Powering up: Building up for sustainable generation

With Malaysia’s steady economic growth and an expected regional surge in energy demand, the country’s oil and gas sector continues to play a key role economically, socially and strategically. Spearheaded by domestic energy champion Petroliam Nasional (Petronas), the industry already has an established track record of discovering and exploiting large hydrocarbons deposits and is looking to build upon previous success to meet the growing needs of both domestic consumption and an resource-hungry region.

Gearing Up

Expanding on these past successes, Malaysia is gearing up investments in the upstream sector to cope with overall energy demand that is expected to be about 50% greater in 2040 compared to 2010 levels, according to projections by ExxonMobil. Demand for natural gas specifically is slated to increase by 60% by 2040. The greatest benefits are expected to be seen in electricity generation, which along with water demand is projected to surge in the coming years in line with rises in both population and standards of living. With the majority of the low-hanging fruit – the so-called “easy oil” – already plucked from Malaysian territory, much of the future growth in the industry will be focused on other more technologically challenging arenas, as well as on diversification.

Some of the areas primed for growth include the development of marginal and deepwater oil and gas plays, expansion of enhanced oil recovery (EOR) projects, development of additional downstream refining and petrochemicals capacities, and the establishment of Malaysia as a regional oil and gas storage and trading centre. On the utilities side there are increasing investment opportunities for private power producers, and ongoing reforms and a growing demand for energy have led to a steady stream of tenders for new large-scale gas- and coal-fired power plants, as well as smaller scale development of renewable energy.

Output

Although petroleum production is not what it once was, Malaysia has managed to avoid the steep, steady declines in domestic crude production that have afflicted other countries in the region as large legacy oil fields inevitably decline in output. In fact, when combined with sustained growth of the natural gas segment, overall domestic hydrocarbons production is stronger than ever thanks to aggressive exploration and development of marginal gas plays, combined with the widespread use of EOR practices in ageing fields.

As of 2013 there were 15 major oil companies from around the globe engaged in exploration and production activities in Malaysia. Most of the country’s major oil-producing fields are located in the Malay basin in the west, with the Sabah and Sarawak basins in the east. As mature oil fields continue to decline in production, development of new fields has shifted to more technically and economically challenging areas, with the deepwater Gumusut-Kakap and Malikai fields under development following Malaysia’s first successful deep-water project, Kikeh. At the end of 2012 there were 132 active oil and gas fields (77 oil and 55 gas) in the country, including eight added in 2012, according to Petronas. For the year, upstream operators combined to invest a total of RM40bn ($12.5bn) in the sector, with the majority channelled towards project development (RM22.9bn, $7.15bn, or 57% of the total) and another RM3.7bn ($1.15bn) spent on exploration activities (9%); the remainder went towards operation of existing assets.

By The Numbers

Total output in 2012 increased 1.9% to 1.59m barrels of oil equivalent per day (boepd) over 2011 levels, with crude oil and condensates averaging 586,000 barrels per day (bpd). Natural gas production averaged 6bn standard cu feet per day (scfd), equivalent to 1m boepd, according to the Central Bank of Malaysia (CBM). While less than the 698,000 bpd produced a decade ago in 2002, the 2012 output represents an improvement over the 570,000 bpd averaged in 2011. This upward trend continued into 2013, with production in the first quarter reaching 599,000 bpd, nearly topping the 600,000 bpd mark last achieved in 2010, before tailing off later in the year to 566,000 bpd and 554,000 bpd in the second and third quarters of 2013, respectively. Bolstered by output from offshore fields in Borneo, natural gas production continued its rise in 2012 by adding 75m scfd to the 5.93bn scfd averaged in 2011, putting it well above the 4.68bn scfd seen a decade ago. Through the first three quarters of 2013 gas output remained strong, with each respective quarter averaging 5.53bn scfd, 6.16bn scfd and 6.01bn scfd, respectively. Higher gas production in 2013 was mainly the result of more output from the Kertih and Terengganuand fields, as well as the Malaysia-Thailand Joint Development Area created to meet higher liquefied natural gas (LNG) demand from China. Oil and gas production was aided by new output from both marginal and new plays, including the Gumusut-Kakap in Sabah and new wells in Sarawak in and Terengganu.

Oil and gas exports are following a similar trajectory to domestic production figures as crude oil and condensate shipments continue to decline from 18.39m tonnes in 2005 to 11.86m tonnes in 2012, according to data from the MCB Bank. Over the same time period foreign sales of LNG have escalated from 21.64m tonnes valued at RM21.34bn ($6.7bn) to 23.77m tonnes worth RM55.53bn ($17.3bn). Through the first 10 months of 2013 oil and condensate exports stood at 9.61m tonnes, with LNG exports at 20.66m tonnes.

After more than a century of oil and gas production, Malaysia’s crude oil and condensate reserves are estimated at 3.68bn boe, as of January 2013, according to Petronas figures, with contingent resources of 2.16bn boe. Natural gas reserves were projected at 6.6bn boe as of January 2013, with contingent resources of 9.78bn boe, according to Petronas. The “BP Statistical Review of World Energy 2014” puts the country’s gas reserves at 1.1trn cu metres.

Revenue Stream

With the fifth-largest reserves in the Asia-Pacific region, Malaysia is a net exporter of oil and gas, despite growing domestic consumption. This wealth of resources has allowed the government to not only provide less expensive energy to the domestic market, but also to reap substantial financial benefits from the sale of oil and gas on the global market.

The government’s take from petroleum production in 2012 from direct taxes and royalties amounted to RM40.36bn ($12.6bn), up from RM32.9bn ($10.3bn) the previous year, and accounted for 19.41% of all government revenue year-on-year, according to data from CBM. Petroleum income tax accounts for the majority of state income with RM33.9bn ($10.6bn) collected in 2012 and RM27.75bn ($8.66bn) in 2011, compared to RM6.42bn ($2bn) and RM5.15bn ($1.6bn), respectively, for royalty payments. Preliminary figures through the first three quarters of 2013 indicate petroleum taxes of RM17.8bn ($5.55bn) were paid along with royalties of RM6.2bn ($1.9bn), although these figures historically spike in the final quarter as evidenced by fourth-quarter 2012 taxes reaching RM15.9bn ($4.9bn).

In terms of capital expenditure in the mining and quarrying sector, which includes oil and gas operations, foreign direct investment (FDI) has roughly tripled since 2010 from RM3.1bn ($967.5m) to RM9.63bn ($3bn) in 2012, according to CBM. When combined with domestic spending, 2012 investments ballooned to a total of RM40bn ($12.5bn) in the upstream sector, according to Petronas, with RM22.9bn ($7.14bn), or 57%, funnelled into development projects; RM3.7bn ($1.15bn) (9%) towards exploration activities; and the remainder to operations of existing assets. Through the first three quarters of 2013 money continued to flow into the industry, reaching cumulative FDI of RM8.6bn ($2.7bn).

Incentives

The government is looking to further expand this lucrative revenue stream in the future, designating the oil and gas industry as a key pillar of its Economic Transformation Programme (ETP). According to the plan, the sector is targeting 5% annual growth from 2010 to 2020. To generate the investment needed to achieve these goals, the government is pursuing an aggressive strategy to further incentivise upstream oil and gas operations. The most recent of these include changes laid out in the 2013 budget for the downstream oil and gas business to the taxation structure of the Petroleum Income Tax Act of 1967 – particularly in the area of marginal oil and gas plays categorised as EOR, high CO gas fields, high pressure/high temperature fields, deepwater and infrastructure projects for petroleum operations. These include the reduction of the tax rate from 38% to 25% for marginal oil field development, as well as a waiver of export duty on oil produced and exported from marginal oil fields and the acceleration of capital allowance from five to 10 years for field development. Other measures present in the budget pertaining to oil and gas companies included a 100% income tax exemption for a period of 10 years, exemption of withholding tax and stamp duty on oil and gas public private partnerships, and 100% income tax exemption on statutory income for the first three years of operations for LNG trading companies.

These come on top of other incentives launched in 2011, the most significant of which included the introduction of risk service agreements for marginal fields as well as the Global Incentive For Trading (GIFT) programme available to qualifying petroleum and petroleum-related trading firms. The country’s maturing legacy oil fields also received attention in the new progressive volume-based (PVB) production sharing contracts (PSC) that began to appear in 2012 in an attempt to squeeze every drop of oil from declining reservoirs. The 2011 efforts proved largely successful, with Petronas entering into 11 new PSCs on the year and another nine in 2012 compared to just four deals in 2010.

Structure

For the past 50 years, Petronas has remained the dominant force in the Malaysian oil and gas sector since its incorporation by the federal government in 1974 in response to the global oil crisis. In contrast to the pre-1974 framework, wherein oil firms were granted concession agreements with exclusive rights over all crude oil produced – subject to payment of rent and royalties – Petronas alone now holds exclusive rights to explore and produce oil and gas in the country. These rights are in turn concessioned to oil firms, either developed by Petronas or contracted through PSCs, the terms of which have evolved over the years in response to the changing landscape of exploration and production activity.

The oil and gas industry is a priority for the current government and represents a key component of Malaysia’s ETP. Complete with 12 entry point projects, the sector is expected to generate RM131.4bn ($41bn) towards Malaysia’s gross national income and create 52,300 mostly highly skilled jobs driven by RM113.3bn ($35.4bn) of investments, according to the Malaysian International Chamber of Commerce and Industry.

Keeping Up

The terms of Petronas’ most recent contracts reflect both the firm and government’s current aim of countering declining production with a three-pronged strategy: maximising recovery through diligent reservoir management and EOR for mature fields; monetising marginal fields and stranded gas; and engaging in aggressive exploration in Malaysia’s mature basins.

The strategy has proven effective in recent years, with ExxonMobil inking a deal with Petronas in 2008 to carry out substantial EOR operations in addition to its conventional oil development. This was followed by a $2.1bn commitment from Petronas to develop seven offshore fields including EOR, and a November 2011 deal with Shell for two 30-year PSCs for offshore EOR in Borneo. The latter deal involves at least $12bn to extend the life and increase the recovery factor of the Baram Delta and four fields in the North Sabah development area. With the addition of the targeted incentives added in 2011-13, this success has carried over: more large contracts have been signed with international partners including Hess and Halliburton which are expected to yield significant production for decades to come (see analysis). A total of 32 oil and gas fields achieved first production in 2012, along with 22 new discoveries, including major finds in Kuang North and Kasawari in Sarawak, according to Petronas.

Transport Hub

Looking to capitalise on its strategic geographic location and its position as the world’s second-greatest LNG exporter in 2013, according to the “BP Statistical Review of the World 2014”, Malaysia is striving to increase value in its energy sector by fashioning itself into a regional trading and logistics hub for oil and gas. In addition to the revenue generated via trading and transporting fuel, the move would also have positive strategic implications as the country moves inexorably towards net energy importer status due to its increasing domestic consumption. In 2012 Malaysia shipped 31.8bn cu metres of LNG, with its largest purchasers being Japan (19.9bn cu metres), South Korea (5.6bn cu metres) Taiwan (3.8bn cu metres) and China (2.5bn cu metres).

One of the primary means employed by the government to foster growth is through the GIFT programme run through the Labuan International Commodity Trading Company (LITC). Designed to woo global trading companies to employ Malaysia as a regional storage and trading base, GIFT programmes offer a wide range of incentives for energy traders with a possibility to expand into downstream products in the future. “Under the GIFT programme, a general LITC is subject to a corporate tax rate of 3%, but an LITC set up purely as an LNG trading company is entitled to a 100% income tax exemption on chargeable profit for the first three years of its operation, provided the company is licensed before December 31, 2014,” Ahmad Hizzad Baharuddin, director-general of Labuan FSA, told OBG. Other benefits include: 100% exemption on director fees for non-Malaysians; 50% exemption on gross employment income tax for non-Malaysians; exemption on dividends, royalties and interest received by or from LITC; and stamp duty exemption on all instruments, mergers and acquisitions of LITC and transfer of shares within the LITC. To qualify for the GIFT scheme, companies must meet requirements including minimum annual revenue of $100m, annual local expenditure of RM3m ($936,300) or more, and employ at least three professional traders.

Subsidies 

While the country’s proximity to large importers of natural gas like Japan, South Korea, India and China lends itself to inherent strategic advantages, some challenges must be overcome for Malaysia to truly flourish as an energy trading hub on par with the likes of Singapore. One of these potential roadblocks is the subsidisation policies that distort and fragment domestic markets and create artificial and unsustainable demand. To rectify this problem, the government is moving forward with plans to reduce subsidies in the coming years and ultimately achieve a market-driven pricing structure by 2015, which will likely have a broad impact on both consumers and producers.

Alongside fiscal incentives for trading, Malaysia continues to expand its LNG infrastructure to accommodate increasing supplies of natural gas. The country’s first floating LNG (FLNG) facility is currently being constructed and is expected to come on-line by the end of 2015. Situated in the Kanowit gas field off the coast of Sarawak, the plant will have an annual capacity of 1.2m tonnes of LNG slated for both export and domestic use. Operator Petronas is also developing a second FLNG plant to be deployed off the coast of Sabah serving the Rotan field. These projects come on the heels of the new Malacca LNG regasification plant which began operations at end-June 2013 (delayed from June 2012). New regasification terminals are also being constructed in Pengerang, Johor and Lahad Datu, Sabah.

Downstream

To serve its rapidly growing domestic energy market, Malaysia has a combined refining capacity of 492,000 bpd spread over five refineries, according to the Ministry of Energy, Green Technology and Water. Petronas operates three plants, accounting for nearly half of all capacity: two 100,000-bpd facilities in Malacca (one is a joint venture with ConocoPhillips) which began operations in 1994 and 1998, as well as a 49,000-bpd refinery in Kertih, Terengganu opened in 1983. The largest single refinery is the 155,000-bpd facility in Port Dickson, Negeri Sembilan operated by Shell and in operation since 1963. The country’s oldest refinery, owned by Esso Malaysia, opened in 1960 and is also located at Port Dickson with a capacity of 88,000 bpd. A sixth refinery will boost domestic capacity when the new 300,000-bpd facility is completed in 2014 as part of the Refinery and Petrochemical Integrated Development project in Pengerang, Johor. Until then, annual output of the sector will remain relatively static at 11.75m tonnes of diesel, 5.54m tonnes of gasoline, 3.50m tonnes of kerosene, 3.23m tonnes of fuel oil, 2.80m tonnes of liquefied petroleum gas and 147,956 tonnes of lubricating oil, according to CBM data.

Domestic oil consumption reached 31.2m tonnes of oil equivalent in 2013, up from the 30.7m tonnes of oil equivalent in 2012, according to the “BP Statistical Review of World Energy 2014”. Natural gas consumption decreased from 31.2m tonnes of oil equivalent in 2012 to 30.6m tonnes of oil equivalent in 2013.

The Johor Petroleum Development Corporation (JPDC) is the government agency entrusted with coordinating oil and gas development in Johor. Part of its remit is to oversee the Pengerang Integrated Petroleum Complex (PIPC), which includes two major projects: the $27bn Refinery and Petrochemical Integrated Development (RAPID), and Dialog-Vopak-SSI, which will include a petroleum terminal and LNG regasification plant. Upon completion, the PIPC will have an oil refining capacity of 1m bpd and a regasification terminal capable of handling 3.5m tonnes per year. “The Petronas RAPID project is a catalytic project for the PIPC and should attract other petrochemical investments into the area,” Mohd Yazid, CEO of the JPDC, told OBG. “At least two foreign conglomerates have demonstrated interest in investing in the oil and gas sector at the PIPC.”

Power

Malaysia’s electricity system is made up of three separate systems serving Peninsular Malaysia, Sarawak and Sabah. The largest by far of these in terms of generation capacity and consumers is the Peninsular system in which state-owned Tenaga Nasional Berhad (TNB) acts as transmission system operator, distributor and power generator, with independent power producers (IPP) taking on an increasing role in generation. Sabah Electricity Berhad (SESB) and Sarawak Energy Berhad (SEB) provide power services to their respective states and are privately owned, although with state governments holding significant stakes in the utilities.

As of December 31, 2012, total installed capacity for Peninsular Malaysia stood at 21,749 MW, with natural gas and coal serving as the primary fuel source and further supplemented by hydroelectricity, according to National Energy Commission (NEC) reports. Taking advantage of large quantities (and subsidised prices) of domestic natural gas, combined-cycle gas turbines (CCGTs) account for 9373 MW of capacity along with 2455 MW of open-cycle gas turbines (OCGTs) and 840 MW of conventional natural gas thermal power plants followed by 7170 MW of coal-fired power production and 1911 MW of hydroelectric power.

Boosted by a new feed-in tariff (FIT) incentive scheme, the fledgling renewable energy sector contributed another 154.89 MW as of February 2014, according to the Sustainable Energy Development Authority (SEDA) of Malaysia. Photovoltaic solar generation accounted for the largest slice of generation with 88.05 MW installed, followed by biomass, small hydro and biogas.

While liberalisation efforts for the power sector have yet to result in a complete unbundling of TNB and are still heavily subsidised (see analysis), significant progress has been made in terms of private sector participation in power generation, with IPP contracts accounting for more than two-thirds of installed capacity. Of the 14,777.4 MW combined IPP capacity, 5570 MW is derived from three coal-fired thermal power plants. Natural gas-fired power plants make up the remainder, with the exception of a 2420-MW thermal power plant that burns natural gas, fuel oil or coal. In spite of divesting some of its generation assets, TNB remains a significant player in the sector and operates 10 power plants (six natural gas and four hydro) with a combined capacity of 6972 MW, according to the NEC.

Outlook

With the state’s concerted efforts, Malaysia’s oil and gas sector should remain healthy for the foreseeable future as new discoveries are tapped, EOR projects rolled out, and the pipeline of new exploration opportunities is seized. The succession of generous financial incentives in the upstream sector as well as strategic efforts by Petronas should ensure strong continued investment flows into upstream operations. This bodes well for the petroleum sector, with production growth set to outpace consumption growth as fuel subsidies are removed and power generation shifts from oil to coal and natural gas. By contrast, domestic natural gas consumption will continue to surge on the strength of electricity production and industrial use, and will surpass output despite production growth in the sector while benefitting from the country’s efforts to develop as an energy trading hub. Eagerly awaited reforms in power generation should also positively affect public and private stakeholders as fuel and electricity subsidies are phased out and tender processes for new plants become competitive and transparent.

Although the double-digit rates of return for power purchase agreement contracts now appear to be a relic of the past, continued growth in power demand should still provide ample opportunities for IPPs going forward, with thousands of megawatts of new generation slated to be built over the coming decade.