By Khairul Khalid
With earnings falling, Petronas’ new CEO Wan Zulkiflee Wan Ariffin wants to adopt a more cautious approach but its huge bets overseas, such as its troubled RM100 billion Canadian project, may undermine any fiscal tightening. Will we really see a more prudent Petronas?
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Is Petroliam Nasional Bhd (Petronas) ready to tighten its belts with earnings falling for the second consecutive financial quarter? The state oil company says that it is preparing a new era of low oil prices by embracing fiscal discipline but its expensive and risky ventures overseas may suggest otherwise.
Wan Zulkiflee Wan Ariffin
“The outlook is not very rosy,” said Petronas’ president and group chief executive officer (CEO) Wan Zulkiflee Wan Ariffin at a major oil and gas (O&G) conference in Kuala Lumpur on May 17.
And so it proved. A few days later, on May 22, Wan Zulkiflee presented Petronas’ results for first quarter of financial year 2015 (1Q15), his first since assuming the CEO post in April.
Although it was a slight improvement over the previous quarter 4Q14, which saw Petronas register unprecedented RM7.3 billion in losses and write down RM22 billion in impairments, 1Q15 was still a disappointment.
Both revenue and profit were down for 1Q15. Revenue and profit after taxes fell 21% to RM66.2 billion and 39% to RM11.4 billion respectively year-on-year, still a substantial drop.
This poor performance was mitigated by several factors including a stronger US dollar due to the fall of the ringgit, a 5% improvement in Petronas’ production volume, and higher crude oil production from domestic fields.
Will overseas projects undermine cost cuts?
Overall, the new CEO’s prevailing message since taking over has been for Petronas to be cautious and adopt a new mindset of prudence.
“We are still adjusting to the new low prices of oil, which is the ‘new normal’,” said Wan Zul, as he is commonly known, at the O&G conference on May 17.
But is Petronas taking a holistic approach in its cost cutting – or what it terms “cost realignment” – both domestic and abroad to adjust to falling earnings?
Domestically, Petronas is taking advantage of a softer market. For example, it is renegotiating for discounted rates with some of its contractors for the RM60 billion Refinery and Petrochemical Integrated Development project in Johor.
Nevertheless, it does not seem to be holding back in its overseas ventures.
Although Petronas is slashing capital expenditure (capex) by 25% and operating expenditure (opex) by up to 30% in response to the turmoil caused by the plunging energy prices, it is still investing heavily in foreign ventures, especially in upstream exploration and production.
Petronas said that it has saved approximately RM200 million so far this year due to its cost cutting measures, but will its expensive, high-risk overseas projects undermine Petronas’ efforts at cost realignments?
Of its capital investments year-to-date in 2015 of RM12.1 billion, 45% has been for international projects.
One of Petronas biggest-ever investments is its Canadian liquefied natural gas (LNG) project in British Columbia, estimated to cost RM100 billion over the duration of the project. The project has had its fair share of troubles and has yet to be approved.
Wan Zulkiflee said during the 1Q15 results announcement that Petronas will be making a conditional final investment decision on the Canadian project in 2Q15. KINIBIZ will explore the various aspects of this massive project in the next part of this series.
Other than Canada, Petronas has exploration and production ventures in at least 22 countries in Southeast Asia, the Middle East, Central Asia, Latin America, and Africa, accounting for almost a quarter of its total O&G reserves.
In May 2015, Petronas completed the purchase of O&G-related assets in Azerbaijan from Statoil for US$2.25 billion (RM8.1 billion). Statoil is Norway’s biggest energy company.
The Statoil deal was Petronas’ third-largest acquisition, after its US$5.7 billion acquisition of Canada’s Progress Energy Resources in 2012 and the US$2.5 billion acquisition of Gladstone’s LNG project in Australia in 2008.
Petronas’ patchy international record
Although all of these international projects undoubtedly look impressive in Petronas’ portfolio, ultimately these investments should be judged on how they perform financially.
Are they worth the risk for Petronas, especially under the current economic climate?
Currently, it is difficult to evaluate each of Petronas’ overseas projects on a case-to-case basis because the company does not divulge these details in its accounts. For example, we don’t know exactly how profitable each of these individual overseas projects is. Petronas’ 1Q15 results does not reveal a breakdown of domestic and international revenue or profits.
The international segment contributed a whopping 43% of Petronas’ total revenue in its financial year 2013, amounting to RM136 billion. However, this was during a period when crude oil price was at its previous high levels. Now that it has come crashing down, it would probably be less.
Wan Zulkiflee himself said that Petronas’ upstream business segment bore the brunt of the oil price drop, with 1Q15 profit after tax (PAT) falling 48% to RM7.9 billion despite an increase in production.
Petronas track record in its international ventures has been patchy at best. In recent years, it has had to pull out of its exploration and production operations in India, Venezuela and Uzbekistan, although it still maintains its presence in war-torn Sudan.
Foreign O&G ventures, especially in exploration and production, require massive capital outlays. Although its returns are potentially huge as well, other external factors beyond Petronas’ control such as price volatility and geopolitics also come into play.
Wider implications on Malaysian economy
There is also the wider-reaching implications of a weaker Petronas on Malaysia’s economy. During the 1Q15 results announcement, Wan Zulkiflee said that due to weaker earnings, Petronas is slashing its dividends paid to the Malaysian government to RM26 billion in 2015, down RM3 billion compared to last year.
Petronas 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.
Subramaniam Pillay
“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 of 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 O&G export earnings could be halved, reducing it by RM40 billion to RM50 billion, given that exports last year amounted to close to RM100 billion assuming no change in export volume. O&G exports accounted for about one-third of the country’s total exports,” said Yeah to KINIBIZ.
The dean said 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.
Fragile oil price recovery
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.
“We are still neutral on the sector despite the ascent of oil price in 2Q15 which we largely attribute to geopolitical tensions in the Middle East, coupled with easing shale production and rig count numbers,” said a TA Securities analyst in a report dated May 25.
The report also added that subdued demand from a sluggish world economy, build-up of US stockpiles, volatile Middle East production, and elasticity of shale production are factors that may derail the fragile oil price recovery.
“Furthermore, steep capex cuts and austerity drives announced by O&G companies back in 4Q14 are currently being effected. The brunt of these measures has resulted in charter rate discounts, project delays, and contract terminations etc since start of 2015. We do not expect a reversal of such measures in the near to medium term given oil price uncertainty,” said TA Securities.
These widespread uncertainties of the O&G market cast further doubts on Petronas’ risky overseas ventures.
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