Petronas’ crashing profits – blip or crisis?

By Khairul Khalid

Petronas’ latest financial results, although not entirely surprising, was still jaw dropping – its first quarterly loss since it started reporting results publicly. Is it just a temporary blip, or possibly the makings of a full-blown crisis for Malaysia’s oil giant?

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Petronas’ (Petroliam Nasional Bhd) spectacular crash in the fourth quarter of the financial year 2014 (4Q14), posting RM7.3 billion losses, was into uncharted waters.

It was the state oil company’s first ever quarterly loss. Quarter-on-quarter, Petronas’ 3Q14 RM12.8 billion profit had abruptly turned into 4Q14’s RM7.3 billion losses.

Malaysia’s only Fortune 500 company and perennially named in the upper echelons of the most profitable companies in the world, had never registered a losing quarter since the company started filing financial results on a quarterly basis five years ago.

Shock to the system

Until now. What a difference three months make.

In its previous 11 quarters prior to 4Q14’s RM7.3 billion losses, Petronas had accumulated RM177 billion in earnings, averaging more than RM16 billion in profits quarterly. And then came the big shock to the system that the oil and gas (O&G) industry seemed ill-prepared for.

Crude oil prices started to free fall after years of soaring.

In June last year, barely eight months ago, the price of Brent crude oil was up to about US$115 per barrel.

Brent is one of the major benchmarks for purchases of oil worldwide. Prices had hovered around the US$100 levels since 2010 mainly due to China’s explosive economic growth spurring demand and political strife in oil-producing countries such as Iraq curbing production.

In an extraordinary collapse, by Jan 23 this year, Brent crude oil price had fallen by more than 50% to US$49 per barrel. Supply of oil, due to a combination of economic and political factors, had finally overtaken demand. There was a glut of oil supply, causing the steep drop of prices.

Damage already done

Although the price of Brent crude oil has rebounded to reach the US$60 level currently, the damage is already done. Profits and share prices of O&G companies have taken a beating in recent months and, evidently, Petronas was not spared.

Petronas’ profit after tax plunged 27% for the full financial year 2014 (FY14) to RM47.6 billion and the company blames this largely on a mind-boggling RM22.6 billion worth of impairments. The impairments are said to be revaluation of Petronas’ oil assets that have drastically dropped in recent months due to the price collapse.

Prior to its FY14 announcement, the signs were already ominous for Petronas.

The financial results of its subsidiaries such as Petronas Dagangan (PetDag) and Petronas Chemicals (PetChem) did not bode well for Petronas.

PetDag’s net profit plummeted 99.7% year-on-year (y-o-y) in its 4Q14 to just RM445,000 from RM151.32 million a year ago.

Similar to the results of its parent company, PetDag’s slump in 4Q14 dragged its full year results. Its profit before tax (PBT) for FY14 dropped a massive 36% y-o-y to RM709 million.

PetDag blames this weak performance on, among others, lower gross margin caused by the steep decline in oil prices.

Another subsidiary PetChem also suffered a year-end slide, with profit before tax (PBT) of FY14 down 21.9% to RM3.5 billion from the previous year. Its FY14 revenue of RM14.6 billion was down 4% from RM15.2 billion in FY13, despite improving plant utilisation rates to 80% from 78% the previous year.

PetChem attributes the drop to lower average selling price (ASP) of its products due to lower oil prices.

New realities for Petronas

Reflecting new economic realities facing Petronas, it recently made some amendments to its RM4 billion contract with another of its subsidiary, Malaysia International Shipping Corporation Bhd (MISC).

In an about turn, the shipbuilding contract for five liquefied natural gas (LNG) carriers has been novated or replaced with a new one. In 2013, Petronas had awarded the RM4 billion construction job to Hyundai Heavy Industries (HHI) and only appointed MISC as project manager and technical consultant.

Petronas wanted to own and run the ships themselves, despite MISC’s expertise in the business. Now, it has made a complete U-turn and transferred ownership of the vessels to MISC, with Petronas only chartering them from MISC for 15 years once they are completed in 2016-2017.

The reversal, although rumoured for some time, was probably fast tracked due to Petronas’ predicament in the current climate of low oil price.

Owning and running the five LNG vessels is probably a less attractive business proposition now for Petronas. Falling back on the lease option, instead of outright ownership of the vessels, is probably a more sensible move financially for Petronas.

Double whammy – capex cuts & RSCs

What lies in store for Petronas amid such turmoil in the O&G industry?

It has already been forced to slash capital expenditure (capex) for its current financial year 2015 (FY15) by 10% and operating expenditure (opex) by 30%. Capex cuts, at least for the next two years, is estimated to be between RM25 billion to RM30 billion.

It has also declared a halt to awarding domestic risk sharing contracts (RSCs) – local joint ventures with local partners to extract more oil from marginal and mature oilfields using enhanced oil recovery (EOR) – unless the oil price returns at least to US$80 per barrel.

This double whammy – Petronas’ capex cuts and halt to RSCs – will further compound troubles for local O&G players already reeling from the shock of the oil price crisis.

Medium- to small-sized O&G players, especially those that rely on Petronas for a significant chunk of their businesses, will feel the immediate financial squeeze from Petronas’ capex cuts.

“It is the new reality. We have to be more prudent and conservative,” said outgoing Petronas chief executive officer (CEO) Shamsul Azhar Abbas.

‘No layoffs’

Petronas has revised its budget for FY15 based on an assumption of oil price at US$55 per barrel, further down from management’s forecast of a “new era” of US$70-US$75 per barrel only last December.

However, Shamsul, whose five-year tenure as CEO ends at the end of this month, dismisses any rumours of impending staff layoffs.

“It’s ridiculous. We will still recruit,” said Shamsul during his last public appearance in a Petronas financial announcement.

Wider implications on Malaysian economy

There is also the wider reaching implications of a weaker Petronas on Malaysia’s economy.

It contributes an estimated 30% to the Malaysian government’s total revenue. In 2013, Petronas contributed RM73.4 billion to the federal and state governments. Its total contribution to the government since its inception is more than RM800 billion.

Although the government has been trying to reduce Malaysia’s dependence on oil revenue in recent years, Petronas’ impact on the domestic economy can hardly be overstated.

“Government revenue will fall because the reduction in oil-based revenues (eg royalty, petroleum tax, Petronas dividends, etc) will be bigger than the reduced spending on petrol subsidies,” said Subramaniam Pillay, professor in International Finance at Taylor’s University, to KiniBiz.

Another academic, Yeah Kim Leng, the dean of School of Business at the Malaysia University of Science and Technology (Must), echoes these sentiments.

“Malaysia’s oil & gas export earnings could be halved, reducing it by RM40 million to RM50 billion given that exports last year amounted to close to RM100 billion assuming no change in export volume. Oil & gas exports accounted for about one-third of the country’s total exports,” said Yeah to KiniBiz.

The dean says that the negative impact on the country’s export earnings, however, could be partially offset by the expected rise in manufacturing exports as well as the depreciation of the ringgit.

However, such is the uncertainty surrounding the oil industry that many analysts are unable to predict how Petronas will weather the flux in oil prices.

“It is still early days. More clarity will emerge within the next three months,” said analysts from TA Securities.

Tomorrow: Petronas’ RM22.6 billion impairment bombshell