Petronas growth plans threatened by Asian economic crisis, oil price woes, cash drain

OGJ SPOTLIGHT ON PETRONAS

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Gas processing plant at Kertih, one of two operated there by Petronas Gas Bhd., provides feedstock for Petronas's petrochemical industry, the expansion of which is threatened by shrinking margins and slack demand. Photo courtesy of Petronas.
The ethylene plant (photo below) at Kertih, owned and operated by Petronas, will be joined by a world-class olefins complex soon under a Petronas-Union Carbide joint venture, despite the downturn in the Asian petrochemical sector. Photo courtesy of Petronas. [33,127 bytes]
Dulang oil field platform is operated by Petronas Carigali off Terengganu, Malaysia. Malaysia's oil and gas revenues are being used by the Malaysian government to shore up the nation's economic liquidity. Photo courtesy of Petronas. [27,440 bytes]
A jack up is shown working on Block PM-3 in the commercial arrangement area between Malaysia and Viet Nam, where Petronas and partners have made some major discoveries recently (OGJ, Sept. 21, 1998, Newsletter). Petronas's strategy to become a world-scale player with petroleum investments abroad may stumble because of its cash drain from local needs spurred by the Asian economic crisis. Photo courtesy of Petronas. [26,143 bytes]
Among the most respected and sophisticated of Asia's state oil concerns, Petroliam Nasional Bhd. (Petronas) has long been seen as one of the few truly integrated oil companies in the region.

Over the past decade, Malaysia's state oil company has maintained one of the most ambitious development agendas in the industry, establishing joint ventures in a string of costly upstream and downstream projects. Petronas became synonymous with Prime Minister Mahathir Mohamad's strategy of achieving rapid industrialization via capital-intensive megaprojects.

But the company may be starting to suffer from the same overextension of ambition and investment made during the boom years that currently afflicts the entire country. Recent project signings indicate the trend toward rapid industrialization is continuing, despite the gloomy market conditions. Investments made mostly in downstream sectors ranging from petrochemicals production to refining and natural gas processing are in the doldrums, and upstream projects are suffering from a combination of low oil prices and an excess of natural gas in the region.

To make matters worse, the company is being used by the government as a cash cow to salvage misdirected investments made by politically well-connected groups in a variety of unconnected industries.

"Petronas is in an unenviable position, there is no disputing it," said a petroleum industry executive in Ma- laysia. "There has been an unfortunate confluence between a natural down cycle in all of the sectors they are involved in and the financial crisis. On top of this, they are being asked to do their national service and have become a critical source of foreign exchange as the government tries to bail out these other groups."

Industry observers estimate that the combination of negative circumstances has caused Petronas to lose the equivalent of at least 10 years, in corporate development terms. "They were about 2 years away from being a true international powerhouse," said another industry executive in Kuala Lumpur. "But, all of a sudden, they get hit on all fronts. It's unfortunate, because they essentially are a very competent company."

Petronas national role

For Malaysia, oil is a critical commodity, and Petronas is hardly just a petroleum company. It has been a direct and important instrument of the Malaysian government's economic development policy, providing critical cash flow to support the establishment of industries ranging from tourism to manufacturing.

It is important to note that Petronas does not report to the Minister of Energy, Telecommunications, and Post, but rather directly to the Prime Minister's office. The jewel in the crown of Malaysia's companies, until recently it had cash reserves totaling $7 billion.

Greatly assisted by its monopoly powers in critical areas of the oil and gas sector, Petronas controls companies and has equity stakes in associated companies covering all dimensions of the petroleum industry: exploration and production; liquefied natural gas and natural gas liquids; domestic gas processing, transmission, and distribution; and gasoline marketing, petrochemicals production, and natural gas vehicle production.

While the megaproject strategy may have been effective when the Malay- sian economy was expanding at 8-9%/year, with a projected contraction of 4.5% this year, Petronas's investments are increasingly seen as unrealistic.

Refinery project problems

Oil refining and petrochemicals are the two most problematic sectors. The economic situation has caused domestic demand for products to plummet, forcing refiners and petrochemical producers to increase exports and look for new customers on the Asian spot market, which is also in decline.

Petronas's most recently completed project underscores the point. The second phase of the $1.4 billion, 200,000 b/d Melaka refinery complex, about 90 miles south of Kuala Lumpur, is in the start-up phase. Built by a joint venture of Petronas 45%, Conoco Inc. 40%, and Statoil 15%, the second refinery train contains a 62,000 b/d vacuum distillation unit, 26,000 b/d catalytic cracker, 28,500 b/d hydrocracker, 35,000 b/d desulfurization unit, and 21,000 b/d coker. The first phase of the Melaka refinery was finished in mid-1994 and consisted of a 100,000 b/d sweet crude distillation unit, which is wholly owned by Petronas and processes Malaysia's Tapis crude oil.

The new refinery train is coming on stream at a time when declining domestic demand, lower margins, and higher costs-due to the fall in the value of the Malaysian ringgit-have wreaked havoc in the refining sector. Refiners have attempted to curtail losses incurred by domestic sales by exporting excess output, but to little avail. Refining margins have fallen to unprofitable levels, and are said by sources to have slipped below $2/bbl.

One of the main purposes of Melaka II is to supply gasoline to a new line of service stations planned for Malaysia. However, the economic downturn has forced the government to postpone or cancel many major infrastructure projects, eliminating potentially prime locations for new stations.

On the domestic side, Petronas sells refined products through its subsidiary, Petronas Dagangan Bhd. (PDB). PDB operates a marketing and retail distribution network nationwide, including 500 service stations, 10 aviation depots, 11 bulk depots, eight bunkering facilities, and seven bottling plants. Revenues at all of these units have declined by 20-50%, and all are either losing money or are only moderately profitable. Through its trading subsidiaries, Petronas Trading Corp. and Malaysia International Trading Corp., Petronas markets crude, refined products, LPG, and petrochemicals.

Despite the diminished market for products from the Melaka refining complex, Petronas signed a letter of intent in February 1998 with Conoco and Statoil for a feasibility study to build a lubricants base oil production plant near Melaka. The plant will have the capacity to produce 7,500 b/d of high-quality hydroprocessed light neutral and heavy neutral grades of base oil. Petronas and its partners began construction on the $200-259 million plant in March 1998, and the plant is scheduled to come on line in 2002.

"I can't think of worse market conditions in which to start a lube plant, but evidently they are going ahead," said an executive.

Petrochemical project woes

In the petrochemical sector, Petronas is even more committed. The company has a direct interest beyond supplying feedstocks, through its controlling and minority stakes in companies operating plants.

Gas processing plants on the eastern coast of West Malaysia, after stripping out methane from Malaysia's natural gas stream, provide ethane, propane, and butane feedstock for petrochemical plants. In terms of feedstock availability, two gas processing plants at Kertih, on the eastern coast, produce 415,253 tons/year of ethane, 578,107 tons/year of propane, and 436,256 tons/year of butane.

In April, Petronas signed a joint-venture agreement with Union Carbide Corp. to build a petrochemical complex at Kertih. Construction of the complex is estimated to cost $3-4 billion and to involve three separate projects. The centerpiece of the JV is an olefins unit with production capacity of 600,000 metric tons/year of ethylene and 85,000 tons/year of propylene.

Petronas will hold a 76% stake, and Union Carbide will hold a 24% stake in this unit, which is expected to be completed by first quarter 2001. Both companies will hold equal shares in the 320,000 ton/year ethylene oxide/ethylene glycol plant and a multi-unit derivatives plant. The derivatives plant will produce amines and ethoxylates, glycol ethers, butyl acetate, and butanol.

In yet another agreement, Petronas and BASF AG agreed to jointly embark on the construction and operation of three petrochemical plants at the Gebeng Industrial Estate at Kuantan, Pahang. The three new plants are a 250,000 ton/year oxo-alcohols plant, a 100,000 ton/year plasticizer unit, and a 40,000 ton/year phthalic anhydride unit. The plants are scheduled to come on-stream by 2001.

The new plants will expand an existing cooperation arrangement, signed under a letter of intent on Apr. 3, 1997, between the two parties for the construction and operation of a petrochemical complex comprising acrylic acid and acrylate plants, each with capacity of 160,000 tons/year. The acrylic acid and acrylate plants are scheduled to come on stream by yearend 1999.

To secure feedstock supplies, Petronas and BASF plan to build a propane dehydrogenation unit with a capacity of 275,000-350,000 tons/year at the same location. The entire complex will necessitate an additional investment for infrastructure development of about $800 million for the building of support facilities.

Other petrochemical projects in the process of construction include:

A joint venture 60% controlled by Petronas and 40% by Mitsui VCM Holdings for a vinyl chloride plant in Kertih. Production will be 400,000 tons/year, and it is scheduled to come on stream in September 1999.

Petronas and BP Chemicals set a joint venture to produce 400,000 tons/ year of acetic acid. Petronas holds 30% of the project, and BP Chemicals 70%. Production is set to start up in September 1999.

Petronas holds 100% equity in an ammonia plant, also at Kertih, that will produce 450,000 tons/year of ammonia and 325,000 tons/year of synthesis gas when it comes on stream in 2000.

Petronas also holds 100% equity in the second propane hydrogenation unit at Kertih, which will produce 275,000 tons/year when it comes on stream in 2000.

Foreign investments, cash cow

In addition to all the downstream investment, Petronas is in the process of purchasing the 70% of Engen, the South African oil group, that it does not already own.

The total cost is $638 million. Although the transaction made financial sense, given low oil prices and the weakness of the Johannesburg Stock Exchange, where Engen is listed, analysts cautioned that this is hardly the time for yet another commitment.

The Engen investment is viewed as an expansion by Petronas into the African market. "I would think it would be a propitious time to hunker down and consolidate," said one executive who follows Petronas closely. "This is hardly the time to delve into yet another market."

Perhaps of most concern to analysts is the degree to which Petronas is being used as a means at bailing out heavily indebted groups with strong political connections. In August, Petronas announced that it would be willing to buy up to $4.9 billion worth of government bonds to aid the country's struggling economy. The proceeds from the bonds would be used to inject capital into Malaysia's cash-strapped banks, which would provide money to heavily indebted domestic conglomerates.

In October, Petronas provided $263 million to the government's Infrastructure Development Corp., a wholly owned unit of the Finance Ministry used to restructure the debts of politically connected infrastructure companies. In this particular case, the funds were being used to rescue Renong Bhd., a construction and engineering conglomerate that operates Malaysia's major toll road. It is widely accepted that this is the first of many such encroachments on Petronas's cash reserves.

"If the nation wants liquidity, we will assist in providing liquidity," said Azizan Zainual Abidin, chairman of Petronas. "Whatever we do, we should ensure that it won't undermine confidence in this country," he said.

Nothing could be more troubling for industry observers than a hollowing out of Petronas's cash reserves at a time when it is in the midst of so many commitments in markets in decline. They fear that if a world recession strikes next year, the company will be in a potentially disastrous situation.

Although difficult to ascertain because its accounts are not made public, Petronas's revenue position is believed to be suffering. Income is sensitive to three major factors, all of which are currently in decline. These are low crude oil prices, the U.S. dollar/ringgit exchange rate, and refined product and pretrochemical sales.

Natural gas concerns

In the case of natural gas, which accounts for about 34% of Petronas's total revenues, the slowdown in demand, and the ripple effects from low crude prices have been particularly difficult. The gas price in Malaysia is not regulated by the government, but rather by the seller and buyer involving upstream contractors and downstream producers. Gas purchased or sold by Petronas is indexed to the medium fuel oil prices in Singapore.

To make matters worse, a number of Petronas gas investments, particularly LNG Tiga, the third LNG facility at Bintulu, Sarawak, are experiencing great difficulties finalizing sales accords (see related story, p. 18).

Petronas officials are already conceding privately that production will be cut back from the nameplate capacity of 6.8 million tons/year. The two-train plant, a joint venture of Petronas 60%, Nippon Oil Co. 20%, and Shell Gas Bhd. 20%, is due to come on stream in 2001 and has yet to establish any cash flow.

Petronas's gas investment in Myanmar faces a similar quandary. Petronas has a 15% stake in Yetagun gas field, 270 km east of Thailand on Blocks M-12, M-13, and M-14 in Myanmar's Gulf of Martaban, which is due to begin supplying 200 MMcfd to Thailand in 2000 under a 30-year arrangement between the Petroleum Authority of Thailand (PTT) and the Yetagun consortium. The consortium is comprised of Myanma Oil & Gas Enterprise, Petronas Carigali Sdn. Bhd., Premier Oil plc, Nippon Oil, and PTT Exploration & Production. However, it now seems extremely unlikely that PTT will be in a position to purchase gas for at least another decade (OGJ, Nov. 16, 1998, p. 27).

The Joint Development Area (JDA) between Malaysia and Thailand is another worry.

PTT and Petronas signed an agreement in 1996 to purchase JDA gas at an initial rate of 600 MMcfd beginning in 2000 and increasing to 1.5 bcfd by 2003. The gas was to be used to support a number of joint venture projects in northern Malaysia and southern Thailand, such as a gas separation plant, power station, and industrial gas distribution system. However, with its pipeline project stalled, PTT is in the process of negotiating with Malaysian authorities to postpone the natural gas delivery date from 2002 (OGJ, Nov. 16, 1998, p. 30).

Although overcommitted, Petronas still has significant revenue streams that will continue well into the next century. Malaysia has 79.8 tcf of proven natural gas reserves and 3.9 billion bbl of oil reserves. But it is the prudent management of the current situation that concerns the industry.

"Petronas will always be around, but you have to wonder if they are not riding for a fall," said an industry observer in Malysia. "I don't see how they can maintain all of these commitments in this environment."