Long-term look: Focusing on a multi-pronged approach to increase energy supplies

The long and storied history of Malaysia’s oil and gas sector has seen the country through its political and economic vicissitudes over the years, providing an economic crutch of export revenue in the lean times and giving rise to a national energy champion that is the country’s sole Fortune 500 Company in the boom years. But with the country’s growing energy consumption fast approaching production levels, the sector may be facing its greatest challenge yet in the form of an impending domestic energy shortage.

BOOSTING SUPPLIES: If current consumption and production trends are maintained, Malaysia will become a net importer of oil and gas for the first time by 2017, according to information from the International Energy Agency released during the 2012 World Gas conference in Kuala Lumpur in June that year. A growing population and thriving industrial activity are pushing consumption levels to increasing heights while annual energy exports account for some one-fifth of the GDP, all with maturing domestic production well past the point of diminishing returns. Not content to compromise local supply for export revenues or vice versa, the government has decided against curtailing either and has instead plunged into a plan to boost energy supplies. The strategy calls for a two-pronged approach of boosting domestic production through increased utilisation of new and marginal oil and gas fields while also securing greater amounts of foreign-sourced supplies. The government will lean on state energy champion Petroliam Nasional (Petronas) to carry out these ambitious plans at home and abroad. Already the company is stepping up its own domestic exploration and production efforts and enlisting the help of other private oil and gas companies to pick up the slack while at the same time signing new production agreements for gas fields from Myanmar to Canada.

PRODUCTION: One of 12 National Key Economic Areas (NKEAs) as denoted in the Economic Transformation Programme, the continued success of the oil, gas and energy (OGE) sector is a crucial cog in the country’s economic machinery. In 2011 petroleum and natural gas export revenues contributed RM122.99bn ($39.7bn) to the country’s coffers, up 20.77% over the 2010 total of RM101.84bn ($32.9bn) and representing 17.71% of total export value, according data from the Department of Statistics Malaysia.

These exports were derived from a total domestic production of 1.61m barrels of oil equivalent per day (boepd) in 2011, approximately 1% less than the 1.62m boepd recorded the previous year. This decline was due to factors including maturing fields, poor reservoir performance of some deep-water fields operated by Petronas and scheduled maintenance shutdowns of facilities. According to Petronas’ annual report for 2011, crude oil and condensate output continued its slow decline, dropping roughly 5% from 657,000 boepd in 2010 to 627,000 boepd in 2011 after decreasing since 2008. Natural gas production projects a slightly more optimistic outlook, with year-on-year output increasing 1% to 5.92bn cu feet per day (bcfd) equivalent to 987,000 boepd, well up from the 5.84 bcfd (974,000 boepd) produced in 2010. Aided by the addition of the Serampang gas field and the West Belumut and D30 oil fields coming on-line in 2011, annual output was above the four-year average production of 980,750 boepd. The addition of these new projects brought the number of active fields in the country to 117, composed of 73 oil and 44 gas fields.

GOVERNMENT PUSH: As an NKEA the government is targeting 5% annual growth for the OGE sector for 2010-20 while Peter Chin, the energy, green technology and water minister, stated in 2011 that the sector’s contribution to the gross national income was expected to increase from RM110bn ($35.5bn) in 2009 to RM241bn ($77.7bn) in 2020 while generating 52,300 jobs. As a means to reach these targets the NKEA has four focal points: sustaining oil and gas production, enhancing downstream growth, making Malaysia an Asian centre for oil field services and building a sustainable energy platform for growth. Other secondary NKEA priorities include growing the downstream area of the sector and providing insulation against price shocks in the commodity market.

EVERY LAST DROP: Within the NKEA framework, entry point projects (EPPs) are utilised as a means to achieve the growth targets of their associated areas. In the case of the OGE sector, one form of EPP is the implementation of enhanced oil recovery techniques (EOR). With much of the low-hanging fruit long since plucked, Malaysia’s oil and gas operators are being forced into ever more marginal fields involving small-scale, mature, deepwater, high-pressure/high-temperature and high CO content gas requiring EOR techniques. Because primary (natural pressure or gravity combined with supplementary lift techniques such as pumps) and secondary (gas or water injection to displace oil) phases of crude development and production generally only yield recovery rates of 20-40% of the oil in place, tertiary (or enhanced) recovery techniques may be employed to boost these rates into the 30-60% range. Three major categories or EOR are employed commercially: thermal recovery using heat to lower viscosity and improve oil flow through the reservoir; gas injection using natural gas, nitrogen or carbon dioxide to push oil into the production wellbore and/or lower its viscosity; and chemical injection using polymers to increase the effectiveness of waterfloods or using detergent-like surfactants to reduce surface tensions which can prevent oil droplets from moving through the reservoir.

INCENTIVES: Because many of the international oil and gas companies which have the expertise and bankroll to carry out these more complex tasks have a proclivity towards larger and more profitable projects, the Malaysian government has decided to aid interest by incentivising the development of such reservoirs. Passed in June 2011, the Petroleum Income Tax Act (PITA) amends the 1967 tax act by offering a variety tax breaks to firms participating in eligible activities such as developing marginal fields and employing EOR. These include: a reduced income tax rate from 38% to 25%; accelerated capital allowance from 10 year to five where full utilisation of capital cost deducted could improve project viability; waiver of export duty on oil produced and exported from marginal oil field development to improve project commerciality; and investment tax allowance of between 60% and 100% of capital expenditure to be deducted against statutory income.

Running parallel to PITA are efforts by Petronas to further incentivise EOR activity by extending the length of existing production-sharing contracts (PSCs) with the caveat that EOR requirements are integrated into the renewed contracts. In addition to satiating partner companies by securing long-term production deals, Malaysia and Petronas benefit twofold. Firstly a new wave of guaranteed EOR investments is injected into the sector boost dwindling production, and secondly Petronas is able to attain valuable expertise by partnering with large international well versed in EOR techniques.

FOREIGN INTEREST: These efforts showed early signs of success in January 2011, with two major ExxonMobil-Petronas EOR projects kicking off in the Tapis and Guntong offshore fields in Peninsular Malaysia. In total ExxonMobil has committed to investing more than RM10bn ($3.2bn) over the next 25 years in EOR PSCs in Malaysia to be carried out on seven fields, which include Seligi, Guntong, Tapis, Semangkok, Irong Barat, Tebu and Palas. The most developed of these are with the Tapis and Guntong fields expected to see results by 2014.

In 2012 Shell Malaysia (a company which has invested heavily in EOR research) and Petronas signed two new PSCs for nine new EOR projects offshore the Borneo provinces of Sarawak and Sabah. Six of these projects are located in Baram Delta offshore Sarawak, with the other three situated in the North Sabah development area. In a reworking of existing PSCs, which were due to expire in 2018 and 2019, the new contracts have extended the licences of the Baram Delta and North Sabah tenements through 2040. One of the largest oil and gas companies operating in Malaysia, Shell has committed a total of RM5.1bn ($1.6bn) to projects to expand its Malaysian facilities.

One PSC Shell will not be renewing is for the Kinabalu oil fields, which was awarded in May 2012 to Canada-headquartered Talisman Energy upon expiration of the current agreement at the end of 2012. Talisman (60% working interest) and Petronas (40% share) have announced they plan to invest more than $1bn in oil recovery and production in the project located off the Sabah coast. The PSC is the first of another new type of contract know as a progressive volume-based PSC, which is also designed to provide greater incentive to develop maturing oil and gas fields. A second contract-based method of encouraging the development of these types of fields is the debut of a brand-new type of petroleum contract called the risk service contract (RSC). Issued through Petronas acting as the government host authority, the RSC establishes the host authority as project owner while private contractors are entitled to recovery of developmental costs, as well as a fixed fee based on the performance of the project (generally the execution and subsequent productivity of the project). The monetisation of smaller fields though RSCs also provides opportunities for smaller players in the oil and gas sector as they develop projects larger international companies generally overlook.

The first RSC was issued in January 2011 for the development and production of the marginal Berantai field to Petrofac Energy Developments (as lead operator) along with equity partners Kencana Energy and Sapura Energy Ventures. After drilling commenced in 2011, the Berantai project platform was tied into the Peninsular Gas Utilisation line in early 2012 and commenced production on October 20, 2012 at an initial rate of 50standard cu feet of gas per day (mmscfd). Platform fabrication for another RSC between ROC Oil, Dialog and Petronas is also being undertaken.

Other marginal gas fields earmarked for development include the Sepat, Beranti, Cendor Phase 2, Balai and Bentara fields, Cenang and Tembikai, Desaru, Jambu and Serendah fields. Additional licences issued in 2012 are expected to help maintain production levels of 650,000 barrels per day (bpd), according to the Performance Management and Delivery Unit.

NATIONAL CHAMPION: In Malaysia’s oil and gas pool, state-run energy giant Petronas is by far the biggest entity with its influence exemplified in Kuala Lumpur’s iconic twin Petronas Towers. The vertically integrated firm is involved at every level of the supply chain from exploration and production to petrochemicals refining and petrol stations, but also has its hands in administrative management of the country’s hydrocarbons reserves. In 2011 the company accounted for 69% of average domestic oil production, at 1.11m boepd, a tick above the 68% recorded in 2010. The country is also moving to secure energy resources abroad for domestic consumption.

Petronas runs gas and petroleum exploration and production, downstream operations and power generation projects across South America, Africa, Europe, Asia and Oceania. The company has signed a series of production-sharing agreements in recent years in a number of countries. In 2011 alone the firm inked five new contracts in foreign countries including its first in oil-rich Venezuela via the Carabobo 1 project. Myanmar and its newly open democratic government has been a source of particular interest where Petronas has been active as of late. Indeed, in April 2012 the company signed a PSC with state-run Myanmar Oil and Gas Enterprise and the private Burmese firm UNOG for two inland blocks. The agreement covers RSF-2 and RSF-3, which are situated respectively in Tuywintaung Myaingtaung and Gwaycho Ngashantaung.

Competition for underdeveloped assets has been fierce as of late, with international oil companies from Thailand, Indonesia, Thailand, France, Malaysia, Russia, China and India all vying for a share of Myanmar’s proven recoverable reserves of 18.01trn cu feet (tcf) of gas and unproven estimated reserves of 89.72 tcf.

Petronas is also exploring the potential of unconventional gas sources, as evident in its 40% participation in the Gladstone liquefied natural gas (LNG) project in Queensland, Australia, which aims to convert coal-bed methane into LNG for transport by 2015. The company announced in June 2012 that it had agreed to acquire Canadian oil shale producer Progress Energy Resources Corp in a deal worth some $5.2bn which would grant it access to Progress’s 1.9 tcf of proven plus probable reserves. However, in October the Canadian government blocked the initial deal with further negotiations expected.

EXPLORATION & DISCOVERY: Spurred on by the drive for new energy sources, local operators are casting a wide net in their exploratory efforts which are already showing some promising signs of success. A total of 11 new PSCs were issued in 2011 compared to just four the previous year. These were PM313, PM315, PM330, PM6/12 for offshore Peninsular Malaysia; SK306, SK313, SK315 and SK317B in offshore Sarawak; and DW Block2G/2J and SB307/308 in offshore Sabah. Investment in the upstream sector totalled RM24bn ($7.7bn) for the year, 71% (RM17.1bn, $5.5bn) of which went to development projects, along with 22% (RM5.2bn, $1.7bn) for exploration activities and the remaining 7% (RM1.8bn, $580.7m) going towards operational expenditures according to Petronas. The 2011 additions bring the total of operating PSCs in Malaysia to 82.

One exploration zone with some of the greatest potential is the North Malay Basin project, which includes nine gas fields located around 300 km off the east coast of Peninsular Malaysia. PSCs for three blocks (PM302, PM325 and PM362B) located within the basin were signed by Petronas and the exploration arm of US energy company Hess in June 2012 with the aim of commercialising 1.7 tcf of gas reserves. The 50:50 equity partnership of the $5.2bn project is targeting its first delivery of 100 mmscfd by 2013 and increasing to 250 mmscfd by 2015. The project is targeting existing marginal fields in order to boost domestic production levels. Gerbert Schoonman, the vice-president of production for Asia-Pacific at Hess, said, “Further development of the north Malay basin is highly dependent upon how future exploration costs are going to be treated with regard to taxes and incentives, as well as domestic pricing of natural gas.”

Two more discoveries were announced in November of 2011, with Petronas revealing new reserves offshore Sabah province in Borneo, for which the company estimated reserves at 227m boe with a maximum production rate of 8200 bpd. The second find was made at the Janglau-1 well located in Block PM308A offshore Peninsular Malaysia. Oil samples were recovered from a depth in excess of 3100 metres by a jackup rig operated by the block’s operator, a consortium of Swedish company Lundin Malaysia with 35% equity interest along with partners JX Nippon Oil and Gas Exploration (Peninsular Malaysia, 40%) and Petronas (25%).

Lundin was also involved in two successful gas discoveries at the Tarap and Cempulut prospects offshore Sabah earlier in 2011, although the Janglau-1 hit was the first confirmed discovery in the area PM308A block. In total, Lundin operates five separate exploration licences in Malaysia with concession areas ranging from 4943-8659 sq km holding interests ranging from 35% to 75%. The company is partnered with Petronas in these blocks, in addition to the British-registered Nio Petroleum, which holds a 42.5% interest in offshore blocks SB307 and SB308 off Sabah along with Lundin (42.5%) and Petronas (15%).

Petronas made another significant discovery in the Sarawak offshore blocks SK316 and SK306 at its NC3 and Spaoh-1 wells in 2011. Drilling to a depth of 4 km, the NC3 well revealed an estimated 2.6trn standard cu feet (tscf) of natural gas in place within Block SK316, while the 3-km Spaoh-1 well in SK306 also exhibited the presence of both oil and gas of an as yet undetermined amount. Other major discoveries were also made at the company’s Kasawari and NC8SW fields (also in block SK316) initially assessed in February 2012 at 5 tscf and 459bn standard cu feet of gas, respectively, in addition to the Bunga Bakawali and Anjung Kecil wells. In late November 2012 the company announced two more significant finds off Sarawak in the Kuang and Tukau Timur fields with estimated gas totalling 4.4 tscf.

The influx of new finds has increased Malaysia’s total discovered resource base by 1.4% to 20.9bn boe as of January 1, 2011, up from 20.6bn boe the previous year, according to Petronas. Proven and probable domestic reserves of crude oil and condensate stood at 3.57bn boe as of January 2011 with another 2.29bn boe of contingent resources. At the same time, proven and probable reserves of natural gas amounted 6.66bn boe along with 8.34bn boe in contingent resources.

In a move to garner further interest, Malaysia Petroleum Resources Corporation (MPRC) was established in 2011 to take on some of Petronas’ oversight and administrative duties. One of the most significant changes is likely to be the hand-over of tender responsibilities for oil and gas contracts from Petronas to MPRC in a bid to attract more foreign investment.

REFINING & STORAGE: As of 2011 there were five oil refineries operating in Malaysia with a combined capacity of 523,000 bpd. Petronas operates three of these in the 100,000-bpd Melaka 1 (100% owned), 170,000-bpd Melaka II ( joint venture with ConocoPhillips) and the 40,000-bpd Kertih refineries.

Royal Dutch Shell and ExxonMobil operate the other two facilities – the Port Dickenson Refinery (125,000 bpd) and the Esso Port Dickenson Refinery (88,000 bpd), respectively. In August 2011 the Philippines’ San Miguel Corporation, through its subsidiary Petron, purchased the Esso complex from its owners, which consisted of Esso Malaysia (a publicly traded company of which ExxonMobil owns 65%), ExxonMobil Malaysia and ExxonMobil Borneo.

Petronas is looking to boost its refining capacity by 2016, with a new 300,000-bpd refinery as part of a $20bn petrochemicals complex being developed in Johor. The refinery will be supported by a RM5bn ($1.6bn) deep-water petroleum terminal with 5m cu metres of storage capacity being developed by joint venture partners Dialog, Vopak and the Johor state government. Other new storage terminals are planned including the Labuan terminal in Pulau Daat and the Tanjong Agas Oil and Gas and Logistics Industrial Park in Pahang.

Much of this new storage capacity is being constructed in accordance to another one of the NKEA EPPs for the sector: developing Malaysia as a regional oil storage and trading centre by 2017. To do so, the MPRC launched the Global Incentives for Trading programme (GIFT) in October 2011. Envisioned as Rotterdam of Asia, the GIFT programme uses the port at Labuan as focal point and allows companies to register under the Labuan International Commodity Trading Company (LITC), which grants them permission to trade in petroleum, petroleum-related products, and other selected commodities including minerals and carbon credits. As of April 2012 Petronas, Dialog Group, YTL Power International, UK-based BB Energy and Rotterdam group Vitol Trading had all signed up for the programme and were awarded trading licences. GIFT-registered companies are eligible for incentives including a flat corporate tax rate of 3%, 100% exemption on director fees paid to non-Malaysian directors and 50% exemption on gross employment income for non-Malaysian traders and other managers of the LITC companies.

COURSE CORRECTION: Seeking to increase the competitiveness of Malaysia for energy companies while lessening the economic burden of energy subsidies on the state, the government is moving forward on a number of different liberalisation fronts. Reflecting the increasing price of natural gas, it introduced a new tariff for the commodity in June 2011, increasing the price from RM10.70 ($3.45) per million metric British thermal units (mmBTU) to RM13.70 ($4.42) per mmBTU.

Similar reforms are under way in the electricity market, where tariffs have been set artificially low by government regulators such as the Energy Commission, which is mandated “to ensure that the supply of electricity and piped gas to consumers is reliable, safe and at reasonable prices”. Although the electricity price tariff system is reviewed every six months, the most significant shift in prices took place in June 2011, when the average price users paid increased 7.12%.

This hike was then implemented on a targeted basis, with domestic consumers using less than 300 kWh (estimated at 4.4m households) exempted from increases while other industrial and commercial consumers saw their rates rise the most. Industrial and commercial consumers experienced an average rate bump of 8.35%, while residential customers consuming in excess of 300 kWh had their rate increase by some 7.12% from 31.31 sen ($0.101) per kWh to 33.54 sen ($0.108) per kWh. In early October 2012, Chin, the minister of energy, green technology and water, announced that electricity tariffs would remain at their current levels until June 2013.

To avoid further input/production inequities for power producers, the government has introduced a fuel cost pass-through (FCPT) mechanism in which the prices of fuels are reviewed every six months with any resulting cost fluctuations then passed on through modifications in the end-user tariff. The rate hike was followed six months later when consumers were hit with another 1% rate across the board increase due to the implementation of the new feed-in tariff of 1% was levied on all power bills exceeding 300 kWh (see analysis).

OUTLOOK: The country’s ambitious plan to expand its energy supply base via a broad approach across a wide spectrum of activities has so far shown much promise. But although Malaysia has displayed impressive progress in the short term, the longer-term economic viability of maintaining production in more costly marginal fields will also depend on future energy prices remaining strong enough to justify the extra expense, as well as continued commitment to liberalising domestic natural gas prices in order to allow sales at or at least nearer to market levels. Diversification of the power sector has also made some crucial changes on paper in 2011 which should be enough to attract substantial attention from international investors provided the government maintains its commitment to its energy roadmap.

Staying the course when it comes to these and other developments will ensure that the country’s oil and gas sector maintains its role as an important mainstay of export revenue, thus allowing Malaysia to continue on its path to developed country status.