Higher royalties may deter investments in high-cost O&G projects

It is important to consider how an increase in royalty can impact the overall industry, says expert


The proposed higher royalties to be paid to oil-producing states could deter investments in Malaysia’s oil and gas (O&G) industry, on risks that high-cost projects may become less viable to undertake.

Asia School of Business assistant professor of management Renato Lima de Oliveira said oil royalties are charged from total production regardless of the extraction costs and can dissuade investments in high-cost projects.

“In areas of high cost, such as in marginal fields or complex reservoirs, a high royalty will discourage investments,” he told The Malaysian Reserve (TMR) in an email reply recently.

“Imagine that you have a business where you have to pay high taxes regardless if you make a profit or not. If taxes are too high, then many people will close their businesses and you get job losses, resulting in lower economic activity.”

De Oliveira, who is also a fellow at Institute for Democracy and Economic Affairs, said Malaysia is not a country with low production costs such as Saudi Arabia and Iraq who have substantial onshore resources.

“Therefore, it is important to consider how an increase in royalty can impact the overall industry and the jobs created directly and indirectly in the supply chain,” he added.

Prime Minister Tun Dr Mahathir Mohamad had announced that all oil-producing states in the country will be entitled to a 20% oil royalty for O&G development works.

Economic Affairs Minister Datuk Seri Mohamed Azmin Ali subsequently said the royalties will be paid from the net profit of a respective project, as opposed to the gross revenue generated.

“By charging from the profit generated, you ensure that the economic activity is first viable, and only later you would collect a part (of the profit),” de Oliveira said.

“So, countries that want to sustain their oil industry in the face of resource depletion or shocks from lower oil prices have adjusted their tax regime, including revising the amount of royalties charged.”

Meanwhile, Galen Centre for Health and Social Policy CEO Azrul Mohd Khalib said the decision to pay the royalties from net profit rather than revenue is a welcome relief for both national energy company Petroliam Nasional Bhd (Petronas) and the federal government.

“The reality is that 20% from revenue would have serious repercussions for Petronas and the federal government, particularly with the current liabilities and debt responsibilities,” Azrul told TMR.

“They can’t afford to concede that much at this point of time.”

Gabungan Parti Sarawak had criticised the change in direction last week, citing the decision as contrary to the current administration’s manifesto pledge.

The alliance for Sarawak-based political parties called for oil royalties to be paid from net profit, as opposed to the gross revenue of a given O&G project.

The move to pay higher oil royalties is further geared at allowing the respective state governments greater resources to fund their own develop- ment activities, which would likely be constrained if royalties are to come from net profit.

Azrul said the move to pay higher oil royalties is focused on the development of the states’ own O&G initiatives and infrastructure, and should ideally come from the gross revenue of a given project.

“If the state is sincerely being given increased autonomy to manage these resources and to be given a free hand to fully develop its potential, then the arrangement should be 20% of gross revenue,” he said.

“Otherwise, it would be similar in arrangement to what exists for Kelantan and Terengganu (who are granted compassionate funds).”

According to Azrul, the current arrangement sees Petronas paying an oil royalty of 10% of gross profit from an upstream project which is divided equally between the federal and state governments.

“The 10% is calculated based on the gross value per barrel at market rate and must be paid regardless of whether O&G production is profitable.”