This article first appeared in The Edge Malaysia Weekly, on March 14 - 18, 2016.

Late last month at a closed-door press briefing to discuss Petroliam Nasional Bhd’s (Petronas) financials, president and CEO Datuk Wan Zulkiflee Wan Ariffin talked about the need for consolidation in the oil and gas (O&G) sector.

“We want to help develop local companies [but] there are more than 3,000 service and equipment players in Malaysia, in contrast to Norway where there are only 700,” he said.

Norway is often used as a yardstick because oil was first struck there in 1969, just five years before Petronas was established in 1974.

In an email response to The Edge, Petronas says, “In light of the persistent low oil price environment with no immediate signs of a recovery, it has become necessary for the Malaysian O&G service providers to lower their cost structure by being more cost-efficient and competitive.

“As such, Petronas views the consolidation of Malaysian oil and gas service providers as one of the key measures to enable the industry players to urgently step up their efforts towards addressing the issues and challenges today.

“Petronas will continue to engage with industry players and encourage them to consolidate, as dictated by the current market forces. Consolidation of the highly fragmented industry is becoming even more crucial now to elevate its capacity, resilience and competitiveness.”

While some agree that consolidation is the way forward, with opportunities lurking, especially for those with deep pockets, others say it is not as simple as it seems.

Uzma Bhd managing director Datuk Kamarul Redzuan Muhamed has been there before.

“This is our third cycle or downturn in the oil and gas industry [and] it’s a lot tougher than it used to be,” he says. “When we started Uzma, it was the year 2000 [and] oil prices were US$20 per barrel. So, we feel there is an opportunity, there is money to be made, but you must be prudent.”

Uzma provides services to the upstream sector across the exploration, development and production phases, and to the downstream sector for facilities construction, operation and maintenance.

In 2008, West Texas Intermediate crude hit a record high of more than US$145 per barrel, and was trading at US$110 in September 2013. Last Friday, however, it fetched only US$38.63 per barrel.

Tan Sri Mokhzani Mahathir, an investor with a 10.26% stake in SapuraKencana Petroleum Bhd and 18.55% equity interest in Yinson Holdings Bhd, explains that the sudden plunge in oil prices is the cause of the bleak outlook.

“What is bad this time is the difference between the peak and trough — it is huge. If you look at two years ago, it was US$100, then it went down to US$27. The gap was huge [and] that was what people could not adjust to.

“But now, people are realistic. They know they have to plan for the long term, they have to consolidate to survive. It’s the small companies that are going to go belly up ... that’s the reality of it,” he says.

Scomi Energy Services Bhd chief financial officer Ramesh Veetikat Ramachandran says the downturn this time is more severe than previous dips.

“This is due to the huge oversupply position in the industry, compounded by the prevailing low growth mode in key economies around the world that resulted in a low demand situation,” he says.

Scomi Group Bhd’s core business is oil drilling fluids. It also has a 72.33% stake in rail company Scomi Engineering Bhd and a 65.64% stake in Scomi Energy Services, which is involved in offshore support vessels and marine logistics services.

Impending consolidation?

The industry has seen pockets of consolidation, including the merger of SapuraCrest Petroleum Bhd and Kencana Petroleum Bhd to form SapuraKencana Petroleum Bhd, the takeover of offshore service provider Perdana Petroleum Bhd by Dayang Enterprise Holdings Bhd and Sime Darby Bhd’s sale of its two fabrication yards in Johor to Malaysia Marine and Heavy Engineering Holdings Bhd (MMHE) for RM695 million. But these instances have been few and far between.

Says Uzma’s Kamarul, “To force consolidation is very difficult, but if it (the downturn) is prolonged, I think there is going to be some activity.”

A big hurdle, however, is the unrealistic expectations of industry players.

Mokhzani says, “When you talk about consolidation, everybody thinks the price of oil will go back up to US$60 per barrel, so valuations go haywire. Everybody must have a base price that is realistic. Oil is at US$40 now ... a few weeks ago, they were looking at US$30 oil, so now the valuation is based on US$40 and no longer US$30 ... it’s going to be very tough to negotiate. Also, some people don’t realise how long this might go on. Some [oil] majors say that if you think 2016 is bad, 2017 could be worse.”

One O&G company official, who did not want to be identified, says another obstacle is that many local O&G companies are controlled by individuals, who might be reluctant to give up control. “There cannot be two tigers on one mountain, so it’s a question of who is willing to let go,” he says.

Some of the people who control O&G companies include Kamarul, who has close to 48% of Uzma, T Ananda Krishnan (34.92% of Bumi Armada Bhd), Tan Sri Bustari Yusuf (27.47% of Petra Energy Bhd), Tan Sri Shahril Shamsuddin (16.9% of SapuraKencana), Tan Sri Ngau Boon Keat (22.86% of Dialog Group Bhd), Datuk James Ling Suk Kiong (about 30% of Dayang) and Datuk Vivekananthan M V Nathanand (31% of Deleum).

Does this mean that companies controlled by Permodalan Nasional Bhd (PNB), such as UMW Oil & Gas Corp Bhd and TH Heavy Engineering Bhd, would make easier targets for consolidation?

UMW Oil & Gas is 55% controlled by UMW Corp Bhd, which in turn is 45% controlled by PNB and its units. PNB, via its various units, also has 15% in UMW Oil & Gas Corp. 

TH Heavy Engineering, meanwhile, is 29.81% controlled by pilgrim fund Lembaga Tabung Haji.

There is also a question of vertical or horizontal consolidation. Vertical consolidation refers to a company gaining new skill sets in different areas of the oil and gas spectrum, whereas horizontal consolidation refers to similar companies merging.

For instance, a company such as Sapura-Kencana offers a wide range of services, compared with MMHE, which is a pure fabricator.

With regard to this, Datuk Hadian Hashim, the managing director of Sona Petroleum Bhd, says, “Mergers and acquisitions provide you with the avenue to focus on what capability you want to grow. You have to choose the right partner to consolidate with.” Sona is a special purpose acquistion company.

Consolidation may also not be a quick fix for all.

Scomi Energy Services’ Ramesh says the need for consolidation will vary from market to market.

“Despite the general slowdown in the industry, certain markets like the Middle East and Russia, for example, have been recording a surge in activities. Therefore, as a service company, we have been focusing on active markets such as those.

“This is reflected in the amount of bids that we put in. In the third quarter (FY2016 ending March) alone, we submitted bids worth US$761 million,” he tells The Edge.

Sona Petroleum’s Hadian, meanwhile, says that consolidation is only one part of the process. “You need to outgrow yourself besides concentrating on the local market. The business model of the oil and gas players need to change. You need to go beyond the shores of Malaysia. And for that, the next question is, are you ready to go? It’s a dog eat dog market,” he says.

Kamarul also cautions that consolidation should not be overdone as things will eventually pick up. “It’s not a question of ‘if’ things get better, it’s a question of ‘when’. There are so many mixed signals, there are so many variables,” he says, when asked when oil prices will rebound to decent levels.

Indeed, with plummeting oil prices, exploration activities have been drastically cut, and there has been little reserve replenishment, no drilling contracts and no production enhancement. Enhanced oil recovery has also been stopped. This could mean that when demand comes back, supply will be a problem.

By then, the O&G sector will hopefully be in a better and stronger position to meet market demand and address future challenges.

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