This article first appeared in The Edge Malaysia Weekly on August 30, 2021 - September 5, 2021
NATIONAL oil company Petroliam Nasional Bhd (Petronas) is going through a period of transition, and could undertake asset divestments, acquisitions into new businesses and other corporate exercises — all of which could dampen earnings in the near term at least.
These changes come at a time when the global economy is being ravaged by the effects of the Covid-19 pandemic and there is a shift away from oil as a source of fuel as environmental, social and governance (ESG) awareness makes cleaner options more desirable. Electric cars are catching on, threatening to sideline internal combustion engines.
“There is one very aggressive consultancy that has told us [oil is going to peak] in the next one or two years. Yes, that soon, mainly because of the convergence of all the OEM (original equipment manufacturer) carmakers,” says Petronas president and group CEO Tengku Muhammad Taufik, in explaining the challenging outlook.
Peak oil refers to the point at which global crude oil production and demand will hit the maximum rate, after which both will start to decline. This is premised on oil production following a bell-shaped curve.
Adding pressure are the high expectations of Petronas’ shareholder, as oil prices have strengthened since demand plummeted during the early onset of Covid-19, crippling the world economic activity. The gradual opening up of markets and economic recovery in developed nations has strengthened oil prices as demand picks up.
At end-October last year, Brent crude was US$37.46 per barrel but it has since gained more than 90% to trade in excess of US$71 per barrel at press time.
With higher oil prices, the government, which is cash-strapped partly as a result of the many economic stimulus packages introduced over the last 1½ years to counter the impact of the pandemic, and lower tax collections, is looking to Petronas for more dividends. (See “Dividend payout increases as funding needs grow” on next page.)
Many market watchers including analysts from Goldman Sachs, UBS and JPMorgan are forecasting that oil prices will trade in the region of US$80 per barrel in the third quarter of the year. Bank of America is more bullish, pegging it at US$100 per barrel by mid-2022.
“We saw a bit of rising optimism at the beginning of the year. It manifests also in our results; you saw that we’ve secured north of RM50 billion in the first quarter in terms of revenue.
“However, on the sustainability of this rebound, the reality is that the current economic rebound and the pace of recovery are deeply, deeply uneven,” says Muhammad Taufik. “When we draw a conclusion, we believe the recovery is going to be fragile.”
Many recent issues linked to ESG could prove to be a thorn in the side of oil companies.
The lessons from Shell
In May this year, climate change activists won a major lawsuit against Royal Dutch Shell, when a Dutch court ruled that the oil giant must reduce its greenhouse gas emissions by 45% by 2030. There is a fear that this could set the precedent for similar lawsuits against other oil majors and national oil companies (NOCs), Petronas included.
“Our hope is that this verdict will trigger a wave of climate litigation against big polluters, to force them to stop extracting and burning fossil fuels,” Sara Shaw from Friends of the Earth International was reported to have said in May after the verdict.
Shell’s initial target was to become a net-zero emissions energy business by 2050, but the court ruled that its plans were inadequate.
The influence of climate change activists does not stop there. Petronas’ former president and CEO Tan Sri Wan Zulkiflee Wan Ariffin was appointed to the board of ExxonMobil in February this year, making him the first non-American to be appointed to the oil major’s board, but he left in June.
Wan Zulkiflee’s departure came about as an activist investor-cum-hedge fund called Engine No 1 managed to get three of its nominee directors on ExxonMobil’s board after pressuring the oil major to reduce its carbon footprint.
Engine No 1 was virtually unknown until June this year. Its rise to prominence was due to the support of some of ExxonMobil’s largest institutional investors, BlackRock, Vanguard and State Street. Engine No 1 wanted members who were more experienced in energy transition and clean energy-oriented on ExxonMobil’s 12-seat board.
“You have seen a lot of these majors correcting their financial positions, and they want to also reduce leverage as they embark on this new wave of greener energy, basically renewables. All of them are signalling intent towards low-carbon investments,” Muhammad Taufik says.
“While they signalled their intent, it does not mean that overnight, they are going to drop the oil and gas (business). For Petronas, as an NOC, we have obligations under the PDA 1974 (Petroleum Development Act of 1974), where we must continue to maximise the value of our hydrocarbon resources. All of these domestic assets, we categorise as ‘cash generators’. We must protect these, we must maximise the squeezing of these assets.
“We continue to go for bid rounds and call people in to monetise the late-life assets. These are existing assets; they provide strong and stable cash flows. At any given time, these assets — the ones at home and the ones already producing overseas — they contribute 70% of the profitability, and you need to make sure this is preserved. It provides a solid base, generates the cash.
“And when we go down to ‘expanding the core business’ into related, adjacent areas, we must do it in a cost-efficient manner. Because right now, we can’t go into a capex spree that doesn’t have a clear line of sight to get to your first gas, or first oil … The last thing you want to do as an O&G company is to hold on to the day oil falls out of favour. You’re going to have to sell to a captive market and that is never a good position to be in,” he explains.
In mid-June, JPMorgan decided to exclude Petronas from its ESG Emerging Market Bond Index and ESG Asia Credit Index, a move that Petronas referred to as “regrettable”. In a response, it said it viewed “The decision (by JPMorgan) as not in any way an accurate or true representation of our continuing commitment to sustainable and responsible investing, in line with environmental, social and good governance practices.”
Diversifying its asset base
Then again, Petronas has been diversifying its asset base in anticipation of the anti-fossil fuel shift. It has also put in place a plan to achieve net-zero carbon emissions by 2050, making it among the earliest of the Asian oil companies to do so. This is part of its holistic approach to business sustainability that balances ESG considerations and provides cleaner energy and solutions to its customers.
As far back as in 2013, Petronas had ventured into its maiden solar photovoltaic project in Pahang. By 2018, it had increased its footprint to five assets across Malaysia and Italy. A year later, it acquired Amplus Energy Solutions Pte Ltd in India, after which it launched its rooftop solar solution, M+ by Petronas. With this acquisition, Petronas has grown its solar capacity both under operation and development, to over 1GW in India, Malaysia and Dubai, servicing over 200 customers in more than 400 projects.
Last November, the national oil company also established Petronas Hydrogen “to go beyond hydrocarbon sources and become an end-to-end solution provider of hydrogen”, as stated on its website.
On how much Petronas was investing in its hydrogen initiatives, Muhammad Taufik says: “To go down the path of renewable energy, it is north of US$1 billion per gigawatt. So, if you are talking about hydrogen, depending on the capacity, we are talking about a multi-billion capex commitment. And if we are going to accelerate in the next eight to 10 years, it will be in the order of … It’s a lot; that’s why we have to be very careful.”
There is also the fear that Petronas’ new assets may take time to generate returns, which could see its earnings take a hit.
“With regards to energy infra and utility plays, they are not going to show project returns like O&G. When you redirect capital, there is naturally going to be a gestation. It’s a trade-off,” he explains.
This could adversely impact Petronas’ dividend payments to its sole shareholder — the government of Malaysia, which currently has a high debt level of RM880 billion and lower taxation earnings because of the pandemic.
It should also be noted that Petronas spends an average of RM50 billion a year on capital expenditure, which in turn ensures that the local O&G industry keeps chugging along.
Petronas may sell assets
With so much going on within the industry, there is a strong likelihood that Petronas may need to review its portfolio, including offloading some of its overseas assets, notably the less environmentally friendly ones.“Those (oil assets) clearly are the candidates if we believe in that (renewable energy) future,” says Muhammad Taufik.
It is expected to announce some of these divestments by the end of the year.
At the moment, about 70% of Petronas’ portfolio is gas and this has put it in an advantageous position as gas is considered among the cleanest of fossil fuels. Gas, including liquefied natural gas (LNG), is seen by many as the favoured transition energy, as the world moves towards replacing fossil fuel with renewable energy.
In July this year, Petronas declined to join an oil licensing round in South Sudan as it said it was “undertaking a strategic review of its assets to ensure that its portfolio remains resilient and commercially viable”. Petronas and China National Petroleum Corp are already operating in Sudan.
In June, speculation was rife that Petronas would exit South African fuel retailer Engen, either selling its 74% stake or paring down its shareholding via an offer for sale in an initial public offering. Engen had RM12 billion in assets as at end-2019.
Last October, Middle Eastern media quoted Muhammad Taufik as saying that Petronas would be reviewing its involvement in the Gharraf oilfield in southern Iraq. However, at that time, Brent crude was languishing at US$40 per barrel. What Petronas will do with its 45% stake in the oilfield remains to be seen.
In March last year, it was reported that Petronas was looking to hive off its 35% stake in oilfield assets held under its joint venture with ExxonMobil and the Chad government. ExxonMobil and Petronas also controlled a pipeline transporting crude oil to a marine terminal in Cameroon for export.
Muhammad Taufik says, “I know we (Petronas) are an NOC and I have an obligation to generate returns for my host government as a shareholder. I know if we don’t do enough to keep the lights on, at some point we are going to have a really quick and steep drop-off of our production profile. But what I do hope that everybody quickly realises is, if there is a policy shift but it comes too suddenly or too slowly, not only Petronas but the entire Malaysian economy could be put at risk, with regards to our energy mix.”
Dividend payout increases as funding needs grow
At Petroliam Nasional Bhd’s (Petronas) results briefing for the first half ended June 30, 2021 (1HFY2021) on Aug 27, the national oil firm confirmed that it would raise its dividend payout this year by more than one-third to RM25 billion, from RM18 billion announced previously.
The higher payout came with the company’s return to the black in 1HFY2021. Amid higher oil prices this year, oil majors globally, from Shell to BP and Chevron, also committed to paying higher dividends to their shareholders and to share buybacks.
During an interview prior to Petronas’ 1HFY2021 results announcement, its president and group CEO Tengku Muhammad Taufik told The Edge that there was some headroom for “a little extra” dividend, considering current oil prices, pointing to what he hoped was the industry bottom last year (see “Taking the ESG route and reshaping portfolios” on Page 62).
“In all openness, there was already a request [for additional dividends]. I think for 1H2021, we are north of US$60/bbl already on average. So, in so far as the price effect is trickling down to our cash flow, God willing, there is some room,” Muhammad Taufik says.
He adds: “At the end of the day, it is all premised on affordability. There’s still some amount of money [required] in order to take the opportunities at hand in expanding the core [business] and stepping out.”
Notably, this is the third consecutive year payout to Putrajaya has exceeded earnings, following its upward revision each year (see chart). In 2019, Petronas paid out RM54 billion, including a special dividend of RM30 billion, which the Pakatan Harapan government said was utilised for Goods and Services Tax (GST) and income tax refunds. In 2020, Petronas upped its dividend to RM34 billion from RM24 billion as the nation scrambled to handle the impact of the Covid-19 pandemic.
With the additional RM7 billion this year, petroleum-related revenue now makes up RM44.8 billion or 18% of total federal government revenue for 2021, from the RM37.8 billion projected previously.
The absence of a big chunk of tax collection amid the pandemic, as well as the termination of GST in 2018, means that the nation has to delay being weaned off of its reliance on oil and gas (O&G) revenue, at a time when Petronas faces a rapidly changing operating environment in the energy industry.
Even before Covid-19, the average return on capital employed in upstream activities among the big oil majors had fallen to just 3.5% in 2019, from over 27% in 2006, a 2020 study by Boston Consulting Group found. Increasing global awareness of climate change has forced O&G companies to seriously reduce their carbon footprint through clean energy investments or carbon offsets, while oil prices — the lifeblood of O&G companies — remain at the mercy of the fragile economic recovery as Covid-19 lingers.
“I still have to spend in order to [ensure] longevity for Petronas. I still have to invest. But in the interim, you know that demand from shareholders is going to emerge, and that’s the tension that the board will always have to deliberate over. Petronas [has to juggle] the growth story, the return to shareholders and the need to ensure the light stays on,” says Muhammad Taufik.
Maintaining operations, securing growth, providing returns
First, the juggling act requires reinvestment to ensure the continuity of Petronas’ current O&G operations. In Malaysia, its entitlement amounts to 1.7 million barrels of oil equivalent per day, says Muhammad Taufik. Second, Petronas is investing in adjacent sectors that could add value to the company’s O&G production, such as speciality chemicals. And third, it also needs to spend on clean energy businesses and new technologies to reduce its carbon footprint, in line with the global ESG (environment, social and governance) push.
“I’ve got to spend to keep the lights on. I’ve got to churn it back in, otherwise you are not going to get your CFFO (cash flow from operations),” Muhammad Taufik says.
“Having to set aside money like our 2018 purchase into [distributed solar company] Amplus in India, funding something like our upcoming Kasawari [gas] project [off Sarawak], which is a high CO2 project … these are the things that are going to generate returns and remove a certain degree of [oil price] volatility [from earnings],” he continues.
With over RM106.58 billion in borrowings at end-June 2021, Petronas is also subject to scrutiny by credit rating agencies, which are cognisant of the responsibility of the national oil company to support the government’s socioeconomic agenda.
To be sure, in 2020, Fitch Ratings and S&P Global Ratings lowered Petronas’ rating to match Malaysia’s sovereign rating, whereas Moody’s Investor Service affirmed its A2 rating of the energy firm.
“For Moody’s, the ability to show the discipline of ploughing back into growth has held us in good stead. But the moment we keep spending — particularly S&P is looking at this now — just to keep afloat and not put [money] into something that is Ebitda-accretive, they’re going to start scrutinising us,” Muhammad Taufik says.
“Obviously, this is a struggle that any business faces. Shell and BP are also facing the same demand [from shareholders] — ‘if you don’t know what to do with it, give it back to us’. So it’s only natural for a national oil company to face that kind of demand all the time.
“But if you keep losing the dry powder to do deals, the longevity of the cash flow could soon come under threat. And then, first, the credit rating will be compromised, then after that, the ability to generate the core money also gets threatened. And then, where does that leave us?
“At the end of the day, I’m fully cognisant I have this amanah. Petronas is an investment of the country and it needs to generate returns.”
During the pandemic, Petronas contributed more than RM100 million to the community, including medical supplies, protective gear and other essentials. This includes RM6.4 million in voluntary salary contribution from Petronas staff to the National Disaster Management Agency (Nadma), as well as RM30 million worth of mobile devices for 12,000 students to support remote learning under the Cerdik programme.
Petronas needs to find the right balance between its three core focuses of maintaining operations, securing growth and providing returns. At the same time, the government, as its sole shareholder, must ensure that its current funding needs do not jeopardise Petronas’ ability to provide consistent returns for the long run.
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