel subsidies in order to stop its deficit from ballooning as global prices surge. Domestic fuel prices were allowed to rise 41 percent; by August, they could increase by a total of 130 percent. The gradual lifting of fuel subsidies has angered the public, which previously enjoyed the cheapest fuel prices in the world outside of Saudi Arabia and Venezuela.

To soften the blow, Malaysia’s ruling political coalition led by Prime Minister Abdullah Ahmad Badawi simultaneously introduced a series of direct subsidies aimed at the poor and those who drive smaller energy-efficient cars and motorbikes. These subsidies will be paid for by a hefty tax on Malaysian energy companies’ windfall profits. In the short run, this strategy could stabilize the country amid high fuel costs; however, in the long run, the combined pressure of the new taxes and rising costs for materials and manpower will damage Petronas’ ability to maintain a dynamic and competitive position in the world energy trade. In the worst case, it could even drive the company toward financial ruin.

Kuala Lumpur is counting on sustained high fuel prices globally and the fact that Petronas is generally highly efficient (unlike other state-owned regional rivals, it competes with other companies for contracts). But the tax plan could backfire if energy prices suddenly fall or if Petronas simply cannot carry the load; then, the government would have to spend massive amounts to bail Petronas out, as has happened with China’s Sinopec and Indonesia’s Pertamina, whose finances are currently in the red though they continue to produce and refine petroleum products with government support.
Petronas’ Future

Malaysia is therefore at a crossroads in planning Petronas’ future. If Kuala Lumpur allows Petronas the flexibility (and the cash) it needs, the company could model itself on Petrobras and become a permanent international player. It would be able to reinvest its profits, develop a forward-looking fiscal regime and enter into tricky deepwater projects. It would also be able to maintain its dominance in the country’s natural gas sector downstream while expanding its holdings in the region’s financial industry. Ultimately, like Petrobras, Petronas would survive in the international energy industry by securing reserves across the world and using the most-advanced technology to develop ultradeep sites.

The alternative is for Petronas to go the way of Petroleos Mexicanos (Pemex). For a long time, the Mexican government depended on the nationally owned energy champion for about 40 percent of government revenues. Congress snatched profits from Pemex throughout the 1990s, mainly by taxing windfalls but also through other legal and constitutional restrictions. The company became embroiled in political battles, and its lack of financial success led output to stall in 2005. Pemex’s production has declined since then.

So Malaysia has a choice. Burdensome and erratic taxation will eventually cripple Petronas’ ability to compete with international energy companies. If profits are taxed away, they cannot be reinvested, and Petronas’ long-term capability will suffer with each passing year. If profits are freed up, they can be employed strategically to prepare for international competition in the long term. Petronas is Malaysia’s only hope, and thus Kuala Lumpur cannot afford to ignore its appeals.”